#32 Network Economies, 2nd of the 7 Powers
This is the second post on a series that summarizes the book 7 Powers by Hamilton Helmer. The first post covers the definition of key terms, and the first source of power - economies of scale. Seems like this post was not delivered by Substack to some of you?
This post discusses the second possible source of power for a business - network economies.
Network economies - a business in which value realized by a customer increases as the installed base of customers grows. Why does network economies result in power?
Benefit: The business can charge higher prices when compared to competition as value provided is higher
Barrier: Unattractive cost/benefit for competitors to gain share
Attributes of an industry exhibiting network economies:
Winner takes all: Once one company reaches a leadership position or a tipping point, it becomes very difficult for other companies to have meaningful business returns
Boundedness: Business of the leader is bounded by the character of the network
Decisive early product: Having the "right" product and scaling quickly is critical in developing Power
The intensity of the power can be calibrated by the surplus leader margin (leader's margin when challenger's margin is zero)
Where Delta is the measure of the intensity of Network Economies and (Ns - Nw) is the leader's absolute advantage in installed base. Delta is the benefit which accrues to each user when one more member joins the network divided by the variable cost per unit of production.
For a player to be profitable the network effect (Delta) needs to be large enough relative to the potential installed base and the cost structure. Hence, building the right product and scaling quickly to reach the tipping point becomes imperative for each player.