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How to End Your Parking Nightmares Once and For All

3 Mar

I love cities, but a settled family and the location of our offices relegate me to life in the suburbs at present. I drive up to San Francisco several days most weeks and though I love the energy, creativity, food, culture and walkability, I truly hate parking. My parking frustrations start with the high cost, expand to the inconvenience of finding a lot and a spot (usually at the point I am already running late due to traffic), and culminate in the unpredictable risk that all nearby lots might actually be full due to a Giant’s game, a convention in town, or just the fact that it’s 8:58am on a weekday and the San Francisco economy is booming.

As a technology venture investor and former product manager I am further frustrated that parking need not be the daily battle it is in most dense cities. There are in fact enough parking spots in most cities most of the time. Reports suggest that US cities average between four and eight parking spaces per vehicle and in some cities parking lots cover more than one-third of the metropolitan footprint. The issue is the information gap of knowing where to find an available spot at a specific time, at a price you are willing to pay, as close as possible to your destination. This sort of linear optimization along three dimensions (location, time and price) would be simple for software to solve if only we had the right real-time data. Unfortunately we don’t.

I am well aware of and have indeed tried many of the parking apps that list garages and their prices, and some that even attempt to indicate (or predict) availability, and yet others that enable you to pay with your smartphone. The problem is that even in their flagship cities no app yet has particularly good coverage of all parking options and the real-time availability data is woefully inaccurate. Even if the perfect app did exist, it is hardly ideal for me to be fumbling with my smartphone at the most chaotic and stressful last mile of my drive–and the app still may dump me many long blocks away from my actual destination. A “full stack” solution is necessary.

I first heard about Luxe while chitchatting with a friend who frequently drives from Palo Alto to various meetings around San Francisco. She emphatically heralded Luxe as an app that has made her life better. I tried the service the very next day and saw exactly what she meant. The experience starts by entering your destination on the home screen of the app. Then start driving. No need to indicate your arrival time as Luxe can track your inbound progress and predict your arrival time based on distance, speed and real-time traffic. As you near your destination the app pops a picture of your specific valet with their name and a brief blurb about their personal interests, setting the tone for a very warm and human experience. The app zooms in a map to show the exact location of your valet, who is actually quite easy to spot on the sidewalk in their bright blue track jacket. You jump out, they jump in, and you are walking to your destination feeling like we live in an age of magic. Luxe will even fill your tank or get your car washed for a small service fee. When you need your car back just confirm your pickup location and click the “return my car” button in the app and watch the icon of your valet retrieving your car and then driving your car towards you. I find Luxe especially awesome when I have a series of meetings in the city such that my last appointment is far away from my first appointment–Luxe brings my car to me so I don’t have to trek my way back across town to where my day started. And the best part is that the cost of parking via Luxe is almost always 25% to 50% less than what I would pay at the nearby commercial garages. Luxe can price attractively due to the volume discounts they get from garages and the fact that their valets can run or kickscooter further from the busiest parts of town than you or I care to when we are rushing to our appointment.

To be fair, this is a very hard business to build due to bursty demand and the unpredictability of traffic, road construction, weather and other variables. Maintaining rapid response times at peak rush hours is a challenge. Algorithms which predict demand, routing and dispatch optimization, personalized CRM, and high standards in hiring, training, and live customer service are key’s to Luxe’s current and future success. Attention to detail and a customer centric culture are essential. While this is not an easy business to manage, I believe it is one of those rare business where generating demand will be far easier than fulfillment. Do not let the name confuse you, Luxe is not a service meant solely for the pampered ultra-wealthy who only fly private and gets massages in their home twice a week. Luxe is an extremely cost effective solution to everything that sucks about parking in busy cities and the service will only get better over time as they grow and expand their coverage universe.

Venrock led the Series A for Luxe because we believe in the team, the concept, and the market opportunity. Finally we can enjoy our cities, parking included.

Will There Really Be an Uber for Everything?

9 Feb

 

The Next Uber

This post originally appeared on TechCrunch here.

