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Welcome, welcome everybody. My name is Jeff Towson and this is Tech Strategy and the topic for today So Young’s cool marketplace and the three effects of network effects So a bit of a mix today basically two smaller subjects I think both are pretty interesting so young international a Marketplace for services in the medical space direct to consumer out of China publicly listed in the US a pretty interesting company and I don’t think people really pay enough attention to this. And the second one is just network effects which I think people get confused about or at least in my opinion. And the reason is because I think there’s actually three things happening at the same time and people kind of mix it together. So I’m going to tease it out into three separate effects that are happening within a network effect and basically how I see it. Now per the format. I’m gonna pose a question to you, which is how would you actually measure a network effect, both in the early stages, which is when everybody talks about, because VCs talk about it and they care about early stage, and then in the longer term, in the more mature stable marketplace, how would you actually put a number around it? And it’s really a couple numbers. So that’s when I think about the metrics, and that’ll be the question for today. Now, for those of you who are subscribers, I’m gonna be sending out an email. later tonight talking about Kuaishou. And I would put this on your radar right now because it’s going public pretty much in the last day and in the next days depending if they do a follow on. Based in Hong Kong, this is the other TikTok, right? This is number two in China. Douen’s number one, which is TikTok, which is bite dance. Number two is Kuaishou going public right now in Hong Kong. I think there’s some interesting strategy stuff. I’ll be on the… the TV tomorrow talking about it. I’ll send that email out tonight. I don’t think people are viewing this terribly well from a strategy perspective. It’s a little bit muddier, it’s a little harder to tease out. So I’ll send that out tonight on the email. So just a heads up, that’s on the way. However, my standard qualifier, that does not mean go buy this company. This is not investment advice, nothing in this podcast or in my writing or on the webpage. is investment advice. The information and opinions from me and any guests may be incorrect. The numbers and information may be wrong. The views expressed may be inaccurate or no longer relevant or accurate. Overall, investment is risky. This is not investment advice. Do your own research. And for those of you who aren’t subscribers, please feel free to go over to jefftowson.com. You can sign up there, free 30-day trial. See what you think. Okay, I’m going to get into the content. Now for those of you who are subscribers, I gave, you know, I put out some information on SoYoung a couple weeks ago, basically posing the question of, is this the next Shopee? Because Shopee was kind of one of the big, spectacular investment returns of 2020. I know quite a few of you invested on that. I was starting, I was writing about this about eight months ago, something like that. But actually if you look at 2019, the returns were spectacular as well. In both cases up three to four times in 12 months. It was really one of these companies that I’ve been pointing to for quite a long time saying, look, this is outstanding strategy. This is real. Whoever’s doing this is very, very good. They’ve nailed it. And then the financial investment returns have been following because usually strategy is a leading indicator. and then the financials follow later on, and then the stock price somewhere in there also goes in theory, usually. But strategy in my book is always a leading indicator. Financials tend to be mid or late indicator. By the time it shows up in the financials look, everybody knows about it, generally speaking. The strategy is where you can often see further down the road ahead of the curve than others. Now, Soyoung is a mix. Shopee just kind of jumps out at you. Wow, this is really well done platform strategy. Okay, Soyoung is also a platform business model, but there’s some really compelling stuff and then there’s some not so good stuff. So it’s like muddier as a picture. Now, the theoretical side of me doesn’t like that, but the investor side does because generally the best opportunities are where it’s a bit of a mixed picture. and you can see through the fog a little bit better than others. So that’s kind of why I think this is one of the reasons I think this is interesting. Now the basics of this company are that it’s founded in Beijing, relatively new company, 2013 founded, really a platform business model strategy from day one. Clearly that’s what they were going after. And of the five… you know, platform business models I talk about, they were going after a marketplace model, okay? The primary interaction, buyer, seller, something like that. If you haven’t picked up already, I really like marketplace platforms as business models. I think they’re great. It’s pretty impressive what they can do for a lot of reasons. They tend to be a little more tangible. They tend to be a hybrid of digital and physical assets. They’re less… prone to games like faking clicks. And also they have negative working capital, generally speaking. Usually your customers are paying you first and then you’re passing on to the merchants later so they can grow. There’s just a lot in there that I like them. And generally speaking, I also like businesses where you are focused on getting a share of a consumer’s wallet as opposed to a share of their time. Because time is a zero sum game. and there’s