We often talk about startups that are leveraging network effects. Some investors, like Union Square Ventures, have built some of the most successful firms with a network effect thesis.
For those new to the concept, a simple way of thinking about network effects is that the value for all users of a product increases as more use the product.
In the past, I’ve written about data as a network effect and how companies like Google and Netflix are ever-expanding their lead beyond competitors due to their superior data.
And Network Effects are so prized b/c they:
-Create barriers to entry… making it difficult for competitors to enter
-Create barriers to exit… making it challenging for customers to leave
-Drive more value for all constituents as they grow… both the company and it’s users extract more value and receive greater benefit as the number of users increase
and this all contributes to the creation of monopolistic, winner-take-all businesses.
And during today’s discussion, I couldn’t help but think of Network Effects in the context of a startup ecosystem.
Imagine for a second a large web… there are many nodes in this web and lines that connect these points to each other. And lets pretend each of these nodes represent a major stakeholder group in the startup ecosytem… for example Startups, VC firms, Angels, Incubators, Service Providers, etc.
One of the key questions when discussing network effects is: “At what point are there a sufficient number participants, so that each added participant creates more value for all?” This is the “critical mass” question. In an ecosystem’s infancy, if there are only a handful of people thinking about startups, there’s just not enough volume to justify the existence of key nodes.
As I consider this visual, a few things become clear:
-The number and quality of nodes is critical
-The number and quality of connections between those nodes is critical
-And the rate at which these nodes and connections are increasing is critical
There are companies, here in the Chicago ecosystem, that are working on this specifically. Startups like BuiltInChicago that are creating the online connectivity and Hubs like 1871, connecting various nodes offline.
But what is the key value driver? What’s the tip of the spear? While so much is required for a thriving, healthy ecosystem, I do not consider this a chicken or egg problem. Is it capital, governments, universities, Mentors…. from my standpoint, they’re all important and they all play a role. But every great ecosystem, starts w/ visionary founders building tremendous value. The startup is the keystone of the ecosystem.
And as I consider this; the single most important question that comes to mind is, “If every new startup that’s founded, increases the value for all in the ecosystem, how do we encourage more exceptional startups to be created?”
If you’re looking for a way to accelerate your own ecosystem, this may be a good place to start.