The Cold Start Problem: How to Start and Scale Network Effects

by Andrew Chen

The cornerstone to amplifying the Acquisition network effect is to understand how one group of users taps into their respective networks to bring in the next group of users.

networks built through viral growth are healthier and more engaged than those that are launched in the typical “Big Bang” fashion, as Google+ did years back. Big Bang Launches can be great at landing, but often fail at expanding—and as we discussed, many networks with low density and low engagement will fail.

bureaus tended to combine into larger bureaus over time because of what’s often described as a “data network effect.” When a bureau works with more merchants, it means more data, which means the risk predictions on loans will be more accurate.

As a network grows over time, its ability to subsidize the ecosystem grows as well.

Almost every large marketplace company is built on an underutilized asset, whether that’s unused real estate in the case of Airbnb, a car that’s sitting idle for Uber, or unused time for many labor marketplaces. Marketplaces allow owners of these idle assets the ability to monetize them more efficiently as the network grows larger.

the Economic network effect states that for networked products, conversion can go up over time as the network grows.

Products with a strong Economic Effect are able to maintain premium pricing as their networks grow, because switching costs become higher for participants who might be looking to join other networks.

When a networked product becomes dominant, typically the alternatives—even when they have the same features—just won’t be considered a substitute.

It may be easy to copy features, but it’s nearly impossible to copy a network.

the growth curves of the best products are rarely smooth. Instead, the trajectories of even the top products—Facebook, Twitch, and others—grow in fits and starts. When a ceiling is hit, product teams scramble to address the underlying causes. Ship the right innovative features, and the ceiling is pushed off—only to return again awhile later in a different form.

workplace products and bottom-up SaaS startups use their network effects to grow virally, but eventually saturate their initial market of startups and early adopters. Then they need to learn how to sell into the enterprise to build the next phase of their business.

A product launches to torrid growth, but momentum eventually slows. The media declares the product over. People become jaded. But if the team can hold it together and keep shipping new features and countering the slowdown, they often pull through.

Establish great product-market fit Get to $2 million in ARR (annual recurring revenue) Triple to $6 million in ARR Triple to $18 million Double to $36 million Double to $72 million Double to $144 million

For all practical purposes, to build a new and impactful product from zero to scale requires very fast growth rates in the hundreds of percentage points a year.

Ultimately, this is why the most valuable products in the world—most of the apps and platforms with a billion users—are typically networked products. When they work, they usually continue to work for a long time.

New products initially grow just by adding more customers—to grow a network, add more nodes. Eventually this stops working because nearly everyone in the target market has joined the network, and there are not enough potential customers left. From here, the focus has to shift from adding new customers to layering on more services and revenue opportunities with existing ones.

the 100th connection for any given participant is likely less impactful than the first few, and as the network gets more dense over time, its associated network effects become less incrementally powerful.

The Adjacent Users are aware of a product and possibly tried using it, but are not able to successfully become an engaged user. This is typically because the current product positioning or experience has too many barriers to adoption for them.

Layering on new geographies—as eBay did by adding international regions—is another way to build up the layer cake.

The Law of Shitty Clickthroughs says every marketing channel degrades over time.

Consumers acclimate to specific brands, marketing techniques, and messaging, and tune them out.

Whereas a traditional product might lean more deeply into spending on sales and marketing, networked products can be more efficient by growing without spend, by optimizing their viral loops.

it’s not unique for the hard side of a network to grow in both importance and scarcity, while simultaneously becoming misaligned with the company over time.

the tyranny of the majority often overwhelms the scarcer part of the network.

this concentration is the result of healthy loops that drive a network toward higher quality. A good content creator gets likes, shares, and follows, and features like algorithmic feeds will distribute their content even more widely.

A networked product generally wants to nudge its ecosystem toward professionalization, because it helps scale the hard side. The idea is to transform mom-and-pop sellers into power sellers, or solo app developers into software companies. This is a big and important transition since it improves the capacity of each member of the hard side, as the sheer numbers begin to slow down because of saturation.

When a network becomes large, rich, and diverse, it’s often described as an “Economy”—you may have heard about the Gig Economy, the Attention Economy, the Creator Economy, and so on.

A networked product is successful when people on a network know how to interact with each other.

Context collapse is what happens when too many networks are simultaneously brought together, and they collapse into one. It’s most problematic for social networks because it inhibits the behavior of content creators—the hard side—as they no longer are able to post photos that satisfy everyone in every context.

What is an attractive product in one context might be less so to another, which is one of the reasons why context collapse can hurt the matchmaking at the core of marketplaces.

At its heart, this is the tension: network effects versus anti-network effects. And when the anti-network effects become strong enough to cancel out the efforts of the team, the network hits its ceiling.

Messaging apps are resistant to context collapse.

Context collapse is meant to be managed carefully, so that there’s enough discovery to hold the network together, but not in such a way that it alienates or overwhelms users.

Leveraging the network itself to combat abuse is one of the most scalable methods of fighting bad actors.

In my chats with Steve, he often likens Reddit to a city, and to his team’s role as city planners. The goal isn’t to run all the activity in the city, but to set up spaces where communities big and small can flourish. To take the metaphor further, in order to administer the city it requires laws, culture, and best practices, all codified in software.

The evolution of YouTube’s solution to overcrowding evolved from manual curation to popularity rankings to algorithmic methods. This is a necessary transition that every networked product has to make to solve the overcrowding problem.

Overcrowding works in a different way for creators than for viewers. For creators, the problem becomes—how do you stand out? How do you get your videos watched?

preferential attachment, defined as: “the more connected a node is, the more likely it is to receive new links.”

None of the approaches—algorithmic or otherwise—are a silver bullet, as the fight against overcrowding never ends. And in fact, the feedback loops can sometimes lead to unintended consequences.

In the early days at Airbnb, we would always talk about creating a positive “Expectations Gap.” In the early days, when we were new, guests go in with low expectations, but then would be blown away by the experience. You need this high NPS to get people to tell their friends, and it makes hosts more likely to join too. Our competitors who took shortcuts couldn’t deliver here.

The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage. The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors.

If a networked product can begin to win over a series of networks faster than its competition, then it develops an accumulating advantage.

I’ll tell you what it’s not: it’s certainly not a contest to see who can ship more features.

Rarely in network-effects-driven categories does a product win based on features—instead, it’s a combination of harnessing network effects and building a product experience that reinforces those advantages.

it’s important to acknowledge a common myth about defensibility and moats: that somehow, network effects will magically help you fend off competition.

Effective competitive strategy is about who scales and leverages their network effects in the best way possible.

the question is, who is doing the best job amplifying and scaling their Acquisition, Engagement, and Economic effects.

Cold Start Theory predicts that competition creates a vicious cycle alongside the virtuous one, where network effects provide a boost to the winner and simultaneously generate strong negative effects to the losing networks. If the value of a network exponentially grows as users join, the opposite must also be true.

it’s much harder to solve the Cold Start Problem with a slower pace of execution, risk aversion, and a “strategy tax” that requires new products to align to the existing business.

The opportunity to unbundle these larger networks requires both building the necessary product features to support these splinter communities and also taking the direct action to message, advertise, or otherwise convince members of the larger horizontal community to shift over.