a lot of stuff we can spend our time doing. Wallets tend to increase over time. And that’s definitely one of the China and Asia stories I am a huge believer in in terms of secular trends, big tailwinds, middle-class families in Asia, and China in particular, are a great secular trend if you can get them behind you. Share of wallet captures that directly. Share of time. kind of does through marketing and stuff, but it’s that zero sum game that makes me nervous. Anyways, those are vague outlines. All right. Now, SoYoung was one of the first platform plays, digital plays in China to really work because most of them failed. There were a ton of digital health plays coming out of China, 2015-ish. All the VCs were talking about it. You know, Alibaba was doing healthcare, Tencent was doing healthcare. You know, it was just, there was ton of private equity shops. Every private equity shop you’d meet with in China, it’s like, this is our new healthcare division. And I’m an old healthcare hand, and I was super dubious, because healthcare is its own creature. The economics tend to be political first, clinical second, and business third. Most people don’t understand the first two aspects terribly well. And yeah, I didn’t think it was gonna work. I was pretty bearish and I looked pretty good. I wrote some fairly well-known articles about why digital health in China is gonna fail, which got some pretty good traction. That was actually kind of nice. But there were some success stories and I said, look, this is where I think it’s gonna work. And I think I was pretty solid on that. And the one that I liked, the areas, you know, the couple areas I really liked in the digital space, one was pharmacy. That’s basically e-commerce with a regulatory approval pending. You know, Alibaba Tencent, they already do over-the-counter stuff, which is non-prescription. They already sell you everything. If they can do prescription stuff, they’re set up. All they need is the regulatory approval. Everyone is still basically waiting for that to happen for various reasons because hospitals in China, even though they are considered public, the vast majority of them, Their economics are overwhelmingly private, and they don’t make their money on fees, they make their money on pharmacies. Most of it, a lot of it. And so they have been very resistant to, look, if you take away the pharmacy and you put that out in the market, how are we gonna survive? And the government basically didn’t have an answer. And it’s all right. So they’ve stayed within the hospitals to a large degree. Everyone’s still waiting. So that was a big opportunity, just waiting to happen. Everyone’s still waiting years and years later. The other one which I liked was anything direct to consumer on a smartphone where the consumer pays. It’s not going through a hospital. It’s not going through insurance because once you do into that, which is core health care, that’s the big money that everyone wants. Surgeries, chronic disease, that’s all the money. I mean it’s huge but it’s also highly regulated. Anything ancillary to that, which I would call ancillary healthcare that goes to direct consumers where you can get people to just pay directly, that will happen immediately because consumers have the money. So you don’t wanna do heart surgery and you don’t wanna do chronic care, diabetes, humodialysis, hypertension, things like that. You wanna do dentistry because dentistry is outside the core. People pay out of pocket for the most part. You wanna do optometry. You want to do glasses, you want to do beauty treatments, you want to do skin peels. You want to do anything that’s direct to consumer ancillary care outside the core of healthcare. The dollars are smaller, but they’re moving right now. Okay, SoYoung. SoYoung launches a marketplace for services, which we’ve talked about a lot. Well, I’ve talked about a lot. And they went direct to consumer in beauty treatments and aesthetics. which is exactly the strategy I just outlined. Let’s build a marketplace for that. We will connect all the medical providers or other types of ancillary care providers, beauty treatment, skin, I’ll give you a list. We’ll connect those groups, which is a big user group in terms of money, but you’re talking thousands, tens of thousands of providers, not a hundred thousand. Not like merchants and drivers on DD, but we’ll connect that group with consumers who want care, who have the money today. direct to smartphone, marketplace for services, bam. That’s a nice strategy. It’s a nice niche marketplace. And here’s what they went after. And here’s what they called it in their filing. They’re public now. They said, we’re going after quote, consumption healthcare. That’s the phrase that got my attention. I was like, wow, that is exactly what I would do. Like that word exactly. Consumption healthcare, consumer healthcare, not core. not insurance, not hospital, direct to consumer. And they basically connected, did transactions between Chinese consumers, a lot of them, and about 6,000 providers of plastic surgery, beauty treatments, medical aesthetics. What does that mean? Laser hair removal, hair transplant, rhinoplasty, breast augmentation, body contouring, neurotoxin injections. It’s everything from a procedure, which is serious, hey, you’re in the OR, to just a one hour treatment to come in and get some injections or get some skin. And people are all over this stuff. You can have different opinions on how healthy that is and whatever, but consumers, a lot of them like it. It’s going mainstream. It’s not as crazy as it was 10 years ago, where it’s like, dude, that guy’s got funny looking hair plugs. What the heck is wrong with that guy? You know who has hair plugs? Elon Musk. Next