In “The Cold Start Dilemma,” Andrew Chen provides a step-by-step guide for creating a successful tech firm from scratch while utilizing the network effect. Chen explains five stages of expanding a tech firm, drawing on interviews with over 100 successful entrepreneurs.
“The Cold Start Problem” by Andrew Chen presents a five-stage plan for building a thriving tech startup through the network effect. The stages involve creating and replicating a subnetwork, accelerating growth, overcoming negative growth, and fending off competition. Chen also offers guidance on marketing, user incentives, and profitability.
Background: What Is a Network-Based Business?
A network-based business is a product or service that gains value as more people use it, and it involves interactions between users. The more users a network-based product or service has, the more valuable it is to each individual user. Examples of network-based tech products include social media platforms, online marketplaces, and multiplayer video games.
These businesses take advantage of the network effect to expand quickly and profit from the user data they collect, an endlessly valuable resource.
Step #1: Create Your First Subnetwork
To create a business at a massive scale, the first step is to create a functional and small network, called a subnetwork, that is as small as possible. The size of the network required to meet the threshold for functionality will differ for different types of businesses.
Chen advises starting with a productive subnetwork and progressively growing it over time. Compared to attempting to establish a huge, dominant network all at once, this is far simpler. You may finally develop a huge and successful network by building innumerable separate but connected subnetworks.
Counterpoint: Prioritize Speed Over Stability
The writers of Blitzscaling dispute with Chen’s advice to give stability priority in the early stages of a business, contending that a company might achieve quick development by forgoing stability, becoming the first major player in a new industry. Being the early market leader has benefits, such as luring top people and investors, which makes it challenging for rival companies to compete.
Here are a few tips for how to get your first subnetwork up and running.
Tip #1: Attract a Group of Users All at Once
Chen suggests that you should persuade a number of users to join a subnetwork at once in order to fast establish network stability. The “Tipping Point” is the quantity of users needed, depending on the product, to establish a working subnetwork. Users will frequently use your product and could recommend it to others after you reach subnetwork stability, providing you a steady or expanding user base.
But, if a subnetwork lacks sufficient users to become stable, its sparse user base will leave the broken system, causing the subnetwork to disintegrate. A specific subnetwork’s size isn’t the sole criteria in determining its viability because certain people’s influence, such as that of “Connectors,” might have a disproportionately large impact.
Tip #2: Target a Niche Group (at First)
According to Chen, a product should be made for a particular user group, such as an online community or event attendees, to ensure that it meets their needs and gives consumers someone with whom to communicate in order to maintain subnetwork stability. By doing this, a reliable subnetwork may be created, making future network expansion simpler.
The secret to creating a successful business is to target a certain market first before broadening it later. No network is too tiny, according to Chen, as long as it is reliable, although Moore suggests concentrating on markets that are lucrative enough to support growth. Network effects will occur after you draw in enough subnetworks of specialized users, making your network valuable enough to draw in a larger audience.
Moore advises creating a product for a niche market since a smaller market is simpler to control and profitable. This is due to the fact that specialized markets are closely knit together, which makes it simpler for a solid product to develop momentum and become well-known.
In contrast, competitive mainstream marketplaces make it challenging for startups to compete with well-established networks that cater to a broad audience. Startups may entice whole subnetworks away from rivals and compete with market leaders by focusing on an underserved segment and developing a product that uniquely caters to that group.
Geoffrey Moore suggests that targeting a niche audience can help startups gain a foothold in a market and achieve profitability. Niche markets facilitate better communication among users, allowing word-of-mouth promotion. Additionally, startups can disrupt larger networks by developing products specifically tailored to underserved niche markets.
Big corporations often ignore niche markets because they may not generate enough profit to justify the investment needed to meet their specific requirements. In contrast, startups can use this to their advantage by focusing on niche markets. Clayton Christensen’s book, The Innovator’s Dilemma, delves into the reasons why bigger companies tend to avoid competing in these markets.
