Adding Value in a Network Business

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In describing electronic payments, observers often speak of the “network effect.” The network effect  – a powerful catalytic force that grows participants on both sides of a platform at the same rate – is often synonymous with growth, scale and the high revenue trajectory commonly associated with a successful business.

For the moment, let’s assume the fundamentals of a good business are there in that you have services that people have a need for, they would use those services given the right proposition and the services are priced competitively. You are operating in a competitive market with others offering similar services. There are distinguishing characteristics about your services, which if given the opportunity, you feel would create customer preference. If the above sentences are not true, then there are other potentially more challenging core issues at work, and the network effect is not particularly relevant.

Simply, the network effect may be described with the following equation:

Participant x Services = Interactions.

If you can sustain a level of growth in both services and participants, and there are no native barriers for active participants to engage in other services, it would look something like this:

(Growth x Participants) x (Growth x Services) = Interactions x Growth²

As more customers use your services and as more services are added for the customers to use, the number of interactions, and therefore profits, should show growth at an exponential rate. That growth is often referred to as the network effect.

Elegantly simplistic but very difficult to achieve, the network effect is dependent on getting the details right. From designing your offerings to servicing your customers, there are many factors that can be catalysts for both igniting and extinguishing the network effect. Businesses that recognize those dynamics usually drive significant growth, while those that ignore them usually do so at their own peril.

There is a subtle but key implication beneath the simple math, and that is the network itself and what it makes possible. The network’s presence ensures that customers have a simple way to access services without significant barriers. It also means that there are no significant barriers to reach the next customer, and those customers on the network become aware of new services as they get created. In other words, reach and scale are assumed.  This assumption is a fair one, largely on the basis of the operating environment we find ourselves in today. With the rapid pace of online and mobile technology adoption, customers have grown increasingly connected. Scale and reach are now easier to achieve if your services lend themselves to online delivery. The dot-com boom has left behind a persistent catalyst of the network effect by creating an environment where connecting to prospective clients is relatively easy.

Another subtle implication is the customer’s desire to use the services available. Good advertising can create a need where one has not existed, but only rarely. Tailwinds in this area help tremendously, and recognizing those tailwinds is also an important factor in creating or sustaining a network effect. In the payments business, we refer to this as the “secular shift” to electronic payments. While the world has seen many incidents recently that had a significant impact on economic cycles, overall, we are still experiencing an unprecedented level of growth. This boom has been largely fueled by the advent of online commerce, and more recently, mobile commerce. In this environment, markets are being created very rapidly, as customers can access offerings anywhere in the world. These markets often show accelerated dynamics of both adoption and attrition. The service offerings that fail to impress are short-lived, because while barriers to deliver a service to the public market have diminished significantly, they also removed many of the exit barriers. So, customers are free to switch services as they like, and as a result, they do so often.With that mind, let’s have a look at the network effect and its main components, starting with the participants:

Participants: Often the most obvious and overlooked component of a business, customers are the users of the services and the principal source of profit. You first need to acquire them. Then, to get the most value out of your customers, you need them engaged, consuming your goods or using your services. To acquire a customer, the service or product must be compelling. Advertising needs to showcase that, and tailwinds from environmental factors should be leveraged whenever possible. To get customers engaged, however, you need to make an active effort to find out everything possible about them, including their preferences and what factors they may have at work in their environment that may be an opportunity or an impediment to their consumption of your service. You also need to find ways to put that information to practical use. Information about the customer after he is out the door is far less useful than when he is in the store making decisions.

When investing in a network business model to attract and retain participants, here are some of the capabilities to keep in mind:

Analytics, or knowing your customer, means investments in technology (databases, CRM, analytics, etc.) whose purpose is to faithfully record any information a client shares about their needs, preferences or any other profile information. At the same time, the customer’s simple act of using your offerings leaves behind data that are equally if not more valuable. Tools that analyze, segment and score the customer base are a near necessity, especially as the effectiveness of advertising continues to decline. Advertising to acquire new customers is often more costly then retaining existing ones, and in the case of a diversified set of offerings, it is significantly easier to cross sell an existing set of highly engaged customers who have tried one of your offerings and have been satisfied than it is to attempt to capture new customers who have no positive experiences with your offering to build from.