time you see Elon Musk, keep in mind that dude’s got no hair of his own. He was bald at like 27. So a lot of this stuff is going from freaky to much more mainstream. Veneers on your teeth. You know, which are basically kind of fake-o teeth that screw in and they look fantastic. Everyone thinks it’s fine. So there’s a… You know, there’s a spectrum here. And generally speaking, a lot of this stuff is getting better and better. It’s getting more mainstream, but there is a sub-segment of this stuff that is clearly in the, there’s a psych issue going on. When you meet someone who’s had 15 plastic surgeries on their face, okay, we’re in the land of some psych issue is happening here. That’s not awesome. Michael Jackson, how many surgeries did that dude have on his face? Right? So there’s a lot of nuance there. But that’s the core, it’s done by medical professionals. Step it down into simpler stuff like skin peels and whatever. You can step it down to even lesser care like manicures and pedicures, spa services, massage, basic physical therapy, foot massage. And there’s a spectrum here, but they’re sitting at the top of the spectrum in terms of complexity and things like that. Okay, that’s the company. They launch, they’re doing this. It’s a fragmented niche market, direct to consumer China, and they get, depending whose numbers you believe, 60, 70% of that market. That’s pretty great. That is dominant market share. Atop of my digital competition pyramid at the winner take all, winner take most category, one of my little bullets there, if you look on it, is local dominance. When you get local dominance geographically, hey, we’re the biggest retailer in the city, we got half of the market, that’s geographic. It can also be local dominance within a services or tech or customer demographic. This is local dominance within beauty aesthetic services in China. Bam, 60, 70%. That’s really interesting. And if you look at their financials, you’re gonna see rapid growth in their revenue. You’re gonna see a healthy growth. Gross profit is generally a good indication of dominance. And you’re going to see some potential expansions cross border. If I can get this treatment done in China, why can’t I fly to Seoul? And a lot of Chinese consumers fly into Seoul for beauty treatments. So there’s a standard joke, which I think is true, but I’ve never verified it, which is so many people out of China were getting beauty treatments in South Korea that when they flew back into China, they didn’t match their passport photos anymore. And they were having a hard time getting into the border. I’ve always heard that, I’ve never verified it’s true, I think it is. Lot of flying into Thailand, lot of flying into Singapore. So there’s a cross border aspect to this, which is interesting. Overall, when I look at the strategy, there’s three or four things that jump out at me that I really find compelling. First one, what I just said. Consumption healthcare, consumer healthcare, direct to consumer healthcare in China is an awesome market to target. People will spend a lot on it. They have the money. There is a gap in terms of what they want and what the public hospitals and public insurance system currently supply. So there’s a supply demand gap that keeps growing year after year, although the supply side, that is actually changing. It’s just happening sort of slowly. It’s a great demand picture. And you could say the same thing about dentistry. You could say the same thing about ophthalmology. You can actually say the same thing about pet care. You know who, like healthcare for pets, insurance, treatments, gourmet food, those numbers are going off the charts. It’s kind of the same idea, like, okay, you know. I have more money, I’m gonna spend it on the health of myself or my family. To some degree pets are considered often part of family. So you actually see the pet care numbers in China are pretty great. Let me take it apart from platform strategy. Okay, consumer side of the platform, provider side of the platform, two user groups, medical providers about six, seven, eight thousand of them. One side of the platform, the other consumer, the other user group consumers. On the consumer side. There’s a lot that’s compelling here in that, why do platform business models exist? Because we’re trying to solve an interaction difficulty. I wanna buy stuff from a small merchant in the North of Thailand or in China, but I can’t. It’s too difficult, I can’t find them. I can’t, all those issues with interaction costs, transaction costs, coordination costs, the Kossian transaction costs, Ronald Koss. Okay. A platform solves those. I don’t really feel comfortable staying in someone’s house, sleeping on their sofa. Oh, Airbnb solved that problem, bam, the market opened. There are interesting problems, Kossian transaction costs within this. What are they? Okay. Do I really feel comfortable getting my nose done? What about a skin peel? What about… Botox injections. I mean, there’s a lot of this that makes people uncomfortable. The same way sleeping on someone’s sofa makes you uncomfortable. I don’t wanna stay in somebody’s house. Can you overcome that? Well, how do you overcome it? Well, you need communication with those providers. So one of the things this platform does is it pairs the marketplace with a lot of content where these doctors, providers, clinics, all of that, they put out a lot of professional content. Here’s a video by a top surgeon in Shanghai just talking about, look, we’ve done five of these, this is how we do it. That sort of getting to know the person takes away a lot of those costs, those transaction difficulties. So there’s content being created by the providers, but there’s also content being created