Tip #3: Keep the Product Simple
Chen advises that to create a successful and expanding subnetwork, startups should focus on designing a product that performs one function perfectly and is easy to understand and use. By keeping the product simple, it becomes easier to attract and retain users, expand the network, and increase its value. Users are more likely to share a product that is simple to explain and understand.
Donald Miller advises that creating a customer-focused story can be the basis of all your brand messaging for a simple product, helping your audience understand what it is, how to use it, and how to explain it to others. The story should identify the customer’s needs, describe how your product can help them overcome a problem, and empower them to achieve their goals. With a simplified marketing message, customers can be compelled to take action and engage with your product.
A story-based marketing approach communicates essential product information, leading to growth. By focusing on what customers want and how the product solves their problem, the messaging catches their attention and encourages them to engage. This approach promotes network growth as customers internalize and share the brand’s story, filtering out irrelevant information and focusing on what’s necessary to improve their lives.
Tip #4: Cater to Your Difficult-to-Attract Users
Successful products and services that serve two-sided markets like online marketplaces, rideshare apps, and social networks require the ability to attract and serve both sides equally. However, one side, known as the “Hard Side,” can be more challenging to attract, causing network instability.
To address this, it’s crucial to design your product with a deep understanding of the Hard Side’s needs, behavior, and incentives. Providing value to both sides and constantly improving the user experience through feedback loops is key to overcoming this challenge, according to Chen.
Appealing to hard-to-reach users is essential for network stability, but it’s only one bottleneck that could limit growth. To maintain steady growth, it’s crucial to identify and tackle each bottleneck one at a time. If attracting hard-to-reach users isn’t enough to drive growth, then it’s time to identify and address new bottlenecks.
Step #2: Repeatedly Replicate That Subnetwork
To achieve exponential growth, it’s important to repeat the process of building subnetworks. As you establish more subnetworks, the next one becomes easier to build, leading to the Growth Explosion. During this phase, cost-effective strategies aren’t necessary, and unprofitable ones can help you dominate the market quickly.
Chen advises prioritizing profits after achieving the Growth Explosion stage, but several tech giants with millions of users remain unprofitable, raising concerns about a potential tech bubble. Despite this, investors are still pouring billions into startups, and the market continues to value growth over profits.
Chen recommends developing a replicable process for launching new subnetworks. The following sections outline various strategies that can be utilized to expand the product’s reach to new subnetworks, which can be phased out after achieving growth. A combination of these strategies can be employed to determine the most effective approach.
Strategy #1: Pay Users to Use Your Product
Chen advises having a replicable process for launching new subnetworks, with various strategies to spread the product to new users. Paying users to complete tasks or offering a free product with premium features can be effective but may require outside investment and sacrificing control.
Strategy #2: Artificially Inflate Your Network
Chen suggests a strategy to boost early growth, which involves temporarily increasing the network’s size by having employees participate in it. For example, hosting gaming events to create a more active network for a board game app. However, it’s important to avoid misrepresenting the network’s size to investors, which can damage trust and potentially lead to fraud accusations.
Strategy #3: Only Let Users Join by Invitation
Chen suggests three strategies for launching new sub-networks: paying or offering the product for free to attract users, temporarily participating in the network to inflate its value, and limiting users to those with an invitation from an existing user. These strategies aim to create lasting and stable sub-networks, increasing the likelihood of long-term success.
Step #3: Streamline and Accelerate Growth
Chen suggests three strategies for launching new subnetworks: paying users, participating in the network yourself, and making the product invite-only. The Growth Explosion stage will be reached after successfully launching enough subnetworks, where the network effect will accelerate growth to challenge market leaders. Chen advises focusing on refining the product to amplify the network effect at this stage. However, rapid expansion can distract from providing the best possible product to existing customers. The network effect drives growth by attracting new users, retaining existing users, and profiting more from them.
Goal #1: Optimize Network Growth
Chen suggests that a bigger user base facilitates word-of-mouth advertising and that companies should enhance their product by adding features that organically expand the network, such as enabling users to share content beyond the app. To encourage users to share the product, companies can make it captivating or exclusive, offering social currency.
