October 21, 2014

Strategy in Networked Industries

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In networked industries, like social networking web sites and Internet auction houses, the purchase of a product by a new customer creates value for existing customers.

The classic example is the telephone; the more people who have phones, the more people you can call, making the value of your phone go up with the number of phone users.

Start-ups are very popular in networked industries these days. So a lot of people ask me what’s different about starting a company in a networked industry.

Here are four aspects of strategy that are different in networked industries. (I have taken them from my textbook, Technology Strategy for Managers and Entrepreneurs)

1. Start large. Networked industries display increasing returns to scale and tend to be winner-take-all businesses. To succeed in these industries, you need to be large; and being large means making big bets in the beginning. As a result, the time-honored method of bootstrapping won’t work and you will probably need to raise gobs of venture capital to put the business in place.

2. Focus on your installed base. Your installed base (number of current users) is a key metric in networked industries. These industries tend to converge on the product with the most customers. New customers derive the most value from buying from companies with the most users at any point in time, and providers of complementary products are most interested in offering products for the producers with the most users.

3. Use penetration pricing to target the mass market. If you want to build your installed base fast, then you want to go after the mass market from the start, rather than focusing your attention on the innovators and early adopters. The mass market is a much larger group of customers, which is what you need to build your installed base quickly.

In addition, you want to charge a very low price to get those customers. How low? Probably negative, like PayPal did when it first started and put ten bucks in the account of its initial users. Paying people to be your customers builds your installed base quickly.

4. Be a first mover. When building an installed base fast is a key to success, you need to move quickly. This means you are probably better off getting a flawed product on the market earlier and fixing it as you go, than being the second mover with a better product. Customers might not switch to your better product if your competitor has a large number of users for its more flawed product.

You are also probably better off creating a virtual company and contracting for the different assets that you need than building them from scratch. It is almost always faster to sign a deal to work with someone who already has manufacturing or marketing assets in place than building them yourself.

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About the Author: Scott Shane is A. Malachi Mixon III, Professor of Entrepreneurial Studies at Case Western Reserve University. He is the author of eight books, including Illusions of Entrepreneurship: The Costly Myths that Entrepreneurs, Investors, and Policy Makers Live By

4 Comments ▼

Scott Shane


Scott Shane Scott Shane is A. Malachi Mixon III, Professor of Entrepreneurial Studies at Case Western Reserve University. He is the author of nine books, including Fool's Gold: The Truth Behind Angel Investing in America ; Illusions of Entrepreneurship: and The Costly Myths that Entrepreneurs, Investors, and Policy Makers Live By.

4 Reactions

  1. Whew! I think I’m happier to be a one-man shop. ;0

  2. Hi Scott,

    Excellent post.

    I would add that on a smaller scale entrepreneurs can create businesses that become substantial following your advice in points 2 and 3. They grow more slowly, but even bootstrapped businesses eventually can grow bigger in a networked economy. It just takes longer and you have to be able to stick with it and not give up before the network multipliers kick in — many small biz owners aren’t able to stick it out, for whatever reasons.

    Regarding pricing approaches in point 3, one of the dilemmas biz owners might have in starting off with a low or free or even negative price, is: how do you eventually raise your prices later on? So that you can actually make money?

    One technique we used in my corporate days, that applies well to smaller businesses, is to position it as introductory pricing or a “beta period”. Never mind that your beta or introductory pricing goes on for a year or more — you see that all the time these days. Or hold back on some advanced features and introduce those later as “paid” features.

    And whatever you do, don’t make broad sweeping commitments you’ll later regret such as “it will always be free.”

    Anita

  3. Scott,

    Do you have any comment on LiveUniverse’s acquisition of Pageflakes?

    From the TechCrunch article, “Pageflakes Acquisition Confirmed”:

    “The personalized start page is dead. Long live the personalized start page. Pageflakes, a nice-looking but perennial also-ran in the world of start-page startups, has been officially acquired by Brad Greenspan’s Live Universe, a deal we reported earlier this week. Terms were not disclosed, but it was a combination of cash and stock. Pageflakes CEO Dan Cohen will remain in charge of the business and help to integrate it into LiveVideo, as well as continue to maintain it as a separate site.

    Despite its easy of use and appealing UI, Pageflakes never really took off. ComScore measured only 50,000 unique U.S. visitors in March, compared to 1.4 million for competitor Netvibes. (And 191,000 uniques worldwide in February, versus 2.4 million for Netvibes). iGoogle had 7.4 million U.S. visitors in March, and My Yahoo had 19 million. But Cohen, who used to run My Yahoo, argues that the difference has more to do with distribution deals than organic growth and that linking up with Live Universe will give Pageflakes the distribution it needs. ”

    http://songeno.notlong.com

  4. Scott, these are some good strategies and I like Anita’s idea of an “introductory price”. That way making people aware that it’s for a limited time will encourage them to act fast before the price goes up.

    When I first started selling online, I gave every customer who ordered a free sample size candle in the scent of their choice. It gave them the opportunity to try a new scent and did not cost me much to give away.

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