How to Optimize Network Growth with Local Network Effects

Successful platform businesses acquire new users at a remarkable pace. We’ve written before about network effects drive network growth. In that article, we touched on how mature platforms nurture individual micro networks within the larger network to strength their resilience against competition. This article dives deeper on how micro, or local, network effects can be not only a shield against competition, but also provide a savvy strategy to position and grow a new platform.

Local v Global Network Effects

When speaking of network effects, the words local and global do not just refer to geography. A global network is the entire network that captures every single user. A local network is a subset of users who are clustered together around a common modality (such as interest, socio-economic class, or physical location).

A global network is the entire network that captures every single user. A local network is a subset of users who are clustered together around a common modality.

Remember that a platform becomes more valuable to one set of users when another type of user join the network. For example, Uber is more valuable to drivers when riders join the network. But that’s not entirely accurate, is it? Why would a driver in New York care if a rider in Chicago joined Uber? Thus, when a new rider in Chicago joins Uber, the value of Uber increases primarily for drivers in Chicago.

However, note that when the Chicago Uber rider travels to New York on business, he or she is also more likely to use Uber in New York. A local network is not siloed off from the global network; there are spillover effects, as it is a cluster within a platform that also provides an easy connection to any other part of the network.

Thus, local network effects describe with greater accuracy how the platform’s value increases when a new user joins the network. The Chicago rider primarily benefited Uber drivers in Chicago, but also secondarily benefited drivers in other cities that this user visits.

Local network effects describe with greater accuracy how the platform’s value increases when a new user joins the network.

Types of Local Networks

While Uber’s local networks are geographically defined, not all local networks are described by geographic location. There are many types of local networks. Three common ones are geography, socio-economic class, and interest (or ‘subculture’).

Unsurprisingly, geography-based networks usually occur in platforms where services are rendered in person, such as with Uber or GrubHub. However, these platforms are not limited to only geographic local networks. Uber, for example, charges a premium price for Uber Black which provides black luxury cars for riders who want to arrive in style. This feature plays to a certain socio-economic class and insulates Uber from losing those users to Uber’s largest competitor Lyft. Uber users who need to arrive in style (either to make an impression or simply to feel luxurious) are not shopping for the cheapest option.

Lyft competes by targeting the most budget-conscious riders. It recently began experimenting with subscription rides to make riding with Lyft even cheaper. If Lyft gets the math on subscriptions just right, Uber will be hard-pressed to win back budget-conscious riders who prefer Lyft’s subscriptions. Seen through the lens of local networks, it’s clear that platforms grow and compete by emphasizing ways to create more value within a local network that the platform wants to capture.

Platforms grow and compete by emphasizing features that enhance the user experience within a local network that the platform wants to capture.

Of course, socioeconomic local networks are more commonly found in marketplaces. Net-a-porter insulates itself from the threat of Amazon by focusing exclusively on luxury brands, while Asos focuses on cheap, fashionable clothes for European urban youths, thereby appealing to a certain subculture.

Subculture, or interest networks are more commonly found on content networks such as Youtube. Youtube has many local networks on its platforms from makeup enthusiasts to music videos to video game streamers to book reviewers to unboxers to – you get the idea.

This strengthens Youtube’s resilience to competition. For example, Youtube still has a strong gaming culture even though  many gamers have moved on to video game streaming platform Twitch. Despite Twitch’s growing popularity, Youtube continues to grow overall because its other micro-networks are robust and growing. If Youtube were dependent on gamers, then Twitch’s growth would be an existential threat.

Therefore, local network effects can be a powerful force in keeping user engagement high and consistent, because it emphasizes and accounts for each user’s individual interest and forms a community around that interest. And it makes your network more resilient to external competition.

Local network effects can be a powerful force in keeping user engagement high and consistent.

Finding a niche to compete in industries with powerful platform monopolies

Notice that Youtube now competes with Twitch for the video game streaming subculture. That’s a remarkable accomplishment for Twitch which launched in 2011 (and was later acquired by Amazon in 2014). How did Twitch, pre-Amazon, grow to such a scale that it could threaten such a well established video platform like Youtube?