Amazon is probably one of the best examples in understanding the concept of managing a customer base and channeling it to a variety of offerings. Originally a book seller, Amazon’s desire to be an online merchant led them to invest in a customer management system to handle the logistics surrounding product selection, ordering and fulfillment. Although this was far from the original intent of Amazon’s founder, the efficient use of the online channel and the creation of a seamless experience for the end client gave Amazon the opportunity to reinvent itself into the largest online merchant, largely by giving their consumers a tool that front-ends the selection, purchase and delivery of their goods online. While Amazon certainly intended to take advantage of the online commerce tailwind, their real catalyst for growth was using best-in-class analytics on the information their customer base generated. “Customers who bought this also bought…” is an elegant way to present an actionable piece of insight to your customers.

The technology needed to render these types of models and insights has historically been the domain of very large enterprises, but with the explosion of online commerce, it has now become almost table stakes. Customers expect a highly personalized experience when they interact with you. They were, in effect, trained by the Amazons and the Yahoos of the world, and customers now expect that their information is actively used in simplifying their interaction. They often will vote with their feet and switch to the providers that offer a simpler method of interaction.

This leads to a subtle but key component in successful interactions, which is even more significant if one has scale aspirations:

Simplicity: Reducing the friction customers may encounter may seem like common sense, yet it still is the top reason why online business sees cart abandonment, and why customers leave relationships of any kind. Along with the insight you may have about your customers, it is equally important that the way the customer is handled is as frictionless as can be. A bad experience will often mean a lost customer. Lost customers have rippling effects to network businesses, because the loss of one participant is a loss to all services, and a lot of profitable future transactions walk away with him or her.

As you think of who excels in this space, I would assume Facebook sits at the top of that list. They recognized that enrollment is often more painful than needed and strove to keep that as seamless as possible for adopters. As a result, even as adoption reaches levels of 1 billion, they are recording an acceleration in their adoption rather than a decline. The experience to enroll and use Facebook is remarkably simple and straightforward. The exchange of a few items of information grants you access to use the site and communicate through an online identity. They extended the utility of this identity credential by creating a utility named Facebook Connect, and now your Facebook credential can be used to authenticate you on other sites. With this “federation” of identity, Facebook managers can engage the marketplace with a large base of committed users and select the incremental services they want to offer to their user base. For the consumer, this is a basic march to simplicity and convenience.

Consumers have expressed their desire for convenience, and Facebook has heard them. With Facebook Connect, partners can now be brought into Facebook offerings. Components of the Facebook functionality also can be externalized, such as publishing or communicating with friends. While not what we would have thought of as our personalized portal, even as recently as a couple of years ago, Facebook now has a relationship with a significant number of customers and has them engaged with using the Facebook platform frequently. On the Facebook platform, many offerings are thriving, such as Zynga. As Zynga delivers new game content on Facebook, the online gaming company seems to continuously find a large set of willing users with established credentials and a predisposition to engage in online social activity. As Zynga begins to charge for the use of games, they enjoy, in an economic sense, a portion of what Facebook’s drive for simplicity has yielded.

Of course, simplicity alone does not account for all of the growth. While it is important to get the customer there, it is equally important to have those users engage in other services to generate the multiplying effect.

Diversification: Cross-selling customers into another set of services can be accomplished in a few ways. Bundling is probably the most immediately effective, as it is primarily a packaging effort. A bundle of multiple services delivered as a way to engage the customer can be very effective, because it captures growth in multiple areas. The simplest example here would be the case of Comcast or many of the telcos today, as they deliver services via a bundle of packages or plans. Comcast was able to increase the lifetime value of a subscriber significantly by the introduction of their “Triple Play” bundle. Customers using three or more services were below 5 percent of Comcast’s user base before the introduction of “Triple Play” in 2006. By 2009, that number had grown to 26 percent and undoubtedly is growing still. The one drawback is that bundling is often regarded as a way to discount services or as a pricing play, so the quality elements of the services may not be the primary factor in the bundle’s selection. Offering just pricing as the reason to adopt a service will certainly not be sustainable long term without the addition of other factors.

