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Strategy in Networked Industries

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]

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 [2]