4 weapons and 6 tactics to ignite your network effects and solve the cold start problem
November 18, 2021
Network effects and physics
I started my studies with engineering and I studied maths and physics before going into economics, business and management, which arrived quite late in my curriculum. As every engineer, when facing an economics, business or management issue, I draw some analogies with physics or mathematics to help me understand the underlying dynamics of this problem.
The sweet spot of a VC fund: increasing returns at scale
A VC fund is not only looking to generate great returns for its investors: it strives to generate outsized returns and that implies going beyond mere scalability. What we look for in generating outsized returns is the notion of increasing returns at scale which means that you need to reduce correlation between the returns and the money invested at scale. In mathematical terms:
Note on Scalability: Scalable business implies that the returns are linear over time (i.e. not requiring an increasing marginal investment with marginal returns) and therefore is a necessary condition but not sufficient in itself. Scalability in mathematical terms is expressed as:
(e.g. software is scalable but don’t necessarily mean increasing returns at scale if no effort is made to reduce the cost of acquisition, customer success, onboarding, etc.).
From a business standpoint, increasing returns at scale imply that the company is building an asset that reinforces over time, the more people who use it. In other words, one of the 4 following components or a combination of them:
Brand: Building a brand asset will generate more acquisition at scale and therefore relatively increase the returns (e.g. Apple).
Economies of Scale: In certain cases, higher volume over time allow lower production costs and relatively increases returns at scale (e.g. hardware businesses).
Switching costs: Embedded product features, connections or integrations that make it difficult for a user to stop using a product. These are likely to increase with individual usage of the product (e.g. SalesForce).
Network effects: A platform that reinforces in value the more people use it. Users can be of the same nature or not (e.g. 2-sided: Airbnb, 1-sided: DeepL).
The network effect equation
Whilst brand, economies of scale and switching costs are very good assets to build to generate defensibility in the long run, at Samaipata we believe that network effects are the best way to generate these increasing returns at scale for the following reasons:
They are capital efficient at scale — vs. Economies of scale and branding that require a lot of capital expenditure to build an asset base or a brand image.
They are built to last in the long run — vs. Switching costs that are usually overcome by better products in the long run.
More importantly, they increase in value with usage, even at scale. In mathematical terms:
Network effects are not created equal and different types can be built — some of them are *asymptotic (*e.g. Uber, Lime), some are linear (e.g. GoPuff) and some other are exponential (e.g. AirBnB). The most powerful ones at scale (and the ones we look at) are the latter for which the following holds true:
i.e. Not only the value increases overtime, but the increase in marginal value itself also increases overtime.
Unstable systems and exponential network effects
Platforms are similar to unstable systems in classical mechanics: once they get an initial flick of energy, their movement is exponential and infinite with less and less effort (vs. unscalable and decreasing return at scale businesses, that are “stable systems” i.e. after the initial movement has been given, if no additional energy is given to the system, it returns to its equilibrium state). What we look for when hunting for the next outsized returns generating company is an unstable system that with the right initial energy, will generate a chain reaction.
A good example of an unstable system generating a chain reaction is combustion. With the right initial energy put at the right place, a chain reaction starts: fuel + oxygen + initial energy creates heat, which burns more fuel and oxygen, which generates more heat, etc.
In this analogy:
Fuel: A multi-billion euros Total Addressable Market (what keeps your ‘fire’ of a business burning forever).
Oxygen: A clear value proposition addressing a deep market pain (a.k.a. an early sign of product-market fit).
Heat: The initial energy flick brought by your early stage investor to light it up. In this case, Energy = Money x Early stage expertise x Involvement
As an example, at Samaipata we bring to founders at Seed stage:
Capital: we lead Seed rounds with tickets from €0.5m to €2.5m.
Early stage expertise: we focus on one stage and know how to bring your company to Series A, we have >80% graduation rate from Seed to Series A.
Involvement: we are a concentrated fund (20–25 companies per vintage) to give actual care to our companies.
Concrete levers to solve the cold start problem or how to bring the initial energy flick
Now that we’re done with the poetic part, let’s get our hands dirty: there are 4 weapons you can build to solve the cold start problem of your platform and 6 tactics you can use to generate this “initial flick”.
Solution: Build a 10x product/service to bring value day 1 to the user. Focus on solving UX pain points, connectivity, portability, etc.
Mantra: “Come for the tool, stay for the network”.
Example 1: Zoom has built a product with nice features (screen sharing, automatic muting, blurred backgrounds), reducing frictions as much as possible (1-click meeting), very portable (available on all platforms) and once they acquired millions of users, they started to build network effects on top (marketplace of applications and integration with many other software).
