Boost your digitalization: network effects

Photo by Marius Masalar on Unsplash

There’s a beautiful saying in American English: build it and they will come. The idea is that simply building something and making it available will cause customers to beat a path to your door. To throw their money at you simply to get access to the amazing thing you created.

Of course, we know that this doesn’t work in the real world. Products and services need to be marketed and actively sold. Building and manufacturing products is half of the job. The other half is selling it, getting it into operations and providing customer support.

When it comes to building an ecosystem around a product portfolio, I meet equally naive views. The general thought is that simply providing an API to the products will cause numerous complementors to flock to our ecosystem. However, even getting the approval and support within the organization to open up an API for third-party developers not seldomly is a humongous battle. Many companies are wired to keep things confidential and internal and seek to minimize information leakage to the outside.

Also, the decision to open up the product portfolio to the ecosystem is often triggered by customers and partners asking for it. Sometimes others have been asking for it for years and there may even have been, frequently successful, attempts to hack your products to extend them with additional functionality. This tends to reinforce the conviction among the proponents that “they” will come if we just build it.

Building an ecosystem tends to be an uphill battle

Despite the strong market signals, building an ecosystem tends to be an uphill battle. It’s very difficult to get to the ignition point where complementors and customers have jointly created a market of sufficient size to make it self-sustaining. However, when we succeed, we ride the typical pattern in digital markets: the winner takes all.

The key principle in accomplishing this is to focus on network effects. A network effect was first discussed with the introduction of the telephone. If you’re the only person in the world with a telephone, the value of the thing is zero. If there’s one other person with a phone, there’s some minor value as you can now talk to that one person. For every additional person acquiring a phone, the total value of the network goes up exponentially.

When building an ecosystem, the idea is to find ways in which you engage the typically very small number of current participants in bringing in new ones. There of course is a direct benefit for ecosystem participants, but typically this benefit is too small for anyone to take action. So, as the keystone player in the ecosystem, we need to offer additional incentives to activate the existing flock.

These incentives can be monetary, but they don’t have to be. Especially in B2C markets, reputational incentives like certifications and other forms of recognition can be equally successful. Another potentially effective mechanism is gamification as many people enjoy engaging in friendly competition, also outside of computer games.

Especially in the case of monetary incentives, one aspect to consider is system abuse. Ecosystem participants care about the incentives but not so much about the goal you’re looking to accomplish with them. Consequently, any way that allows them to game the system and maximize their incentives with minimal effort will be happily exploited. This can become quite costly for the company without having the effects to show for it.

The abuse may cause you to want to stop the entire incentive system, but that would be throwing out the baby with the bathwater. The challenge is to develop an effective system to exploit network effects at the lowest cost, taking into account that this easily leads to a cat-and-mouse game with the players seeking to abuse the system. Constant evolution of the incentive system in response to the learnings takes real work, but the reward will be immense if you’re successful.

Successful ecosystems have reached a state where the network effects in the ecosystem are self-sustaining and require minimal effort from the keystone player. Getting there, however, calls for active engagement in building the ecosystem. The most effective mechanism is to identify, reinforce and introduce network effects through carefully designed incentive systems. You may wonder why you should pay to persuade others to join your ecosystem, but the fact is that most ecosystems are only sustainable with a significant number of participants and achieving that requires investment.

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