- Anu Hariharan, a partner at YC, discusses network effects in this video
- Network effects occur when a product or service becomes more valuable to users as more people use it
- Growth and network effects are often confused, but growth is about speed while network effects are about value
- Virality refers to unpaid growth driven by word of mouth or organic use of the product
- Facebook and Skype are examples of products that grew virally, while Airbnb had more word of mouth growth
- Founders should focus on engagement and value for existing users as they grow their network
- Distribution is a challenge for consumer apps, and finding a unique entry point and distribution strategy is important
- Musical.ly is an example of an app that gained traction through word of mouth and providing a fun and easy-to-use tool

- Musical.ly was facing financial difficulties but found success by promoting their app through Instagram and Twitter
- They focused on building a community by creating a Q&A platform for top users and adding features to enhance the app's network
- The concept of network effects is important in determining a company's success, with barriers to entry and exit being key factors
- Ride-sharing services like Uber and Lyft have a weak network effect, but can still dominate through economies of scale
- Self-driving cars may not be necessary for achieving monopoly status in the ride-sharing market
- Amazon's success is an example of a company with supply-side economies of scale dominating a market
- On-demand services have a debated network effect, as it is difficult to replicate them on a large scale
- Messaging apps like WhatsApp have a strong network effect due to barriers to exit for users
- The growth of messaging apps in the US may be influenced by larger international players entering the market.

- The status feature of WhatsApp was initially meant to inform others of the user's availability, but it did not gain much popularity.
- WhatsApp differentiated itself by using phone numbers and address books instead of usernames, which was contrary to the trend in 2009.
- The focus on user engagement and retention helped WhatsApp evolve into a messaging application and drive more value to its users.
- The introduction of messaging and MMS features led to a spike in growth and expanded the app's usage beyond SMS.
- WhatsApp and other international messaging apps with strong network effects are difficult to disrupt overnight.
- It is important for founders to understand whether they are building a network, marketplace, or platform and ask different questions accordingly.
- For network builders, entry strategy, growth, engagement triggers, and market targeting are key considerations.
- Marketplaces should focus on balancing supply and demand and may take longer to realize network effects.
- Successful marketplaces often prioritize demand first and adjust their strategies based on customer feedback.
- Instacart focused on demand and city-by-city rollout to refine their value proposition and fuel growth.

- It took about a year for a company to develop their playbook in San Francisco before expanding to other cities
- When launching in a new city, understanding demand is important and supply will follow where demand is
- It is common for marketplaces to not get it right the first time and to learn as they expand to multiple markets
- Building a strong platform requires understanding which side is more important and demonstrating commitment to the platform
- Subsidizing the harder side of the platform can drive value for the money side
- Researching YouTube videos of founders who scaled successful products can be a valuable resource for learning about product philosophy and decision-making

- Anu Hariharan, a partner at YC, discusses network effects and growth in this video.
- Network effects occur when a product becomes more valuable as more people use it.
- Virality and word of mouth play a role in product growth.
- Founders should focus on engagement and value for existing users as they grow their network.
- Distribution and finding a unique entry point are important challenges for consumer apps.
- Musical.ly found success through word of mouth and promoting their app on Instagram and Twitter.
- Network effects are important for a company's success, with barriers to entry and exit being key factors.
- Ride-sharing services like Uber and Lyft have a weak network effect but dominate through economies of scale.
- Messaging apps like WhatsApp have a strong network effect due to barriers to exit for users.
- Understanding whether a company is building a network, marketplace, or platform is important for founders.
- Successful marketplaces prioritize demand and adjust strategies based on customer feedback.
- Instacart focused on demand and city-by-city rollout to refine their value proposition and fuel growth.
- Building a strong platform requires understanding which side is more important and demonstrating commitment.
- Researching YouTube videos of successful founders can provide valuable insights into product philosophy and decision-making.

Anu Hariharan is a Partner at Y Combinator. She was previously a partner at Andreessen Horowitz.

Check out this study Anu put together on network effects - http://a16z.com/2016/03/07/all-about-network-effects/

Anu and Craig go over the core learnings from her research, discuss examples, and share advice for entrepreneurs.

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0:10 - Anu's background.

0:50 - What is a network effect?

1:35 - What's the difference between a network effect and growth? What is virality?

