About a year ago, I had the pleasure of attending a speech by Scott Cook, the founder of Intuit and one of the best business minds in Silicon Valley. During his speech, Scott discussed what he called "the best barrier-to-entry" that any company can have - something that results in the most powerful competitive advantage. Can you guess what it is?

eBay Has It. But Not Google!
It is something eBay has but Google doesn't - any guesses yet?!

Scott was talking about "Network Effect". This is a term that was grossly misused by many dotcoms during the boom days of late nineties. What exactly is "Network Effect" then?

Network Effect is the phenomenon whereby a product or service becomes more valuable as more people use it, thus encouraging ever-increasing numbers of users.

According to Metcalfe's law, the total value of a product/service that possesses a network effect is roughly proportional to the square of the number of customers already using that product/service.

How eBay Benefits From Network Effect
eBay's online auction marketplace is a great example of a service that benefits from network effect.

• As more and more buyers use eBay's auction marketplace, the value of the marketplace increases for sellers...
• causing more sellers to join which in turn increases its value for buyers...
• causing even more buyers to join...
• and so on...

When a competitor starts a new online auction marketplace, it is very hard to break the dominance of the incumbent. Reason: In the beginning, there are few buyers in the new marketplace - as a result of which few sellers join which in turn discourages even more buyers.

A proof of this plays out in almost every mature internet market today. Whether it is the US, Japan or Germany - one company has the dominant share of the online auctions marketplace, while all others lag far behind.

In the U.S., even when competitors like Yahoo make their auctions free - they still cannot make much of a dent in eBay's dominance despite the fact that eBay itself is raising prices! Network effect can be that powerful.

How Common Is Network Effect?
Although many of the now defunct dotcoms claimed to create network effects, network effect is not very common. Some products/services naturally lend themselves to network effects, while most do not.

The products/services that have inherent network effects usually fall into one of these categories:

• Marketplaces & Trading Exchanges:
• Physical/virtual gathering places and exchanges that enable buyers and sellers to come together and engage in trade
• Examples: eBay, Paypal, New York Stock Exchange, NASDAQ
• Platforms & Standards:
  • Frameworks upon which multiple vendors in a marketplace create products to ensure compatibility and interoperability
  • Examples: Microsoft Windows, CDMA, DVD
• Communication Tools:
• Tools that enable one person to communicate with another person who has the same tool
• Examples: AOL Instant Messenger, Skype, Microsoft Word, Adobe PDF
• Social Networking (Community) Applications:
• Tools that enable friends, business partners, or other individuals to connect and/or share information over the Internet
• Examples: LinkedIn, Friendster, Flickr, Del.icio.us

Most of the other products/services do not have network effects. An online portal doesn't create "Network Effect" by acquiring eyeballs - this was one of the popular (and incorrect) claims by dotcoms. I don't gain more value from Yahoo.com just because more and more people use it.

A search engine doesn't have network effect either - again I don't get any more value from using Yahoo Search just because many others also use it. I believe this is one of the major reasons Google was able to so easily take away Yahoo's leadership in online search.

Likewise, I don't believe Google Search itself possesses any network effect today. If a new entrant provides a significantly better search experience than Google - I believe that they can, over time, take the market leadership away from Google.

Can You Build Network Effect For Your Products?
In his interview with HBS in 2001, Scott Cook says:

I also think that a fundamental understanding of network effects is very important. ... Network effects are a fundamental characteristic of certain technology businesses. When network effects are possible, it is the most important thing in the world to follow, to understand, and to make happen. (emphasis added)

While not all products/services lend themselves to network effects, analyze your products and services thoroughly and often to see whether you can build features that result in network effects similar to the products/services in the examples above.

If you're able identify any such possibilities, make it the the most important thing in the world for your Product Management and Product Marketing teams "to follow, to understand and to make happen". You will be glad you did.

When you hit it big by doing this, don't thank me - just send money! :)

Until next time...

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Posted by michael at 08:51 PM | Permalink | TrackBacks (0) | 12 Comments | Post Comment

In my previous blog entry, I discussed the issue of selling "Features" vs selling "Benefits". I used Socialtext and comments by its founder/CEO Ross Mayfield as a starting point. I'm thrilled to see all the great comments, thanks everyone for sharing your thoughts!

Features or Benefits?
According to Ross - his company sells "Features" of their enterprise wiki software product, and lets the customers figure out the "Benefits" for themselves.

