Network effects[moat] in SaaS - Part I of II
Major lessons from Atlassian, Zoom, Carta, Shopify, Postman and many more. Types of network effects in SaaS. Bonus - Moat taxonomy in SaaS.
Q: What are network effects(NFx)?
Every startup confronts this question at some point, I learnt the hard way while building & scaling a managed market-place.
A product has network effects when every new user makes the product more valuable to every other user.
Most technology companies have network effects(NFx) and much of their value is derived by network effects(NFx).
But, most about NFx has been written around consumer, marketplace or FAANG. I was surprised that very little has been written about NFx in SaaS.
Below, you’ll find essentially every major SaaS and their identifiable NFx, including lessons from Zoom, Shopify, Atlassian, Carta, Postman, Slack and many more. Enjoy!
Network effects in SaaS
My takeaways from this research :
If Your Product Doesn’t Have Network Effects(NFx), You Need to Rethink Your Strategy.
5 identifiable network effects(NFx) for most of the SaaSs.
NFx is one-of-a-kind forms of moat that deter competition with competitive advantages, barriers to entry, and creates barriers to exit for existing users.
NFx increases the value of a product. It is said that 70% of value in tech is driven by Network Effects.
It is very rare for a SaaS startup to have NFx that are sustainable from their very beginning, in most cases, sustainable NFx are built over time. But the reason this is true depends very much on how NFx are obtained.
Platforms garner value from 3rd parties creating new use-cases and UX, and those 3rd parties would prefer to create use-cases for large platforms rather than smaller ones. The users of those platforms, meanwhile, prefer more use-cases to fewer. This makes it difficult for competing platforms to get a foothold. Google Maps Platform, Shopify Partner ecosystem and Apple’s iPhone with its App Store are good examples.
If you have any additional insights or feedback to share, don’t hesitate to DM me. Otherwise, let’s dive into NFx, but before that a primer on moat.
Moat
Value is created through innovation, but how much of that value accrues to the innovator depends partly on how quickly their competitors imitate the innovation. Innovators must deter competition to get some of the value they created. Ways of deterring competition are called, in various contexts, barriers to entry, sustainable competitive advantages, or, colloquially, moats.
Every business strategist seems to have a list of moats–Porter, Rumelt, Hamilton Helmer etc. This series is an attempt to isolate the underlying mechanisms that moats have in common to determine the difficulty a startup might have in establishing a barrier against competition.
Moats draw their power to prevent imitation from one of 3 basic sources:
Scale,
System rigidity, or
State granted
Below is a taxonomy of identifiable moats in SaaS
This post, first in the series of the Moat in SaaS is centred on network effects. We’re going to be here for awhile. Go get some coffee. ☕
With that said, let’s turn to the learnings itself. Ready?
Let’s go:
Zoom
It’s a great sign for a company when its brand name becomes a verb - Colloquial NFx (e.g. Google, Photoshop, Xerox). It’s an even better sign when the company stock spikes more than 100% in less than two months. Of course, the 2nd order effects of CoVID19 and the resulting shift to working from home have played a significant role in Zoom’s recent success. It has been able to achieve this success by focusing on building a superior product, establishing strong network effects, and leveraging network bridging.
One of the best little low-friction growth aspects of Zoom is that you don't need an account to join a call. Almost every other service uses this as a way to force account creation - Zoom decided to let people in and see it's good first.
Zoom reported daily meeting participants of 300M+ in April’20 from 10M in Q4’19.
Zoom Network Effects
Zoom, Direct Network Effects
As adoption continues to grow, it eventually reaches collaborators ‘network bridges’ who work cross-functionally. ‘Network bridges’ within the company ‘same-side’, help Zoom spread organically across teams but restricted within the boundaries of a company - Intra-Company/Asymptotic NFx. But, Zoom becomes unstoppable when ‘network bridges’ cross the boundaries of a company & start collaborating externally - Inter-Company/Direct NFx.
Zoom, Multi-sided Network Effects
Zoom for Developers and Zoom App Marketplace enables developers to integrate video, voice, chat, and content sharing into other applications. Their APIs, SDKs, and MobileRTC powered an average of 140M+ API engagements per month in FY’19.