Though the press has turned on them as of late, seizing on every allegation and misstep, I love using Uber. From the very first time (September 28, 2010 to be exact) I saw the little town car icon crawling across the map coming towards my little green dot I knew taxi cabs, airport car services, and parking lot attendants in downtown SF were going to see a whole lot less of me.   Tens of millions of riders around the globe love this service so much it has become its own verb. And at a $40 billion valuation, it is no wonder that it has become cliché to describe other on demand mobile services (ODMS) as the “Uber for X”. Any offline service that can be reserved, or delivered to you physically, or transmitted to you virtually through your smartphone seems to have a startup or several trying to become the Uber for that particular vertical. A few of these will turn into very large and successful global internet brands, grabbing major market share and even greater market capitalization from the offline rivals they out innovate. Most, however, will succeed on a much more limited scale, making only a small dent in their industry and servicing limited geographic markets.

My own framework for trying to determine which markets and which companies will be truly transformational is basic in concept. Start with a service where the greatest percentage of customers are most painfully unhappy with the existing providers. Fortunately for entrepreneurs and investors (but unfortunate for our daily lives as consumers), many service sectors suffer major challenges around availability, quality, transparency, and pricing. Not all problems are equally painful, however. Most people don’t consider the logistics around getting a massage or attending a yoga class nearly the same level of pain and frustration as home renovation or trying to sell their old car privately. There is also the question of how often one needs such a service, with frequently used services having the advantage of being more likely to become sticky habits versus one-off trials that may be forgotten over time. We are much more motivated to find solutions for frequently encountered pain than occasional pain. Next, ask yourself how can an on demand mobile service leverage smartphone technology, network effects, economies of scale, rich data, crowdsourcing, and the other tools found in a tech entrepreneur’s arsenal to build a service that truly delights customers and “bends the curve” in terms of customer experience. This is obviously the really hard part. Great service is hard to consistently deliver in general, but there are those services that are innately more challenging, such as home or auto repair, where the nature of the service is to diagnose and fix idiosyncratic physical problems that catch consumers by surprise leading to an initial state of frustration and financial worry. While aspirational to think that an ODMS can fix even the most broken service sector, often the symptoms of pain in the hardest industries may need to be treated progressively over time. Thus, it is the total distance travelled between the typical incumbent service level and the redefined ODMS service level, rather than the start or end point on an absolute scale, which creates the opportunity to create a truly great business.

How can on demand mobile services create delight versus their offline incumbents?

Immediacy and Reliability—the main point of most ODMS is to use the smartphone to be your remote control for life so that when you push the button for your ODMS stuff needs to happen, as fast and consistently as possible. Uber leverages local network effects between drivers and riders, and invests heavily in data science and AI simulations to insure that rider wait times are as short as possible and drivers are as busy as possible so they can earn the most money. Without short wait times Uber would not be nearly the magical experience we all love. Another example of instant fulfillment is Doctor on Demand*, a service providing immediate smartphone video visits with a board-certified physician so that you don’t have to wait for days or weeks to get an appointment to see your doctor or head to an after-hours clinic or emergency room for routine medical needs. Clearly you wouldn’t use Doctor on Demand if you have severe chest pain or are bleeding profusely, but there are a huge variety of use cases for which you don’t need to be in the same room as your doctor and the convenience of an immediate appointment, at one third the cost (on average) compared to an in-office visit, is so compelling that employers are offering DoD as a benefit to their employees.

For the majority of services that can’t be delivered virtually like Doctor on Demand, the act of rolling out city by city is expensive and time consuming, often requiring an investment in “boots on the ground” to recruit and train workers, market to new users, and assure quality in new cities. If you are truly bending the curve with a revolutionary service breakthrough you can attain a superior growth rate which attracts the capital to enable a nationwide and even global expansion strategy like in the case of Uber or Airbnb. For many ODMS that are only incrementally improving upon the traditional service model, geographic expansion will likely have to come more slowly and may ultimately max out at the major US cities or even just a region or two. This is not necessarily a bad thing as many enduring businesses can be built as the most technologically advanced player in a region. Personally we still enjoy PurpleTie’s drycleaning home delivery services, which started as a 1999 VC backed effort to go big with an online nationwide dry cleaning service but failed and got acquired by bootstrapped CleanSleeves (who apparently liked the PurpleTie name better.) Fifteen years later PurpleTie.com operates only in the Bay Area between San Mateo and San Jose and seems to have a healthy business. Perhaps the new generation of ODMS startups providing dry cleaning and laundry deliver services will go substantially further than did CleanSleeves, and if so it will be because they figured out how to create more customer delight than just mobile app order placement and efficient delivery. My wife is quite eager to give Wash.io a try, but whether or not she would stay loyal to them versus the next cheaper version will depend on how well they turn a relatively commoditized service category into a truly differentiated experience.