This runs counter to one of the most important high-tech Product Marketing and Product Management concepts - that of identifying product "Benefits" and using that to create marketing/sales messaging (instead of just the "Features").

That being the case, how has Socialtext managed to achieve success so far? Is it an exception to this concept?

First There Are 'Early Adopters'
The answer to this question is found in the popular Crossing the Chasm book by Geoffrey Moore:

In this book Moore talks about what became known as the "Chasm Theory", which is best explained with the image below (this image is loosely derived from the book, but not identical):

When a new technology product is introduced in the market, it is initially adopted by customers Moore refers to as 'Innovators' and 'Early Adopters' - who usually make up ~5-10% of most markets. In order for the product to become a mass market success, it needs to be adopted by customers he refers to as 'Early Majority' and 'Late Majority' who make up ~70-80% of most markets.

Then Comes the Chasm
Moore points out that there is a huge "Chasm" between 'Early Adopters' and 'Early Majority' segments. Why so?

The main reasons are these. 'Innovators' and 'Early Adopters' buy interesting and cool technical tools, and figure out how to use those tools to their own benefit. They don't need to be told what the benefits are by the technology product vendors. They also don't need references from other customers, success stories, etc.

On the other hand, 'Early Majority' customers expect the technology product vendors to tell them what problems their product addresses and what benefits it offers to them. Not just that, they expect customer references and success stories too. And clearly defined ROI (Return on Investment). They buy solutions to business problems, not cool technical tools.

Most Startups Never Cross the Chasm!
Most technology startups never cross the chasm because they never figure out a compelling benefit or ROI for a target market. But many fall under the illusion that they've made it while the small part of the market made up of 'Innovators' and 'Early Adopters' is scooping up the product.

As a result they never master the critical techniques needed to successfully cross the "Chasm", such as choosing a target market, creating the "whole product" for that market, positioning the product, building a focused marketing/sales strategy, etc.

My Take On Socialtext
Coming back to where we started - is Socialtext correct in saying that it can simply sell features and let customers figure out the benefits themselves, because it is a Web 2.0 software company?

My answer to that question is "Not really". I believe that they're yet to cross the chasm - they're selling to 'Innovators' and 'Early Adopters' and hence don't need to demonstrate benefits or ROI.

However, in order to really make it big by crossing the chasm - they must do what every successful "enterprise software" company does. Demonstrate benefits, prove ROI, provide customer success stories, etc - basically answer the most important question the prospective customers have: "What does your product do for me?".

It is still about the "Benefits", not just the "Features". Even for the so-called Web 2.0 class of software which are all the rage these days - expecially in the VC community in Silicon Valley.

Posted by michael at 06:03 PM | Permalink | TrackBacks (0) | 8 Comments | Post Comment

I attended a panel discussion at a forum event in Silicon Valley last week. The topic was "Web 2.0" - which I think is mostly a meaningless buzzword. In any case, on with the story...

Ross and Socialtext
One of the panelists was Ross Mayfield, founder and CEO of Socialtext a Silicon Valley startup that sells "enterprise wiki solutions" - basically software to create and manage wikis.

A member of the audience asked a very relevant question: "What problems does your software address?". I thought Ross will give a summary of Benefits.

Features, not Benefits?
Instead, he gave a long answer the gist of which was "We sell features. Our customers figure out the benefits".

Really! I was surprised to hear this answer from the CEO of a company that describes itself as an "Enterprise software" vendor. Other panelists, made up of VCs and analysts (not sure any of them had marketing/sales operational experience at a real high-tech company), mostly concurred.

For those of us who have done Product Marketing and Product Management in the high-tech industry, we've always been told that we should emphasize "Benefits" over "Features" when creating product messaging (brochures, sales presentations, etc). Was that wrong? What is the deal?!

Au Contraire!
I discussed this topic over lunch with four friends who have lot of experience in marketing and sales at successful large as well as startup companies in the valley. The unanimous opinion was that it is most important to clearly communicate product "Benefits" if you hope to achieve mass market success.

What about Socialtext then? They have real customers who pay them real money, and real VCs who have given them much much more real money! The answer to this riddle is found in the popular Crossing the Chasm book by Geoffrey Moore. Can you guess what it is? Till next time...

- Michael

Posted by michael at 12:41 PM | Permalink | TrackBacks (0) | 10 Comments | Post Comment