Integration: Platform integration is another great way to catalyze diversification, and Apple is a great example of this. If you recall the period after Steve Jobs returned to Apple and led the transformation of the company’s image, you may remember the colorful debut of the newly-transformed iMac. The recreation of the Mac into a more visually compelling machine, the introduction of the iPod, the debut of the Xserve and the move to a UNIX operating system were all newsworthy events that at the time probably captured more mindshare than the delivery of a free piece of software named iTunes. Yet iTunes has been perhaps the most profound innovation that Apple has ever delivered. With iTunes as the integration layer, Apple now can drive customers to any number of products or services – every single one of which forces users to enroll in iTunes. This is a self-powering cycle of adoption and diversification that has allowed Apple to generate a significant customer base that is highly receptive to Apple’s new products, whatever they may be. When the App Store made its debut within iTunes, it created an opportunity for Apple to introduce external participation into a well-regulated environment while still controlling risk to disintermediation.

Today, Big Box retailers carry a range of Apple products in their inventory, telcos enjoy a significant number of subscribers to their networks via the iPhone, and developers the world over are able to distribute innovative applications to those subscribers for fun and profit. None of those participants would be able to reach that set of customers without the aggregation platform that Apple built and deployed with iTunes, and the simple but powerful identity subscription it created. As documented in this striking example, integration offers a compelling ability to keep your customer set in close contact and ensures that they continue to find value with using your product.

This brings us to the final point – paying attention to your customers, who are often vocal but rarely heard.

Awareness: Knowing what a customer wants and delivering it is hugely valuable but only to the degree that that there is a commitment to perpetually listen and react to the customer need as it changes. Blizzard Entertainment has been able to engage users with very compelling and immersive games. They attract users by allowing free use of their system and converting users to subscribers after a period of time. The quality experience their games deliver is very compelling, as proven by the number of users they have across games, like World of Warcraft, StarCraft, Diablo and others. However, users within these games have long wanted to take the economy of virtual goods that Warcraft created and be able to trade it in the real world. This was something Blizzard opposed fervently, banning users for that type of behavior and even going so far as bringing legal action against some.

Despite all these efforts by the games’ creator to stifle its own customers’ attempts to engage in that economic behavior, the “shadow economy” created by the customers of Blizzard’s games – the relevant value of customers’  exchange of virtual goods as expressed in real world value – neared $2.5 billion USD in 2009. Blizzard provided all of the capability within its games to manage that virtual economy, yet the company did not hear the customer need and did not participate in the economics customers were generating, citing game balance as the reason. Since that time, they have entered the space of commercializing those goods, even offering part of the proceeds to charity to address any ethical concerns. Listening to customers is highly educational. As in this example, it often will show how the network needs to innovate. In most cases, the customers you serve will clearly point you in the direction your service needs to evolve.

It is in attracting and engaging participants that a network business may most effectively create, grow and sustain value. The examples above teach every manager of a network business a highly valuable lesson, namely: “Treat every interaction you have with your customers as a wonderful opportunity to build your business with their loyalty!” In every customer interaction, you can learn more about what drives your customer and what aspects of your offering they prize the most. It is the time when you can find out about an unmet need that you could and should meet. It is important to mine this interaction to the fullest but do so in a way that the customer values. If you are careful in optimizing that interaction, you may increase the value of your CRM, optimize the mix of products you offer, identify the features your products need to make them more compelling, as well as find new areas in which you could service your customer. With careful application, you may move the growth of your network from linear to exponential. Remember that every interaction holds within it the permission for your next interaction, and that great, successful companies honor that permission and act on it.

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