Mapping The Web

In this post, we will take a look at how the network effect can lead to monopolies. To facilitate this discussion and provide clarity around the matter, we will look deeper at two specific companies - Microsoft and Walmart. In one instance, we examine a tech company, and in the other, we step outside of the Internet/tech world to see how basic principles and underlying fundamentals stay true across numerous disciplines.

Firstly, we will take a look at an itsy-bitsy software company that came about in the late 70s - the company everybody loves to hate - Microsoft. During the early 80s, the personal computer (PC) boom began. Computers became more affordable and accessible. Now we step back for a second. What do all computers need in order to run properly, or even boot for that matter? An operating system (OS). This is where Microsoft came about. After buying a fundamental chunk of code, Bill Gates and Paul Allen began a journey to conquer the PC operating system market, when few OS’s were available to choose from. Microsoft developed MS-DOS, then went on to essentially steal Apple’s concept of a graphical user interface (GUI). So where does the network effect come into play? Be patient…

As Microsoft’s OS caught on, became more and more popular, and more PCs began using the system, it became the industry standard. Coders and programmers alike began developing software for the Microsoft operating system (which later went on to become Windows). As more and more software products were being created for the Microsoft system, other OS’s were getting left in the dust. And the cycle continues. As more software product became available for the MS OS, it soon became apparent that if you were developing code, you might as well design for the system that has the widest distribution channel (i.e. maximizing your potential target audience). Programmers began to wonder, “Why would I develop for any other system, as the audience and money just aren’t there?” I’m obviously over-exaggerating a lot of these ideas, themes, and concepts, but my goal is simply to showcase the magnitude of Microsoft in comparison to the smaller guys. Obviously Apple was there all along, receiving much less exposure and market share, as well as several other smaller OS’s. Essentially, Microsoft hit a critical mass, which led the company into the snowball effect, further catapulting it ahead of potential competitors.

At a point where Microsoft has over 90% market share of the world’s OS market, why would anyone develop software for another platform (forget Macs for just a second here)? More importantly, why would anyone try to create a new operating system from scratch, then have the impossible task of getting programmers to develop software for that system. It doesn’t make sense. Microsoft was light years ahead - so far ahead that it almost seems impossible for anyone else to step in and put up a challenge. Good luck to a willing rival.

Now can you guess how Walmart is exploiting the network effect to its favour? Well, the situation in this case is much simpler to explain and understand:

Walmart:

1. Buys wholesale from suppliers.
2. Optimizes inventory turn-over.
3. Expands by adding more stores.
4. Buys larger and larger quantities from suppliers, demanding a deeper discount with every increase in demand.
5. Repeat cycle.

In other words, Walmart has such wide distribution and power over its suppliers that it can dictate all terms of the relationship, including pricing and payment terms. Walmart sucks every last penny out of its suppliers, as it knows they rely on the consumer giant for survival. It’s sad really. And as Walmart continues to grow through expansion and economies of scale, the problem will only get worse and worse. The network effect forces Walmart’s suppliers to operate under its rules. And I haven’t even mentioned Walmart’s world-class logistics and inventory management systems, which includes satellites and sophisticated inventory control software. Walmart forces people with a low (even medium or high) income to shop there, as they are basing their purchasing decisions solely on price. Good luck to all the little guys out there and the mom-and-pop retail stores.

If I had to pick one company to be around at the end of the world, it would be Walmart as I cannot see them slowing down or losing market share unless something very drastic happens. 

Click here for part 1 or part 2 of the Network Effect series.

With social networks like MySpace, Facebook, hi5, and Friendster dominating the market, how does one go about competing against these giants? Simple. You don’t.

The social network (SN) space is so crowded right now that adding another generic entry into the mix will accomplish nothing. So then, what do you do? Once again, it’s simple. Choose a niche.

Here’s a phrase I like to use that others believe to be true as well: “There are no niches on the Internet.” Although, this sounds contrary to my previous statement above, it’s all about perception. A niche topic such as “parenting” sounds like a very narrow topic, but on a worldwide scale, the target audience is immense. This is why I say to choose a niche, although there really aren’t any on the net.

Parenting? And a social network? That sounds ridiculous. Not necessarily. Just ask Minti. This small start-up out of Australia is generating huge amounts of traffic and interest from many parent-centric companies, such as diaper and baby food companies. In addition, the company has been approached by several large conglomerates and known consumer brands as a potential takeover target and doorway to a valuable market.