Quality—Service businesses are so hard to build because they rely on people to deliver service and interact with customers as much or more than they rely on computer code. Managing people, especially a workforce of independent contractors rather than full time employees, is a lot more variable than executing software routines and so recruiting, selecting, training, and managing workers is a core element of any ODMS. Background checks, license verification, detailed applications and face to face interviews are all part of the selection process. Most services rely on their customers to rate service providers and tend to ruthlessly cull those drivers/doctors/plumbers/etc that fall below a rating threshold, often a fairly high bar. Doctor on Demand checks the lighting, sound, and appearance of every doctor before every virtual shift. Some services even provide a satisfaction guarantee on the completed job, such as Red Beacon’s* $500 offer. Service quality can often be a matter of individual taste. For example, in the home cleaning category services like Homejoy may delight 9 out of 10 customers but it will be an endless uphill battle to please the pickiest consumers when it comes to something as subjective as a clean home.   Quality is not just the absence of problems, but also those unexpected touches which delight. Good Eggs, for example, would unexpectedly throw in a free gourmet treat or two when we first started the service. The freebies stopped once they hooked us as repeat customers but the amazing quality, friendly service, and personal touches like handwritten notes have made us loyal. There are simply no shortcuts when it comes to delivering consistently great services levels and ultimately quality can make or break a business regardless of whether they have the best looking mobile app.

Price—Tech enabled services are often far more efficient than traditional businesses at acquiring customers and aggregating demand through digital channels, viral marketing, and highly visible brands. This often enables cutting out layers of middlemen in the value chain. Additionally ODMS can rely on large regional facilities on cheaper real estate for physical goods processing versus sub-scale storefronts and expensive Main Street locations of their offline peers. Passing a good portion of these savings on to consumers is perhaps the smartest way to generate trial, grow quickly and hook customers on your service. BloomThat is a flower and gift delivery service that does a wonderful job of curating their selection and providing same day delivery, but their pricing advantage vs 1-800-FLOWERS is so significant that they have dramatically grown the frequency of gift giving among their customers far beyond the traditional Mother’s Day and Valentines Day holiday spikes. Some of the smartest pricing plans still include premium and ultra-premium levels, such as Uber Black or Uber Lux, for the truly price insensitive segment, but the mass market almost always appreciates a good value, especially when being asked to try a brand new service through a new medium. In the long run, however, one hopes that there is enough technology leverage, economy of scale, and disintermediation in your ODMS to be the good margin, low cost provider in your industry, not just the company most willing to subsidize losses indefinitely.

Payments—Rolling out of your UberX curbside without having to fumble through your wallet for cash nor waiting for your credit card to be run through a mobile POS is simply addictive. Getting food delivered by services like DoorDash or Seamless without the awkward eye to eye tipping procedure with the pizza guy is very easy to get used to.   Customers simply expect that effortless payment is part of the magic in a service that has been newly redefined as on demand and mobile. The nice part is that this also solves many business model problems around your workers handling cash or credit card numbers, deadbeat customers, and leakage from your workers attempting to cut you out of a side deal they offered your customer after you so nicely made the match between them.   The downside for the ODMS is that for low priced transactions the interchange fees on these credit card payments can be a significant hit to your margin, and on the other end of the spectrum certain high ticket services that require onsite estimates like home renovation may not easily lend themselves to being in the payment flow. Over time, however, we will see the vast majority of ODMS handle payments in the background as part of the consumer experience.

So, will there be an Uber for every service industry? There will be some for sure, but not many in terms of a global, dominant, hugely valuable iconic brands.   Some industries are just not important and/or frequent enough to our daily lives, or unpleasant enough as they exist today, whereas other industries face service challenges so fundamentally hard to solve that it will be a long while before we see an ODMS truly solve them. Just like with the B2B Marketplace craze of the late 1990s we will see massive experimentation across an enormous swath of the consumer services sector. We will also see traditional offline service businesses forced to up their game and become more technologically sophisticated. So while there may only be a handful or so of Uber-sized winners, there will be many smaller ODMS who find some degree of success, and the biggest winners of all will be consumers themselves.