by the other users, the consumers. So when you do one of these procedures, you keep a diary. Here I’m getting ready to do the procedure, I’m flying into town, here’s me before, here’s me after. All of that content is also put out and that gets people comfortable. Oh, this woman is like me or this guy’s like me. He did it. We live in the same town. I can see all of that overcomes those difficulties and you start to enable the transaction. It’s the perception of risk. It’s the idea of I don’t know how good this is. Even if I do feel comfortable, I don’t know how to find a doctor I’m comfortable with. What am I gonna just go on Baidu and search? Good plastic surgeon. That doesn’t work. I don’t trust those. What I’m gonna call a friend? Well, most people don’t have a plastic surgeon. How do I, there’s a search cost. There’s a comfort level, there’s a risk. And then when I do find them, what’s the right price? Well, in this case, you put out the content, you follow, they handle the searching, they handle the matching, and then there’s price transparency. Oh, I can see there’s 10 surgeons who do this, this is the price. So it’s addressing a lot of those coordination costs, bringing those down. And therefore the interactions start to happen in a way that they otherwise wouldn’t. And that’s what a platform business model is selling. They’re not selling products, they’re not selling services, they’re selling lower co-sian coordination costs, such that you can find a person and do the procedure, such that I can buy something on my phone, sitting in Bangkok, even though it’s made in Chongqing and I have no idea who these people are, I’m comfortable with it. That’s the point of a platform business model. There’s training, there’s education, there’s search costs, there’s information, there’s all of that. That’s what the consumer sees. There’s a lot there that a platform can go after. If there’s no problem, there’s nothing to solve. Okay, now we flip two user groups, consumer user group, provider user group, other side of the platform. Okay, how do they view this? You always have to view it from both sides. What do they care about? What are their problems? You have to win on both sides with both groups. to get both groups to participate and then the transaction happens. What do they care about? Well, it turns out there’s some actually really compelling stuff on the provider side. If you’re a small two to three person doctor organization in, I don’t know, Wenzhou, how do you find patients? How do you do it? This is a rare thing. People don’t do this every week. It’s discretionary. How do you communicate that you’re better than others? How do you find your patients? It’s actually hard to get that traffic in the door. If you’re a heart surgeon, you don’t have any of these problems. You just sit there and people call you because they have a heart attack, right? But it’s actually, you have to do a lot of outreach. So their biggest problem is how do we spend money? This is a strategic cost for them. Their marketing, their customer acquisition costs. How do I spend that money to get patients? and they don’t view this as a necessary cost, they don’t view this as a critical, this is a strategic cost. If I can spend another $100,000 on marketing, but I make another $300,000, I will keep doing that all day long, as opposed to if I spend $100,000 on new office equipment, it doesn’t make me money. And if I can spend 90 instead of 100, I should do that because I saved some money. That’s not, so for them, They perceive this as a strategic cost, not a necessary cost. And one of my concepts in the concept library is how do B2B transactions happen and is it perceived as a necessary, critical and or strategic cost? If you can sell to a company’s strategic cost, life is much, much easier. It’s one of the benefits of doing marketing. So I like the, I mean, it’s not like the surgeon has any choice. It’s not like they say, yeah, we’re not gonna do any marketing this year. They kinda have to. I mean, they have fixed cost. They have staff they have to pay. So if their volume goes down, what do they do? They have no choice. They have to start pumping out those marketing dollars. So I like all of that. Anyway, so I like the provider side of the equation more than I like the consumer side. I like the fact that there are real interesting Cosian transaction coordination costs. And I like that the way that this platform is addressing those is not just something simple like I’ll match you with a rider, a driver in your area to take you downtown. That’s very simple and sort of a shallow transaction. I like that for them to solve this problem, they need a combination of commerce, content and social media. All three things are happening on this platform. We’re doing the transactions. There’s a ton of content being created by the providers, the doctors, by the users, by the consumers. And then there’s a nice social media aspect because if you have a nice, people share their pictures. Here’s how I looked before and how I looked after. They share that online. People like that, they share this stuff. The doctors do it and the consumers do it. So it has all three components in there. That makes it fairly hard to replicate. So overall, what I like, it’s a services marketplace that’s highly specialized in what it is doing. That makes it hard to replicate. The provider side is fragmented, and the services they’re doing are fairly specialized and differentiated. This provider is different than that, it’s different than that. And it’s sort of rich with content and social marketing. I like all of that. All right, here’s what I think are the negatives. Biggest problem. It’s a low frequency transaction. If you look at any