Another such niche success story is Sneakerplay. Branded as a social network “designed specifically for the global sneaker culture”, this shoe destination is already receiving attention with relatively low traffic. Because it is so lucrative to sneaker companies and the audience is a perfect advertising match, Sneakerplay was recently approached by Nike as a partner. Not only are they receiving top dollar for their ad placements, but they are proving out their model with credible industry players. In addition, the site becomes an instant potential takeover target for any large shoe company (i.e. Nike, Reebok, Adidas, and the list goes on).

Finally, we can add Facebook to this list. I won’t go into much detail about this play as it is already well known. Obviously, the company has taken a university/college niche approach to the social network game, which has proven to be extremely successful.

So what are the advantages of the niche approach? There are several. The most important being:

• Higher CPMs and ad dollars due to narrow target market
• Instant takeover target for large offline industry players
• Lower competition due to niche area

Having said all this, don’t rush out and start your own SN without doing the necessary market analysis and due diligence. A little bit of research goes a long way and may save you time in the long run.

So what’s your niche?

Just when you thought the web was corrupt enough (see previous post on PayPerPost), another evil company pops up with bad intentions. In this case, I am talking about UserSubmitter. I first read about this company on Read/Write Web and Richard MacManus strongly disagrees with their practices as well. I like his use of words to describe the company - ‘pond scum’. Very fitting.

The premise of UserSubmitter is the following: the company pays Digg users $0.50 for every 5 stories they digg. From the opposite side of the spectrum, companies or individuals can pay $20 per story, plus $1 per digg. In other words, UserSubmitter is creating a monetary Digg marketplace system. This not only skews Digg’s results, but also jeopardizes the entire premise of the service.

Why are people doing this? Obviously money is the motivation, but at what point do morals and ethics come into play? Scoundrels like the guys behind UserSubmitter need to take a look in the mirror and realize what they are doing. Once again, I hate to sounds cynical, but I see the Internet as an avenue for growth and opportunity, not neglect and misrepresentation. But as is the case with any social system, it will be exploited and there will always be those who are looking to make the quick, easy buck.

Let me take the time to tell everyone about a company I disrespect. Now I’m not usually a negative or cynical person, but in this case there’s no holding back. I HATE PayPerPost.

Why the anger and outrage? Let’s just say that this new service jeopardizes the trust of the entire blogging community, as well as the basic concept of news reporting. The idea behind PayPerPost is a marketplace where advertisers pay bloggers to post about their company. Seems a little devious, but there’s more. All blog posts MUST be positive and transparency around payment is optional. In other words, you may read what you think is a legitimate blog post from your favourite blogger about a great new company with an exceptional product or service - but little do you know, he/she doesn’t give a @#$% about the company or the product, but rather did it for the money. Sounds very honest and sincere. I absolutely despise this model and I do not respect any blogger (sell-out) who engages in this practice. Blog posts should be written by the fingers of the blogger, not by the chequebook of the corporation. This evil company was first brought to my attention by TechCrunch in late June. On Tuesday, the company will announce that it has raised a round of $3 million. Those VCs make me sick. Shame on you.

PayPerPost is a pretty decent name though. I guess IllegitimateBlogging.com was already taken. I like this company about as much as Mike Arrington likes Jigsaw. I wish you all the worst, PayPerPost.

Let’s look at another great example of the ‘network effect’ (click here for part 1). As previously mentioned, with every user you add to your userbase, your network becomes more valuable and relevant to all. So let’s take a look at instant messenger clients (i.e. MSN Messenger, AIM, Yahoo Chat, Google Talk). To facilitate this process, let’s create fictitious characters and a conversation dialogue.

Tim: “What IM client do you use, John?” 

John: “I use MSN Messenger. I have about 100 contacts.”

Tim: “Have you seen the new Google Talk. It’s great. Full of new features and functionality.”

John: “That’s great, but I’ll stick with MSN.”

Tim: “Why is that?”

John: “Well all my contacts currently use MSN. If I were to switch, they would all have to switch as well to make it worth my while. This would be next to impossible, as all their contacts would have to switch as well - and the cycle continues onward. All I’m really interested in is a tool that will allow me to chat with them. Added features and functionality are great, but they’re not my main focus, nor will they tempt me to switch.”

Tim: “Fair enough. Makes sense I guess.”

This example showcases the power of the network. With every added user, the network becomes more valuable. In addition to IM clients, social networks are also a great example of this phenomenon. If all your friends and/or family are using Friendster, for example, why would you want to use hi5? It wouldn’t make sense and wouldn’t provide any value to you. There are huge barriers to entry for the product to become valuable to you.

Once again, do not underestimate the power of this effect. Next time we’ll look at how the network effect may lead to a monopoly. And what better example than this ‘little’ operating system company you may have heard of…