Example 2: Back Market started by fixing the refurbishing problem of second-hand electronic buying for consumers and then built a network of refurbishers and suppliers to serve them.
Solutions: Build a strong brand asset that will bring users onboard and keep them using your service and eventually build the usage vs. competition. Users come for the brand and stay for the network and the service or tool.
Mantra: “Come because it’s cool, stay for the network”.
Example: ClubHouse enjoyed a very cool brand and PR in the US yet had no liquidity in other countries at the time. Strength of the brand fetched clients onto the platform and in the end generated liquidity.
Solution: Build a community of enthusiasts who will generate traffic and engagement and then at scale, start to build features that have high value because the engagement is already high.
Mantra: “Come for the network, stay for the tool”.
Example: On many Web3 projects, founders start by building a community to engage around similar values while developing the actual platform. Once the product is out, the community is already there and liquidity is reached very quickly after launch.
4. Digital Asset
Solution: Your platform dynamics imply a virtual asset such as a token, that has a financial value for the users.
Mantra: “Come for the asset, stay for the network and the tool”.
Example: Many Web3 projects have tokens embedded both in their utility and governance dynamics. The market value of these tokens can generate additional liquidity from people who are purely interested in the financial value of these token at first.
Tactic: Start by saturating 1 node of the market with your value proposition. 1 node = demand segment x supply segment. Understand who are the 20% of users covering 80% of your go-to-market and saturate that node. Then expand.
Example: Uber went for Black Cabs in San Francisco and saturated that node before going to other cities.
Tactic: Build 1 of your side by piggybacking on an existing community. You can use a scraper (there are many on the market) to automate the acquisition of that community.
Example: Piggybacking on LinkedIn, Amazon, Airbnb, Instagram, Classified (LeBonCoin, etc.).
3. “Big Bang” start
Tactic: Use the founder’s initial network to generate liquidity fast among 1st and 2nd level relationships. This will restrain the type of users but will allow to saturate nodes quickly.
Example: YC companies are fueling each other thanks to a strong network and community feeling.
Tactic: Make something cheaper or free to acquire a lot of customers on 1 end of the equation and once the network effects are built, let the market decide the price.
Example: Delivery platforms subsidized the cost of meals by injecting money in between.
5. Start by a single-player value proposition
Tactic: Start by serving 1 side of the platform by owning the other side.
Example 1: GetAround has its own cars to start kicking off the demand side and then opens the supply side.
Example 2: Amazon started as an e-commerce companies before starting its marketplace business model.
6. Connect “by hand” / manually
Tactic: Start your platform by connecting things manually and generate supply and demand before having built a tech product. “Do things that don’t scale at first” (YC).
Example: Click n Boat did part of its discovery component by hand to help demand side find its supply until liquidity was reached.
At Samaipata, we are always looking for ways to improve. Do not hesitate to send us your thoughts. We strive to partner with early-stage founders and to support them in taking their business to the next level. Check out more ways in which we can help here or for all our other content here
And as always, if you’re a European digital business founder looking for Seed funding, please send us your deck here or subscribe to our Quarterly updates here.
More insights to better the world through technology
Unlocking Business Expansion with This Strategic Framework
There comes a time within your business where you realise that your team needs additional skill set and expansion. Typically, product-market fit has been established and the opportunity to grow revenue and profit is there.
Scaling your customer service team: in-house or outsource?
As an early-stage startup, making the decision to manage your customer service team in-house or to outsource really depends on a variety of factors including where you are as a company in terms of your lifecycle, size and complexity, what your strategic customer service vision & goals are, and finally, what your financial resources and priorities are.
In a rapid-growth startup, demands can be high, budgets can be low, and processes can be lacking. There’s also strong competition for top talent in the startup environment and it can be challenging to keep talent as other companies also look to acquire people with specific skills, many of which can afford higher salaries.
Restructuring data teams that are ready to scale: 5 learnings from BlablaCar
In today's interconnected world, data has become a powerful driving force behind innovation and growth. Companies that harness the potential of data hold a competitive edge, and one such company at the forefront is BlaBlaCar. As a pioneer in the carpooling industry, BlaBlaCar has revolutionized the way people travel and the way it leverages data plays a critical role in its business strategy.
In this article, we delve into the fascinating world of BlaBlaCar's data team strategy, exploring how we restructured our teams in order to scale.
What role software can really play in helping us reach net zero goals?
While considerable venture capital investments have already flowed into the software sector, the intensifying climate crisis is pushing the need for radical action to the forefront. Software is currently receiving negative publicity as seen as involving too “shy” of an effort. On the other hand, hardware and infrastructure investments, which were traditionally overlooked by asset-light venture capitalists, are gaining momentum.