3:45 - What's a good example of virality?

4:55 - Airbnb's word of mouth growth.

5:48 - How product decisions influence growth.

6:29 - Facebook's focus on engagement for long-term growth.

8:40 - What are effective tactics for growing a consumer product today?

11:38 - Two ways to test for a network effect: barriers to entry for competitors and barriers to exit for users.

13:06 - Are businesses with network effects winner-take-all?

13:45 - What will happen with Uber and Lyft?

16:40 - Will self-driving cars create a monopoly?

18:29 - What other markets have weak network effects?

19:05 - Will international messaging apps gain traction in the US?

20:44 - Can small improvements to your product create a network effect?

23:00 - Will there eventually be only one messaging app?

23:50 - What should founders building a product with a network effect ask themselves?

24:20 - Are you a network, a marketplace or a platform?

25:25 - Questions to ask yourself if you're building a network.

27:43 -  Questions to ask yourself if you're building a marketplace.

28:35 - Tips on getting over the chicken/egg problem.

31:22 - Questions to ask yourself if you're building a platform.

32:40 - Find your money side and your subsidy side.

33:37 - If I want to learn more about network effects, what should I do?

Hey everyone, today we have Anu Hariharan, and we're going to be talking about network effects.

Would you mind giving us some background?

I'm an electrical engineer by training and worked at Qualcomm in San Diego.

This was the pre-iPhone days when we were trying to design mobile video streaming all the way integrated to the stack.

After spending many years at Qualcomm in San Diego, I went to business school, worked at BCG for a bit, and then prior to joining YC, I was at Andreessen Horowitz, focused on consumer tech investments, so had the opportunity to work with a lot of great YC companies like Instacart, Airbnb, and a few others.

You also published this network effect deck at Andreessen Horowitz.

So you've kind of become an expert in the field.

So just to start out, can you define what a network effect is?

I think the simple definition of network effect is basically As more users use the product or service, it's more valuable to the people using it.

The more friends that join Facebook, the more powerful the network became because it was easier for you as a user to connect with more friends and exchange messages, you know, and now you see the newsfeed and so you see a lot of content shared.

So the more users that join Facebook, the more powerful it is even for the existing user base.

And then there are a couple terms thrown around in that space as well, so that virality and growth.

Yes, I think, see, I mean, if you take a step back, growth is what is confused with network, network effect.

I think, and it's very easy to confuse the 2, because when you are a startup, you're growing, and if you have a really valuable product that provides inherent value, you're growing really fast.

And so what happens is The common misconception is you think growth is equal to network.

And there are different forms of growth, and that's where virality comes into the picture.

I think virality is actually about the speed of growth.

So in the early days of Uber, for example, when people took the right point to point or arrived at an event, they would rave about the service to other users because it was 10x better than using a taxi and over time became cheaper.

Virality is often about free growth, meaning unpaid growth, which you can drive without marketing because your product is just much superior to the alternate option available.

Network effect, on the other hand, is about value.

What does the network offer in terms of its value?

So for example, Facebook, how would you know whether it had a network effect in the early days?

It really is about usage, which in other words translates to retention.

So in the early days of Facebook, even though they were growing quite fast, I would say reasonably fast, when compared to apps today, because it was first a web service.

The retention improved, meaning, if you looked at their daily actives to monthly actives in the early days, as they added more users, that percentage kept improving.

And so that retention is the sign of network effect because existing users were willing to log in more frequently and be more active because the service was more valuable.

And so what's a good example of virality?

Like an app that everyone knows about that was viral.

I think a lot of apps out there are viral.

If you ask me, Facebook's early days were viral growth.

I mean, Airbnb didn't have as much virality.

I think they did have virality in the sense they had word of mouth growth, but the product itself didn't spread as an organic consequence of its use.

So if you look at Facebook, the reason why it grew quite fast was because if you were 1 user on Facebook, it was not that useful.

The early days, the app was launched to see the online student directory.

They leveraged the Harvard directory to launch Facebook.

But beyond that, it wasn't as useful unless the entire class or the group of students taking that class was on Facebook.

So therefore you started inviting other friends who were in the same class.

And so the product itself was designed such that it was useful for other users.

If you wanted to place a Skype call, you needed someone on the other end.