*Current or past Venrock investment.

10 Rules For Disruptors In The Financial Services Industry

20 Mar

Having worked in the FinTech space many years ago, invested in the space for over a decade, and met with hundreds of talented teams in this area, I have observed the following ten traits among the most successful companies:

Rule #1: Unlock Economic Value   Most traditional financial service firms have invested heavily in branch networks that create expensive cost structures which result in higher prices to customers. Mass-marketing channels and poor customer segmentation also result in higher costs and marketing expenses which translate to higher prices. Online-only financial services can unlock significant economic value and pass this along to consumers. Lending Club offers borrowers better rates and more credit than they can get from traditional banks, while offering lenders better rates of return than they can get from savings accounts or CDs. SoFi is disrupting the world of student loans with better rates to student borrowers and superior returns to alumni lenders relative to comparable fixed income investment opportunities.

Rule #2: Champion the Consumer   Consumers are disenchanted and distrustful of existing financial institutions. Let’s take this historic opportunity to champion their interests and build brands deserving of their love. The team at Simple has envisioned a new online banking experience that puts the consumer first via transparency, simplicity and accessibility. Its blog reads like a manifesto for consumer-friendly financial service delivery. LearnVest is another company on a consumer-first mission to “empower people everywhere to take control of their money.” Its low-cost pricing model is clear and free of conflicts of interest that are rampant in the financial sector.  There is plenty of margin to be made in championing the consumer. The speed at which consumer sentiment spreads online these days creates an opportunity to become the Zappos or Virgin Airlines of financial services in relatively short order.

Rule #3: Serve The Underserved  In my last post explaining why the FinTech revolution is only just getting started, I described how the global credit crunch left whole segments of consumers and small businesses abandoned.  Some segments at the bottom of the economic ladder have never really been served by traditional FIs in the first place. Greendot was one of the pioneers of the reloadable prepaid cards bringing the convenience of card-based paying online and offline to those who lacked access to credit cards or even bank accounts. Boom Financial is providing mobile to mobile international money transfer at unprecedented low rates and ultra-convenience from the US to poorly served markets across Latin America and the Caribbean, and eventually globally.   No need for a bank account, a computer, or even a trip downtown to dodgy money transfer agent locations.

Rule #4: Remember the “Service” in Financial Service  Just because you are building an online financial service does not mean that your service is only delivered by computer servers.  When dealing with money matters many people want to speak to a live person from time to time or at least have this as an option just in case. Personal Capital delivers a high tech and high touch wealth management service via powerful financial aggregation and self-service analysis tools, but also provides live financial advisors for clients who want help in constructing and maintaining a diversified and balanced portfolio. These advisors are reachable via phone, email, or Facetime video chat.  As a rule of thumb every FinTech company should provide a toll-free phone number no more than one click from your homepage.

Rule #5: Put a Face on It  Chuck Schwab, Ken Fisher, John Bogle, Ric Edelman.  These stock market titans may have very different investment styles but they knew that consumers want to see the person to whom they are entrusting their money and as a result they each plastered their face and viewpoints all over their marketing materials, websites, and prolific publications. If your startup wants consumers to entrust you with their nest eggs, you ought to be willing to show your face too. This means full bios of the management team, with pictures, and clear location for your company as well as numerous ways to be contacted. It’s also a good idea to make sure that your management team have detailed LinkedIn profiles and that a Google search for any of them will yield results that would comfort a consumer.

Rule #6: Be a Financial Institution, not a vendor  The real money in FinTech isn’t in generating leads for FIs or displaying ads for them. That can be a nice business, but the real margin is in making loans, investing assets, insuring assets, or settling transactions. In just a few years Wonga has a become a massive online lender in the UK by instantly underwriting and dynamically pricing short term loans. Financial Engines and a new crop of online investment advisors make and manage investment recommendations for their clients.  You do not need to become a chartered bank or an investment custodian as there are plenty of partners that can provide this behind the scenes, but if you can brave the regulatory complexity and develop the technology and skills to underwrite and/or advise exceptionally well, the opportunities are huge.