Goal #2: Optimize Network Preservation
Chen says that having a larger user base allows for more data collection, which can be used to improve the product and retain users. By identifying the most engaged users and analyzing their behavior, businesses can make targeted changes to keep them interested. For example, a board game app could add a “discover new games” feature to encourage users to play more games and increase retention.
A Low-Budget Alternative: Conversations With Customers
To improve your product without analyzing data, you can gather valuable information by speaking directly with customers about their past behavior rather than opinions or predictions. In his book, The Mom Test, Rob Fitzpatrick recommends asking objective questions, such as when customers last used your app and which social network they used before yours, to gain insights that can inform product development and make it more engaging.
Goal #3: Optimize Network Monetization
Chen states that more users can benefit your product in three ways: attracting more users, providing more data for analysis, and increasing revenue. Offering premium features that become more valuable as the network grows can incentivize users to pay for them, optimizing network monetization.
Don’t Stress Out About Raising Your Prices
Chris Guillebeau suggests that as your startup grows, raising prices is reasonable, but many small business owners fear losing customers. However, customers expect occasional price increases and it can boost profits without significant customer loss. Guillebeau also advises offering premium and super-premium tiers to increase revenue and make standard prices more attractive.
Step #4: Push Through Negative Effects of Growth
To achieve rapid user base growth through the network effect, Mike Michalowicz suggests designing your business to function without your direct input. Extreme growth can create new problems that harm product quality and hinder further growth. Three unique problems of large networks can stall growth and must be addressed.
Problem #1: Market Saturation
Chen highlights the value of a large user base for product monetization, but excessive growth can cause problems and hamper quality. To sustain growth, Chen advises innovating beyond the original idea and targeting new users or introducing paid features. This opens up new revenue streams and ensures continued growth even after market saturation.
Market Saturation Shouldn’t Be Your First Assumption
How Brands Grow argues that entrepreneurs may underestimate their market potential and set low sales goals, hindering customer acquisition. Therefore, it’s crucial to avoid risky decisions until market saturation is confirmed. Instead, entrepreneurs should target all potential users and set aggressive growth targets until they become market leaders.
If growth stalls, entrepreneurs should identify obstacles deterring specific demographics from using the product rather than assuming market saturation. For instance, a language-learning app should investigate factors hindering user growth in certain demographics.
Problem #2: Community Dilution
As a network grows, community dilution can occur due to an influx of malicious users or mainstream adoption. To prevent this, subnetworks can be created with tight moderation tools. Avoid heavy-handed moderation and censorship by applying transparent rules consistently across the network.
Shifting User Motivations Can Dilute Your Community
Community dilution can occur when the network becomes mainstream or malicious users join. To regulate this, subnetworks can be created with tight moderation tools. However, if users’ motivations change, such as prioritizing audience building over personal connections, it may cause an irreversible cultural shift in the network.
Problem #3: Too Much Content
Chen recommends creating subnetworks and automated moderation tools to prevent community dilution and information overload. Precise discovery algorithms can also aid in content search. However, such algorithms may have adverse effects, such as promoting disinformation and political polarization.
Step #5: Ward Off Challengers
Chen states that becoming a market leader and earning profits through the network effect requires monitoring competitors and adjusting user acquisition strategies. Data analysis is crucial to track user behavior and the impact of these strategies. However, success can lead to negative mindset effects, such as entitlement and paranoia, so keeping ego in check is important.
Avoid Making “Beating Competitors” Your Primary Goal
Chen highlights the need to monitor and compete with rivals as a dominant market leader. However, Sinek suggests that focusing on a noble mission is more important than obsessing over competition, which can demotivate employees. Sinek advises learning from competitors and improving your product, rather than solely stealing their users. He argues that prioritizing competition can hinder learning from competitors and ignoring their strengths.
I’m founder and director of The Digital Agency; a certified Google Partner and Shopify Partner digital marketing agency operating in London and Istanbul. The Digital Agency has a solid track record of delivering high growth in eCommerce, Facebook & Google advertising, social media communication, search engine optimization, eCommerce and website production through 16 years of experience with 140 brands in 500 projects. Visit The Digital Agency here