So the product spread as a result of organic consequence of its use.

And versus Airbnb, I think did have vital growth, but it's word of mouth growth.

Because if you look at Airbnb in the early days, it was about renting a room in your house to other guests.

So you talked about it because it was less sterile than hotels, especially during events when the hotels were sold out, it was 30 to 80% cheaper than hotels.

So you talked about it to your friends and therefore they discovered it.

But to actually use Airbnb, you didn't need your other friends on the other end to actually use the app.

So I think there's a difference and there are different forms of growth.

And so you need to understand whether your product, you know, has an organic consequence of its use because of which it tends to grow really fast versus, you know, word of mouth, referrals, anything unpaid attributes to vital growth.

And so at this point, what do you recommend to founders?

I mean, are people approaching you asking you like, I want to build a network effect into my product?

Yeah, I think, you know, If you talk to most founders, even the founders that have built really amazing products, I don't think anyone would talk to you in the context of a network effect or viral growth.

But the key decisions they took as to what their product should do will help inform how they focused on the network.

This keeps coming up repeatedly as a question from founders.

I always go back to the example of Facebook.

I'll also touch upon WhatsApp as an example.

So when Facebook first launched, they launched in Howard, and it was quite a popular service.

They could have easily rolled it out to multiple universities pretty quickly, But they didn't.

And the reason for that was they wanted to make sure that, if you ask the early days, they would say they wanted to make sure that at least 80% of Harvard students were using Facebook and maybe 60% or 70% were using it daily.

Because I think if you didn't focus on engagement in the early days, you could end up growing too quickly and lose your older user base, and therefore you're not really focusing on products or improvements that help the overall network.

And you may end up focusing on features that help you grow in the interim.

So I think 1 of the things Facebook did really well was always pay attention to how the network grew and not just the user growth.

In fact, in the early days, based on the numbers they've quoted on the S1, if you look at the amount on month growth and user base was 16%.

In today's world in mobile, you might say, 16% month on month growth is solid, not great.

But I think it's important to focus on, are you driving inherent value to your existing code users as you grow?

In the case of Airbnb, which is a low-velocity use case, people don't travel as often, maybe once or twice a year.

The way to measure that is bookings and rebookings, Cohort after cohort, and Airbnb did that.

That was a measure of, you know, do your customers really love you?

Because if they do, they will come back and use it more often, and for more use cases.

And so I think focusing in the early days, especially as you build a product, it's very important to focus on, as you grow, how strong your engagement is and how much are your existing users willing to use your service more and more.

What are you seeing now that people are doing that's been effective?

I think these days, you know, especially in recent years, I would say in consumer apps, it's become harder to find the distribution.

I think there are 2 challenges a consumer app should think of.

And then 2, how am I going to distribute this?

When you have powerful networks like Facebook, Twitter, Snapchat, it becomes harder and harder if you launch something as just a feature.

Because these other platforms have the network.

So you have to figure out what your distribution strategy is.

1 app that recently has gained a lot of traction is Musical.ly.

And Musical.ly actually pivoted from being an education app.

And they first launched as a tool among teens.

And the tool was creating short form lip sync videos.

And the tools they provided made it really easy for teens to create videos.

And so suddenly, a lot of students in school started using it.

But for the first 14 months or so, even after they launched Musical.ly, it was sort of a slow growth.

And I think the founder, Alex, has talked about this.

They were almost about to run out of cash.

And then what they did is they realized that a lot of the Musical.ly videos were being shared on Instagram and Twitter.

So to sort of shape it towards a community, 1 of the things they tried was to make their logo more prominent so that when it was shared on Instagram and Twitter, people knew about Musical.ly and downloaded it.

A lot of people created lip-sync videos, but they were clearly top musers.

The people who had a lot of fan base and following and were really good at creating these lip sync videos, they created a Q&A platform on the app for the followers to interact with them.

And so that helped shift some of their audience back into the app.

And they started focusing on features that helped create the community and network on the app itself.

It's still early to say, you know, if it will become a network.

But I think these are some of the things they've tried to at least, you know, form a community.

And now you have more users going directly to Musical.ly.

And so, like, if I'm just getting started, how do I know that, like, when is the time that I can start, you know, trying to pull people over from other platforms?