Rule #7: Use Technology Creatively  The incumbents have scale, brand history, brick and mortar presence, and armies of lawyers and lobbyists. If FinTech startups are going to disrupt the incumbents, you will need to work magic with your technology. How clever of Square to use the humble but ubiquitous audio port on smart phones to transmit data from their swipe dongle and for using GPS and the camera/photo album to make everyone feel like a familiar local when using Square Wallet.  MetroMile is a FinTech revolutionary disrupting the auto insurance market by offering pay per mile insurance so that low mileage drivers do not overpay and subsidize high mileage drives who tend to have more claims.  They do this via a GPS enabled device that plugs into your car’s OBD-II diagnostic port and transmits data via cellular data networks in real-time.  Start-ups playing in the Bitcoin ecosystem such as Coinbase and BitPay are certainly at the vanguard of creative use of technology and are tapping in to the mistrust of central banks and fiat currencies felt by a growing number citizens around the world who trust open technologies more than they do governments and banks.

Rule #8: Create Big Data Learning Loops  Of all the technologies that will disrupt financial services, Big Data is likely the most powerful. There has never been more data available about consumers and their money, and incumbent algorithms like Fair Isaac’s FICO scores leave most of these gold nuggets lying on the ground. Today’s technology entrepreneurs like those at Billfloat, ZestCash, and Billguard are bringing Google-like data processing technologies and online financial and social data to underwrite, advise and transact in a much smarter way. Once these companies reach enough scale such that their algorithms can learn and improve based on the results of their own past decisions, a very powerful network effect kicks in that makes them tough to catch by copycats who lack the scale and history.

Rule #9:  Beware the Tactical vs. Strategic Conundrum  One challenge when it comes to financial services is that the truly strategic and important financial decisions that will impact a person’s financial life in the long run, such as savings rate, investment diversification and asset allocation, tend to be activities that are infrequent or easily ignored.  Activities that are frequent and cannot be ignored, like paying the bills or filing tax returns, tend to be less strategic and have inherently less margin in them for FinTech providers. Real thought needs to go into how you can provide strategic, life changing services wrapped in an experience that enables you to stay top of mind with consumers so that you are the chosen one when such decisions get made. Likewise, if you provide a low margin but high frequency services like payments you must find a way to retain customers for long enough to pay multiples of your customer acquisition cost.

Rule #10: Make it Beautiful, Take it To Go  A medical Explanation of Benefit is possibly the only statement uglier and more obtuse than a typical financial statement.  Incumbent FI websites are not much better and over the past ten years many large FIs have heavily prioritized expansion of their branch networks over innovating and improving their online presence.  As a FinTech startups  you have the golden opportunity to redefine design and user experience around money matters and daresay make it fun for consumers to interact with their finances.  Mint really set the standard when it comes to user experience and beautiful design, while PageOnce pioneered mobile financial account aggregation and bill payment.  To deliver a world class consumer finance experience online today one needs to offer a product that looks, feels, and functions world class across web, mobile and tablet.

There has never been a better time to be a FinTech revolutionary, and hopefully these rules for revolutionaries provide some actionable insights for those seeking to make money in the money business.

Why The Financial Technology Revolution Is Only Just Getting Started

20 Mar

OccupyWallSt

The Occupy Wall Street protestors are gone (for now), but the real revolution against banking is still taking place at breathtaking speed, thanks to a new breed of technology entrepreneurs. The financial services industry, long protected by complex regulations, high barriers to entry and economies of scale, is ripe for disruption. Here’s my take on the macro environment, how consumer attitudes are changing and why technology and available talent make now the best time to challenge the status quo.

Global credit markets clamped shut in late 2008 and froze entire sectors of consumer credit. Mortgages became less available, millions of credit cards were revoked, lines of credit dried up, and banks essentially abandoned the small business and student loan markets. This left tens of millions of households in the position of “underbanked” (have jobs and bank accounts, but little to no credit) and the “unbanked” (no traditional banking relationship at all.)  This credit crunch fueled demand for startups like Wonga, Billfloat, and OnDeck Capital to establish themselves and grow rapidly, and the reloadable prepaid card market pioneered by GreenDot and NetSpend soared. While credit has eased for certain segments in certain markets, there are still big opportunities to fill credit voids, especially at the lower end of the market.