Twitch established its foothold by focusing on a subculture and optimizing its platform for just that user group. Twitch simplified video game streaming by displaying the game and the gamer side-by-side (originally with third-party integrations, and, later, natively), streaming live comments, and making it easy for the gamer to read comments while playing so that he or she could respond to the live audience. Youtube’s live streaming tools (which also launched in 2011) were not optimized for gaming specifically.

twitch focused on local network in gaming

Twitch screenshot taken in October 2014 for Fortune.

Seen through this lens, a new platform should never try to target everyone, but instead focus on a niche subculture or demographic. Even Youtube in its early days began primarily as a music video platform that enabled aspiring musicians to post video and embed it in MySpace.

Platform designers should search for holes in the current market. Etsy, the craft and handmade items marketplace, explicitly started in response to a gap in online marketplaces. According to David Lifson, who ran Etsy’s product management team in 2008,

“The original founders of Etsy (2/3rds are now my co-founders) started out after college doing simple freelance website building. One of the projects was a community forum for crafters who wanted an updated design and some additional features.

They built the new forums and started reading through the conversations people were having. The overwhelming topic was, “I wish there was a place I could sell my crafts! Ebay sucks – it’s hard to use, doesn’t care about us [emphasis ours], and charges high fees.”

So the founders saw an opportunity, built Etsy, and announced it to the community. Instantly, thousands and thousands of sellers registered for the site and started selling. They also told their friends at even larger crafting community forums about Etsy, which brought even more sellers.”

What did crafters mean when they said eBay didn’t “care” about them? They meant eBay wasn’t optimized for their needs. It was a gap in the market that a new player could, and did, fill to great success.

Seen through this lens, a new platform should never try to target everyone, but instead focus on a niche subculture or demographic.

Build a platform by growing local networks

In a platform’s early days, one niche may be your entire network. However, in the future that niche will represent just one strong local network in a larger platform. A good growth strategy for platform managers looking to expand their network is to consciously target new local networks that are adjacent to the ones you already serve well, and then to optimize the platform to serve that new segment.

That’s been Amazon’s strategy since inception. Focusing on Amazon’s retail marketplace alone, we can see that Amazon lept from books to electronics to clothing, furniture and groceries and beyond. They move was largely guided by customer needs. Jeff Bezos routinely discusses his obsession with customer satisfaction. On a platform, meeting customer needs translates to optimizing features that give users exactly what they want.

Bezos than had the foresight to bundle the best features (such as free two-day shipping, video and music streaming perks, and more) to a premium subscription service that further tethers customers to Amazon’s platform. Today, premium subscribers spend more than double on Amazon than non-subscribers.

Looking beyond Amazon’s retail marketplace, the platform monopoly also built entire new services to satisfy user needs that were discovered on the retail marketplace. For example, sellers wanted a better and quicker way to ship product to Amazon shoppers. Fulfillment by Amazon and Amazon Logistics are separate services that make product delivery easier for third-party sellers on Amazon’s marketplace, thereby further entrenching sellers in the Amazon ecosystem.

The idea of starting small and growing methodically is also not new to business. Linear businesses have long been advised to do the same. But it is even more essential for platforms given that they always serve at least two customer groups – consumers and producers. The chicken and egg problem this creates means it’s essential to start with a narrow focus. If you expand to widely too soon, you will greatly weaken your network effects by spreading them across too many local networks.

Once you build up a strong critical mass in your initial network, you can then look to expand in to adjacent networks that have some overlap with your existing users. At every stage of this process, you need to be optimizing your platform and core transaction to balance the needs of your existing users with those of the new networks you’re attracting. This balancing act is no easy task, and it’s a big reason why platform design must align your product roadmap with your growth plan.

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Filed under: Network Effects | Topics: digital transformation, enterprise hacks, marketplace design, network growth, platform business model, platform design, platform innovation, platform thinking

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