Zoom, Colloquial Network Effects
Zoom’s brand name has become a verb leading to Colloquial NFx (e.g. Google, Photoshop, Xerox). An excerpt below from an all-hands meeting inside Google.
Zoom stock soared 100% in the last 2 months
EV/Revenue: 70.30 X || EV/EBITDA: 1,130 X
Zoom pro-tip: Get yourself a great virtual background. Few options here.
Shopify
Shopify’s core business is a complete eCommerce platform to design, launch and manage online stores across multiple sales channels.
As of this post, the company’s stock has risen 820% over the last three years and 2020 has seen 105% growth, thus far.
Tobi Lutke, the co-founder and CEO of Shopify, was asked if ‘Shopify was the next Amazon.’ His response was incredible, and he said:
“Amazon is building an empire, but Shopify is arming the rebels”
Shopify competes with BigCommerce or Adobe’s Magento and a few more, they all are head-on with feature comparison, but product differentiation can be more than a software iteration. And that is part of Shopify’s mounting advantage- Shopify Partner ecosystem.
Founder Tobi Lutke, Harley Finkelstein, and team stumbled upon a new form of competitive advantage, a moat in commerce SaaS which is the catalyst for network effects -
Shopify Partner ecosystem that kicks off a fly wheel of multi-sided network effects.
Takeaways from Shopify Partner ecosystem
Ecosystem of services built for developers & partners, a catalyst for multi-sided network effects:
Shopify partner ecosystem-3rd party developers & partners, generated a massive revenue of $6.9 billion in 2019.
Shopify’s product philosophy
We’re only going to build internally what most of the merchants need most of the time, for everything else we will rely on partner ecosystem -
Brandon Chu
Platforms that are built around empowering their base to compete with incumbents and congregate partners will flourish in the next wave of internet companies.
Highly recommend you listen to this podcast on Shopify’s product philosophy.
Carta
Carta’s first product was a cap table software that connected startups to their shareholders, i.e when a startup enrols to Carta it brings along its shareholders; Carta’s benefit plateaus after a while within the boundaries of this private company-Asymtotix NFx. Prior to Carta, startups or a private company had to manually update cap table spreadsheets for every equity liquidity event/shares transaction. Carta optimised this process, improving cap table visibility for startups and improving portfolio visibility for investors & employees. This is may look trivial, but investors and employees can also have holdings in multiple startups and this is where the network effects kick in, Carta now evolves from just a cap table SaaS to a SaaS with ownership graph; a marketplace for secondary equity transactions - Multi-sided NFx; Carta’s benefit increases unlocking further growth.
To give a sense of the scale of dominance that has been achieved,
Carta holds the ownership graph of 35% of all venture-backed businesses.
Framed as equity value, they have over
$1 trillion USD in total equity value
managed on their platform today.
Carta Network Effects
Carta, Multi-sided Network Effects
Carta with ownership graph is now a marketplace for secondary equity transactions layered on top of cap table SaaS. This goes to show that SaaS for network management- shareholders and startups/private companies, can be layered on top of each other to gain even more structural advantages to unlock further growth.
Arjun Sethi nails this post on Carta, N of 1 company: 1) capture at scale, 2) become the central utility.
Carta, Indirect Network Effects-Data
In a blog post written by Carta CEO Henry Ward, Carta from a cap table software evolving to SaaS with ownership graph, marching towards becoming NASDAQ for private markets: A startup focused on “build[ing] analytic investment tools for venture as an asset class, providing insights on - ownership graph, portfolio analytics, including deal IRRs and cash management valuations and more”; A startup focused on helping other companies come up with fair and market-fitting “total compensation” for employees including both cash and stock; a startup focused on executing and publishing research on private companies.
To do all of the above, Carta’s dataset needs to be continuously updated and is consumed in real-time. So the larger the network, the more accurate that data will be at any instant - Indirect NFx(Data). More data continues to produce value almost indefinitely, so there’s less of asymptotic effects.
Oh dang! we’ve reached email length limit. Learnings from Postman, Atlassian, Slack, Nasdaq and more in part ii.
If you have any additional insights or feedback to share, don’t hesitate to DM me on Twitter & Linkedin.
You can always read everything on the website at vishwanath.substack.com
Thanks again, and please tell a few friends if you feel like it.
Sincerely,
Vishwanath 👋