The last few years have seen significant changes in banking, payment, tax, investment and financial disclosure regulations. While complex legislation such as the Dodd–Frank Wall Street Reform and Consumer Protection Act is hardly intended to unleash entrepreneurial innovation, and virtually no single person can comprehend it in entirety, it does contain hundreds of provisions that restrict incumbent business practices, and typically when there is change and complexity there are new opportunities for those that can move quickest and are least encumbered by legacy. Other regulations such as the Check 21 Act which paved the way for paperless remote deposit of checks, and the JOBS Act crowd funding provision are examples of technologically and entrepreneurially progressive laws that create opportunities for entrepreneurs and tech companies. Inspired by the success of pioneers such as microfinance site Kiva and crowd funding sites like KickStarter and indiegogo, I expect that once the JOBS Act is fully enacted and allows for equity investments by unaccredited investors we will see a surge of specialized crowd funding sites with great positive impact on deserving individuals and new ventures.

Within a few weeks of Occupy Wall Street in Sept 2011, protests had spread to over 600 U.S. communities (Occupy Maui anyone?), hundreds of international cities (did I see you at Occupy Ulaanbaatar Mongolia?), and every continent except Antarctica. Regardless of what you think of such protests, it is safe to say that as a whole we are more skeptical and distrustful of financial institutions than virtually any other industry. Clay Shirky’s term “confuseopoly”, in which incumbent institutions overload consumers with information and (sometimes intentional) complexity in order to make it hard for them to truly understand costs and make informed decisions, is unfortunately a very apt term for the traditional financial services industry. There is thus a crying need for new service providers who truly champion consumers’ best interests and create brands based on transparency, fairness, and doing right by their customers.  Going one step further, peer-to-peer models and online lending circles enable the traditional practice of individuals helping one another without a traditional bank in the middle, but with a technology enabled matchmaker in the middle.  Perhaps the ultimate example of bypassing the mistrusted incumbents is the recent acceleration in the use of Bitcoin, a digital currency not controlled by any nation or central bank but by servers and open source cryptograpy.

As a Product Manager for Quicken back in 1995 I remember sweating through focus groups with consumers shaking with fear at the notion of online banking. Today it is second nature to view our bank balances or transfer funds on our smartphone while standing in line for a latte.  And while Blippy may have found the outer limit of our willingness to share personal financial data (for now), there is no doubt that “social” will continue to impact financial services, as evidenced by social investing companies eToro and Covestor. You can bet it will be startups that innovate around social and the incumbents who mock, then dismiss, then grope to catch up by imitating.

I think we will look back in 20 years and view the smartphone as a technical innovation on par with the jet plane, antibiotics, container shipping, and the microprocessor.  While the ever improving processing power and always-on broadband connectivity of the smartphone are the core assets, it has been interesting to see such widespread capabilities as the camera, GPS, and even audio jack used as hooks for new FinTech solutions.  While there are over a billion smartphones worldwide, the ubiquity of SMS service on virtually all mobile phones means that billions more citizens have mobile access to financial services 24×7 no matter how far they live from physical branches.  Cloud and Big Data processing capabilities are further fueling innovation in financial technology typified by the myriad startups eschewing FICO scores in favor of new proprietary scoring algorithms that leverage the exponential growth in data available to forecast credit worthiness.

Financial institutions have long employed armies of developers to maintain their complex back office systems but until recently the majority of these developers worked in programming languages such as COBOL which have little applicability to startups.  While COBOL has not gone away at the banks, more and more of the technical staff spend their time programming new features and interfaces in modern languages and web application frameworks that provide highly applicable and transferable skills to startups only too happy to hire them for their technical training and domain experience.  In addition, successful FinTech companies from the early days of the internet such as Intuit and PayPal have graduated experienced leaders who have gone on to start or play pivotal roles in the next generation of FinTech startups such as Square, Xoom, Kiva, Bill.com, PayCycle, OutRight, Billfloat, and Personal Capital.