Because it seems like you can, you know, piggyback onto these platforms to a certain extent, but at some point to create lasting value for your company, you need to have people that like you have in your community.

So I think, so this is where the network effect definition is important.

I think, you know, people often say, oh, you know, this is where people get confused about, does this company or this product have really a network effect or not?

I think the 2 quick ways to really test for that is barriers to entry.

This is your competitive mode as a product and barriers to exit for the user.

I think the second 1 is the 1 people usually miss out on.

So barriers to entry means you are growing really fast.

There are some demand side economies of scale because of which it's not easy for someone to come and disrupt your network overnight.

The barriers to exit for the user is you've built such strong connections and you have a lot of value from this network that it's not easy for you to switch as a user.

Google Plus actually made it really easy with the circles to import all your contacts, have the same graph, even help break down your friends, right?

Some people have thousands of friends on Facebook.

And so how do you break it down into close circles versus these circles you probably touch base every now and then and so on.

But it was so hard for users to switch, let alone what the companies tried.

As a Facebook user, you found it so hard to switch because you have all these connections, the communication that you've had with these users, you have the newsfeed set up, there's a lot of things and a lot of value you're already deriving for the platform that it was absolutely hard for a user to switch.

So do these platforms end up being winner take all?

I think if you're a business with network effects, you are a winner take all.

And it actually helps you tip towards becoming a winner take all businesses.

And this is why 1 of the focuses sometimes investors look at is, is your app a destination app?

And that's a sign for barriers to exit for the user.

If more and more users are coming to your app directly and spending a lot of time, and time spent per user is going up, that's a sign that the barriers to exit for the user is going up as well.

And so then what ends up happening with like Uber and Lyft at this point if it's 1 or take all?

Yeah, so You know the right shedding has always been a little bit of a controversial topic in terms of network effects And I think you have you know 1 school of thought in Silicon Valley and even a you know broader ecosystem who think that they have very strong network effects.

And on the other spectrum of people, they think that they don't have a strong network effect.

My personal view is, You have to break it down in terms of what the product does, what service they offer, and what sort of moat each company offers.

I tend to think that the basic point-to-point right sharing service does not have a very strong network effect.

And the simple reason is, it's a point-to-point write.

So as a writer, beyond taking me from point A to point B, I don't have any other value trapped in it.

So if there is another service that is equally good and provides the same value, then you are willing to switch.

So, the barrier to exit for the rider is not as high.

So, does that mean they don't have any network effect?

I think that if you look in a city by city basis, they do have some form of network effect, but I think of it as a weak network effect.

Meaning, if you have many drivers and riders on the platform, for the rider, the promises that the ETA is less than 5 minutes.

So you know for a fact that you are going to get a ride and there is going to be a driver that's going to pick up in less than 5 minutes.

And for the driver, it's the dollar they make per hour, right?

But the problem is, beyond that 5 minutes, there's no other connection.

So if there's another service that can provide you something in less than 5 minutes, you are willing to switch, right?

And you see people switching because of surge pricing every now and then.

However, having said that, can this still be a vernetic all market?

I think that companies that have economies of scale, supply side economies of scale, can still have monopolistic share.

And that's what I think is playing out in the ride sharing market.

So 2 reasons people use Uber or Lyft is, 10 times better than taxi and cheaper than a taxi ride.

Now the cheaper than a taxi ride, I think this is where you see economies of scale.

So the more drivers that are in the platform and the more riders that are in the platform, the cost of unit output that an Uber incurs is probably much lower.

Simply because, you know, if there is a lot of demand on the platform, then the drivers are doing more trips per hour.

So therefore they make more dollars per hour and therefore Uber can, you know, charge less per ride for the rider.

So right now it's kind of like a race to raise all the money, it seems like.

When self-driving cars happen, do you think it's a race to reach self-driving cars because that unlocks the network effect ultimately for these companies?

I don't know if you need self-driving to be a monopoly, to be honest.

Because I think that even in the current market dynamics, you are seeing, depending on the market, who is first to come or who has executed really well has economies of scale because of which they'll have monopolistic share.

Simply because I think driver, the trip efficiency is a very key metric to focus on because that drives cost, right?

I mean, you've seen a lot of Uber for X services that have sprung up, but I think that Uber might likely win most of the Uber for X services, simply because they can drive delivery efficiency unlike no 1.

