This post is an extract of my forthcoming book on business model innovation. The innovation book looks at why business model innovation is needed and how it works. You can read more about it here. These posts are early drafts of planned content and I’m putting them out to get feedback. Please do comment below, or subscribe to these pages to get each new section as it is published. In today’s post, we will be looking at finding opportunities in this new world.
When Agamemnon took the Greeks to Troy, the battle was in part, less about Paris debauching Helen and stealing her away as it was a battle for control of the trade network of the Eastern Mediterranean.
Usually, we think of network effects as involving wires and computers, but it is worth stepping back a bit and see, how they work in realities that more of us are comfortable with.
The Network Effect in the Ancient Ruins
If you’ve been on a holiday to Greece, Italy or Turkey, you’ll have spent some wonderful days in the wonderful little seaside towns with their ancient ruins. If you’ve been more adventurous, you may have gone to similar places in Lebanon, Syria, and Egypt. Each of these towns was a trade center. They brought in goods and local produce from the surrounding region and put it onto traders’ ships, Phoenician, Rhodian, Greek. The ships then had an increasingly larger choice of cities that they could take the wine, olive oil, mussels (for purple dye), or sylphrena (the ancient viagra, 100% organic and an order of magnitude more potent).
During the 4the Century BC, the greeks, after they had trashed Troy and seized control of the network, established hundreds of colonies (read Cities – if you have a 20th-century negative impression of the C-word) across the Mediterranean. This created a lot more places to trade with and a much much larger number of different trade routes.
This trade became so rich, that pirates flocked to prey on it, and eventually, the Romans had to mobilise their entire state to crush the Pirates. Putting this in context, the Romans had to raise a fleet that was at least 5X stronger than the modern US Navy, relative to their economic power, to make the Mediterranean safe again.
How Did The Network Effect Help The Mediterranean Become A Center of Civilisation?
This network of trade routes was one of the big reasons why the Mediterranean was a center of civilisation in the early world. Sea routes were quick and easy to transport goods, money, men, and ideas. As the Romans took control of it, they extended it inland with their roads. More roads, connecting more colonies (Much more the negative meaning of the C-words here) creating more wealth.
Compare this to somewhere like the Baltic – a similar sea with an abundance of natural resources on its shores (just ask the Hanseatic traders two millennia later), but, with no cities, no roads, there was no equivalent wealth creation until the 16th century.
This is what a network is all about. More nodes – cities and ports – means more different ways to connect between them. The more different routes, the more trade, or value that you can create.
A Telephone
Imagine that I gave you the world’s first telephone (made by Thomas Edison). What could you use it for? I’d use it to impress guests by popping it on my desk. I could also use it as a paperweight. It could be used as an impromptu cockroach squasher. In an emergency, I could use it as a hammer to smash my window so I could escape from a fire raging in my house.
I couldn’t use it as a phone though. Why not? Because you need two phones to be able to make a call. When you have a few people in your network, there are only a few ways of connecting them. When you get to a hundred, there are thousands. And when you get to thousands, you have millions or billions of different ways of connecting.
As you get more people, the number of different conversations goes up a lot, really a lot, faster than the people do. This is the idea at the core of what we call network effects.
The value of the business goes up faster than the cost to run it.
Network Effects In Relation With The Mug Factory
I was in Starbucks the other day, and because I hate small cups of tea, I bought one of those super-sized Starbucks china mugs. Because I hate Starbucks tea, I took it home and brewed my own cuppa. When the factory that makes these mugs makes their life simple. It gets some clay, makes it mug shape, adds some art, and puts it in the oven. Tada! A mug comes out.
For every kilo of clay that you put in, you get about a kilo of mugs. That’s a business without a network effect.
If this mug factory worked with network effects, it would be a bit like this.
We buy 1kg of clay and get a kilo of mugs. We buy 10 kilos of clay and get 30 kilos of mugs. So if we buy 50 kilos of clay and get 1000 kilos of mugs.
It’s not rocket science to see that this would be really good for the mug factory owner. Fortunately for Starbucks shelf space, mug factories don’t work like this. Many digital factories do.
Network Effects and Digital Factories
With a digital factory, it becomes a LOT easier to separate what you are creating from the value of what you create. (this is part of the scarcity/abundance magic that we talked about earlier)
Facebook created a digital factory to connect people. As it gets larger it becomes more and more efficient. The result is that it is able to create value for a lower and lower cost (for each connection) as it grows. That makes it a highly efficient value creator. Boom!
This is the underlying magic of a lot of the most valuable companies in the world today. Amazon, Google, Microsoft, Apple all rely to a greater or lesser extent on the power of network effects. When we are looking at business models, part of our search is always to see whether there is the opportunity for a network effect or its close friend the feedback loop, which we shall come to next.
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