In Network Effects we trust

If revenue and growth are proportional to value created, then there is definitely one effect that increases the value of any business. Network Effect

Apple, Amazon, Meta, Twitter, Uber, Tesla and Salesforce are some of the world's most significant and influential companies. All in all, they created an impact. Each had its own way and differences, but a single property defined them to success.?

That is the network effect, the primary way to create defensibility in the digital world. A recent study by Nfx suggests that network effects are responsible for 70% of the value created by tech companies since the Internet became a thing in 1994. Even though they are a minority of companies, companies with networking effects make the lion's share of the value.?

What is Network Effects?

People have the power to the business value creation. The concept of the network effect in business demonstrates that the value of a product or service escalates as more individuals utilize it. The more the user base, the higher the product value.?

The network effect, a concept rooted in the early 20th century alongside the telephone's rise, holds enduring significance. Theodore Vail, Bell Telephone's pioneering leader, used it to advocate for Bell's telephone network monopoly. He recognized that a network's value surged as more people connected.?

In the digital age, Robert Metcalfe's Metcalfe's Law reaffirmed this idea, stating that a network's worth grows exponentially with users. This enduring concept continues to guide technological innovation, from the telephone's inception to today's interconnected digital world, emphasizing the limitless potential of connections in driving progress.

As the Internet gained broader adoption, it became a more essential tool for professional activities, fostering relationships, research, and other purposes.

In the ever-evolving online world landscape, Alphabet Inc., the parent company of Google (GOOGL), stands as an undisputed titan, commanding a staggering 80% share of the global online search market. At the heart of Alphabet's dominance lies the awe-inspiring power of its Google ecosystem, which is its network effects.?

With its suite of digital marvels that includes the ubiquitous search engine, the universal Android operating system, the ever-mapping Maps, the communicative wizardry of Gmail, and the video-sharing juggernaut YouTube, Alphabet has ingeniously woven a web of connectivity that spans the globe. Morningstar, the acclaimed financial research firm, aptly describes Google's influence as unparalleled.?

They note, "Google has the world's most widely used search engine, and such a large and growing user base has created a network difficult to replicate." In a world where information is king and connectivity is queen, Alphabet's reign appears unassailable, and its network effect is nothing short of awe-inspiring.

Eloelo and network effects?

Warren Buffett rightly suggests that economic moats are more durable than competitive advantages. Network effects are the most potent economic moat when a product becomes more valuable as more users join.

When we invested in 'Eloelo', we confidently knew this power of network effects. We believed "Eloelo was creating the perfect mix with its social gaming and live streaming setup by enabling the content creators to build a community. Creator economy is the future, and India is massive (literally), Networks Effects is THE moat, and Saurabh & Akshay are the dream team." Today when Eloelo has been awarded the fastest-growing app in India and sees a growth of 7x with more than 37 Million + downloads, our projections and the power of network effects need no words.?

Defensibility and positive feedback loop?

As the network effect of a company becomes more substantial, the more defensible it is to existing competitors and potential new entrants. The mere fact that its existing operations become more valuable with every new user added results in the business beginning to pull away from its competition regarding the number of connections its network facilitates. As a result of these companies aggregating more users, they become one-stop-shops for all existing customers available to that industry. This creates a lock-in effect, resulting in higher user retention and profitability.

Advantage over competition?

With defensibility, the competitive advantage is obvious. Suppose competing businesses become bankrupt and cease operations. In that case, the existing clientele of the distressed company will migrate towards becoming clients of the surviving firm and thus allow it to aggregate a more significant market share. Well, the world is full of many such examples. Amazon was one most famous examples when it tried to enter the credit card space by competing against Square.

Scalability is essential?

To create a business ecosystem that provides additional value for every new user added, the company at hand must have the potential to scale with as little friction as possible for an internet-based company lie whose business model is focused on creating a global network of short-term rentals. This is fast-paced and easy for digital companies. Airbnb offers its 150 million users the option of choosing from over 7 million rental properties worldwide. From a math standpoint, the company has created a network that can facilitate 150 million X 7 million potential connections.

Use of network effects in future technology?

Network effects have dictated the success of technologies from the telephone to shopping platforms like Etsy, and AI tools such as ChatGPT are no exception. What is different, however, is how those network effects work. Data network effects are a new form. Like the more familiar direct and indirect network effects, the value of the technology increases as it gains users. However, the weight comes not from the number of peers (like with the telephone) or the presence of many buyers and sellers (as on platforms like Etsy) but from feedback that helps it make better predictions. More users mean more responses, further predicting accuracy and creating a virtuous cycle.?

Companies need to consider three lessons: 1) feedback is crucial, 2) routinize meticulous gathering of information, and 3) consider the data you share, intentionally or no.?

About Rocket Capital?

Rocket Capital?is an early-stage VC fund investing in New Media Technology start-ups. We invest in pre-Series A, Series A and Series B stages, but we are open to investing earlier/later if we have strong conviction in the idea and founders. We have deep respect for all founders and the products they are building, and believe in creating long-lasting relationships in the industries we invest in.