These are just some of the reasons now is a great time for financial technology startups and why venture capital is flooding in to the sector.  In my next post I will offer some suggestions for FinTech revolutionaries.

Network Effects are Magical

30 Mar

ImageNetwork Effects are magical.  They are the pixie dust that makes certain Information Technology businesses, especially on the Internet, into juggernauts.  They can be found in both consumer and enterprise companies.  Network Effects are special because they:

  1. Provide  logarithmic growth and value creation potential
  2. Erect barriers to entry to thwart would-be competitors
  3. Can create “Winner Take All” market opportunities

Network Effects are like a flywheel–the faster you spin it the more momentum you generate and enjoy.  But not all markets lend themselves to Network Effects.  They are not the same as Economies of Scale where “bigger is better.”  To be certain, Economies of Scale can give strong competitive advantage and defensibility to the first to get really big (or Minimum Efficient Scale as the economists call it.)  For example, SAP and Oracle benefit from having massive revenue bases which enable them to employ armies of engineers who develop rich feature sets and also to hire huge sales forces.  However large these companies are today, though, their growth rates, especially in their early years, were far more modest compared to those Network Effect companies whose growth resembled a curved ramp off of which they launched into the stratosphere.

There are four main types of Network Effects:

  1. Classic Networks, in which the value of a product or service increases exponentially with the number of others using it.  Communications networks like telephones, fax, Instant Messaging, texting, email, and Skype are all examples.  Metcalfe’s Law captured this as a simple equation where the Value of a network = N², where N is the number of nodes.  Typically, each node in a classic network is similar to each other and possesses both send and receive capabilities.  This will become clear juxtaposed against the other network effects below where there are different types of nodes.  Other examples of classic Networks are social networks (eg Facebook) and payments (eg PayPal).
  2. Marketplaces, where aggregations of buyers and sellers attract each other.  Lots of sellers means variety, competition, and price pressure, which all serve to attract more customers.  And because the customers flock, more sellers are enticed to participate in the marketplace.  eBay, stock exchanges, and advertising networks are all examples.  One nuance of marketplaces, however, is they differ in terms of the scale required for acceptable liquidity.  For example, ad networks can achieve sufficient reach and liquidity at relatively low levels which is why you see thousands of online ad networks, where they each exhibit network effects but not in a winner take all fashion.  Stock exchanges and payment networks require far greater scale for network effects to operate, which is why you see much greater concentration in these industries.
  3. Big Data Learning Loops.  “Big Data” is all the rage in techland, but just having gobs of data is not necessarily a Network Effect, nor any sort of competitive advantage per se.  What you really need is unique data and algorithms that process that data into insights which then lead to decisions and actions.  A flywheel effect comes when you get a critical mass of data that you mine for insights; pump that value back in to your product or service; which attracts more users which get you more data.  And so on.   Venrock portfolio company Inrix is a good example, where they mine GPS data points to derive automotive traffic flow data.  The more commercial fleets, mobile app users, and car companies they can get data from, the better their traffic analysis becomes, which gets them more users and hence more data.  They turn data into an accuracy advantage that earns them the right to get even more data.
  4. Platforms are a very special and powerful form of network effects.  In Information Technology, a true “platform” is where other developers build technology and businesses on top of your technology and business because you offer them one or more of the following:
    1. Lots of users/customers, and you represent a distribution opportunity for them
    2. Compelling development tools, technology, and (sometimes) advantageous pricing
    3. Monetization opportunities

Example include Operating Systems like Microsoft Windows, Apple App Store, and Amazon Web Services.

Each of these four types of network effects can be extremely powerful on their own.  Yet, even more power is derived when a business can harness multiple types of network effects in synergistic ways.  Google, Apple and Facebook do this for sure, but a less well known example is Venrock portfolio company AppNexus that operates a real-time online advertising exchange and technology platform.  The exchange aggregates advertisers, agencies, publishers and ad networks for marketplace liquidity, but also offers a hosting and technology platform for other AdTech companies and ad networks to augment their own businesses.  And the vast troves of data AppNexus processes every millisecond flows back into the system as optimized and targeted ad serving.

Network Effects are what you want fueling your business.  Sometimes you just need to get clever about discovering and harnessing them.