Get our report on investing trends!
By providing your email, you will shortly receive the latest report from Pepper.
Network Effects and The Asset Manager
Network Effects is the the defining phenomenon representing the modern digital economy. With the growth and dominance of the FAANG stocks over the last 2 decades network effects has been identified as the overwhelming creator of value in the economy. It has propelled companies to grow exponentially, leapfrog competition, create defensible moats and dominate entire economic segments.
Most people intuitively grasp the advantages of strong networks. The economic theories underpinning these effects are recent in origin, but provide a fascinating view of how organizations of the future can compete in the future.
What is a Network Effect
There are many definitions on what constitutes network effects. The famed financial strategist and thinker Michael Mauboussin* has put it best:
“A network effect exists when the value of a good increases because the number of people using the good increases. All things being equal, it’s better to be connected to a bigger network than to a smaller one. Adding new customers typically makes the network more valuable for all participants because it increases the probability that everyone will find something that meets their needs. ”
Put simply, the sum of the whole is bigger . . . much bigger . . . than the individual parts. As more people join the network with more goods and services, the value of the network grows exponentially.
The economics of network effects
An extremely interesting case study done by NFX shows that over the past 23 years, network effects have accounted for approximately 70% of the value creation in tech. ***
Their wide ranging study included over 334 companies started since 1994 that each became worth over $1 BN.
Microsoft’s Excel, Apple’s ioS, Google’s many platforms, Uber and many other have provided case studies on how networks have been built and leveraged to add value to both the supply side and demand side of products and services. Companies that can leverage networks can grow exponentially.
How Asset Managers can build their own networks:
Complex networks exist in every business. They are simply not formalized using a technology platform. The Asset Manager (“AM”) already works with a network of partners, investors and service providers. Between these external resources the AM is able to
- Source new deals
- Structure the deals
- Price the deals
- Finance the deals
- Manage the deals
- Raise new capital
These products and services start becoming more valuable as more people join the network. A carefully curated network can add immense value to every other player in this network.
For example: A Real Estate Manager is searching for a new deal in the infrastructure deal in one of the Emerging Markets. S/he will need a host of local partners who can help validate the deal. They could involve local analysts, lawyers, auditors and partners for the deal. This new network can start becoming more valuable as they can uncover new deals or get involved in other transactions.
Another critical point that has been made is that “Affinity between participants, and the value of trade between those participants, matters.” ****
Current generation platforms like Pepper are helping companies build network effects into their target segments business model. They are creating a playbook for Asset Managers to bring each of these partners together in creative partnerships.
Steps to leverage the network effect:
- An understanding that the products and services involved are complex and specialized. These products and services require complex interactions that are often played out over the long term.
- With each complex need, the services required are unique and the expertise each player brings to these marketplaces matters.
- Players collaborate around one or more products. Oftentimes one initial collaboration leads to longer term partnerships.
- Referrals to new partners are highly valued and bring needed trust.
- Players working together on collaborative SAAS software platforms increase the transaction velocity and overall satisfaction.
Building strong networks allows every partner to become stronger add more value over time. Networks can be valuable — but to reap the benefits the products must be valuable to each participant in the network. A Linkedin network, which cannot provide this leverage, is not the solution for Asset Managers.
The noted VC Bill Gurley** asked this question:
Can the marketplace provide a better experience to customer “n+1000” than it did to customer “n” directly as a function of adding 1000 more participants to the market?
If the answer is “Yes” to the Asset Manager, then they should be building the network for tomorrow.
— — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — –
***
*
****
On the economics of Network Effects by Stan Liebowitz and Stephen Margolis
http://www.utdallas.edu/~liebowit/
About the different types of Network Effects
One of the Earliest examples of Network Effects
The Image is from : https://www.nfx.com/post/network-effects-manual