And if they are able to do 2 or 3 trips or 4 trips an hour, then the cost per trip is so low that they don't have to charge the rider as much.

And so they can pass on those savings to the rider.

So, I mean, this is exactly what Amazon first party was.

You know, when Amazon launched their service, you know, many years ago, more than a decade ago, it was all first party.

And first party is all about economies of scale, shared warehouses, shared shipping.

They made the cost of delivery of each good a lot cheaper.

Today they have a big marketplace, so they have both demand side and supply side economies of scale, but Amazon first party is primarily supply side economies of scale, and yet they have monopolistic share.

So I think people tend to focus too much sometimes on network effects and think that's the only winner take all businesses.

I think that companies with supply side economies of scale, especially which have huge operational challenges and who execute really well can have monopolistic share too.

And are there Any other markets right now that you think many people consider it to be a network effect, but in reality it's not that strong of a network effect?

I think on-demand has been the biggest debate.

It's not easy to replicate it across even nationally or globally.

So it remains to be seen as to, you know, what, you know, how these networks evolve.

You know, each of them do provide some value, So I don't want to discount that they don't but it may not be as strong as you saw in social networks

So then what about messaging at the spot?

Like I know you want to talk about what's up a little bit Do you see them continuing to grow in the US or do you see some of these like larger?

International players coming in and having a network

I think that messaging has a very strong network effect.

It goes back to the simple thing of barriers to exit for the user.

I have been a WhatsApp user for very long because I have a lot of family in India.

So it is the cheapest form of communication, especially it was a great replacement for SMS.

They also had, I think in 2009, when they first launched, They launched it as a status feature.

I don't know how many of them know, how many of the readers know that, but it was literally a status feature to let others know that, hey, if I'm in the gym, don't call me, or I'm busy in a meeting, don't call me.

That didn't take off, But the things that, I mean, they still have the status feature, but I think that things they learned in the status feature really helped them evolve towards a messaging application, meaning it was 1 of the first apps at the time that used phone number and address book, did not use a username.

And it was very, today it seems like, well, that's the way to go.

But in 2009, when most of them were all about creating user accounts, it was very contrary to how they approached the sign-in process.

And WhatsApp did not, you know, quite a lot of the users asked them to change it to a user sign-up, but they decided not to because they felt if you're leveraging the address book, you would know who that person is.

So that's something I always wonder, like, are all those things that could be considered growth hacky type things, do they amount to marginal gains or can you in fact build a really powerful network with that in terms of adding it to your product?

Because I think a lot of people end up like creating thing that will never have a network effect and consistently trying to add these little things.

Yeah, so I think the most, it comes back to the same point, which is if you pay attention to engagement, retention of your users, you will automatically know whether it's a network or not.

It is the single strongest sign of a network effect.

And I think WhatsApp did pay attention to that.

They paid a lot of attention, Even though I don't know the exact metric they used to measure it, but they talk about the fact that they always focused on did their core users continue to use the product?

And how can they drive more value to the users?

And in fact, that's 1 of the reasons they moved from status to messaging.

I think within 6 months almost, by the end of summer of 2009, they launched messaging, and they saw a huge spike in growth, because it was an alternate version of SMS.

It started off with the Russian community in San Jose, communicating with their family in Russia, and then it took off in other international markets.

By the end of 2009, they launched MMS, basically a way to share photos and videos.

It was too expensive to share a photo or a video at the time.

And this became a great platform to share photos and videos.

So now you have this app that started growing their user base, but existing users started using it for more things than just SMS, and their product features sort of went along that, which is, am I driving more value to my users as I'm growing my user base?

And with more connections, people were able to connect with more users.

And they have a very strong network effect simply because the barrier to exit for the user is really high.

I as a user have all my communication with my family, photos exchanged and videos.

It's not easy for me to jump to another messaging app.

So how do you see this playing out with like all of these international messaging apps becoming, I mean, they're just massive.

Do they dominate in 1 country and that's how it plays out ultimately?

Or will 1 eventually be the 1 international?

Yeah, I think that any app that has a very strong network effect, it's very difficult to disrupt them overnight.

This is another reason why companies tend to focus on building a network, because it's not easy.

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Anu Hariharan on Network Effects