of my blue diagrams, blue diamond diagrams where I show market platforms with two user groups, in the center of the platform, I always say, look, digital platforms are made of four assets. They’re made of users, engagement, data, and some degree of capital produced because there’s no money coming in, it doesn’t grow. Okay, it is hard to get engagement when you have such a low frequency transaction. I like ride sharing and I like food delivery because it’s every day people do this stuff. That’s better than say booking a hotel, which is one of the problems of Ctrip and Expedia is it’s a low frequency activity. So therefore they don’t get a lot of engagement on their platform and therefore they don’t generate a lot of data. They are continually trying to lure people back basically by paying Google to refer searches to a large degree. Airbnb actually doesn’t have that problem. One of the interesting things about Airbnb is the majority of their traffic is coming direct to their app, not through a search engine. But they still have the same problem is people don’t rent rooms very often. Okay, now Maytwan, as I’ve talked about before, they got around this problem by pairing a high frequency, low profit activity, like ordering food, with a low frequency, high profit activity, like booking a hotel room. And they offer both in their suite of services. They’re a suite of services. in a marketplace business model. Okay, SoYoung doesn’t have that. This is a very low frequency activity. That’s a problem. It’s very, they need to move into some higher frequency activity, something that people do every week, like, I don’t know, get a skin injection or a beauty treatment or manicures or something to get the frequency up, even if they don’t make money on that. Perfect, do that. The other problem they have, which is the problem that a lot of services platforms have, is they tend to move off platform. So you do the first interaction, hey, I found this great nose doctor in Shanghai, and they’re gonna do my nose, and the platform helped us merge. And the way the money works is, the platform gets marketing fees from the doctor. And then they also, when you book the reservation, you have to put down a deposit and that deposit covers the fee for the platform. But then you’re going into the office and you’re meeting the doctor personally. So if you do a subsequent transaction with that doctor, you’re not coming back to the platform. So the recurring revenue with doctors tends to happen off platform. That’s a problem. And a lot of these services marketplace like fiverr.com and Upwork and… They all have this problem. It’s just the nature of the beast. Ultimately, so that’s sort of point two, point three. Ultimately. When BCG, I talked about this in a previous podcast, when BCG talked about, I’ll put the link below, talked about why platforms fail, the number one, one of the common three to four reasons why a platform fails is too small of a problem to solve, that these animals have to get to scale for the economics to work. This might be too small volume-wise of a marketplace. It’s a problem. These are difficult business models to build. You need a big opportunity to target. This might be too small, and ultimately it’s a discretionary purchase. You’re always having to convince people to do this because they don’t need to do any of this. If you’re gonna build a platform business model, like the biggest two levers you can pull, let’s say three levers. One, target a big opportunity. Number two, make it free. That helps you get people on board quickly and not at big scale. And three, make it something people need, not something they just want. I’ve gotta get to work. I’ve gotta order food. Make it a need. It’s a lot easier to pull huge numbers of people on the platform if you’re speaking to something they have to do rather than something you have to convince them to do. This is a small volume. marketplace, infrequent transactions, for ultimately a discretionary purchase. And then the last bit, watch out for regulation. This is a space where the Chinese government in the past has been involved. There used to be like, it used to be whenever you watch TV in China, it’s like 10 years ago, you know, it was just every third commercial for a while was some sort of beauty treatment. There were all these like, girdles that you would put on and would make your waist look thinner for women. I mean, it was like every third commercial was something like this. Padded bras, girdles, and there were so many eventually the government stepped in and stopped it and said, you can’t do these commercials anymore to this degree. They do have concerns about these sorts of beauty, plastic surgery, products, because rightly so there is a segment of the population. that has a problem with these procedures and there’s something going on mentally. Where, you know, if you’ve ever met someone who’s had like five plastic surgeries, you’re like, dude, what’s wrong? I mean, this is, it’s not normal. Something’s going on. There is that. So anyways, there’s always a risk that the government will jump in. Now, to a certain extent, everything I just said that’s a problem isn’t, well, not everything, but most of them. are not a problem for the platform, they are a problem for the providers. All of those problems, infrequent purchase, government regulation, the main group that’s a problem for is the doctors. So you can kind of count on them to solve it for you a little bit. Anyways, those are kind of the negatives. For those of you who I sent out a longer, quite a bit longer email on this with a lot more in this, but that’s kind of some of the main points. And I think that’s enough for this subject. I think it’s an interesting company to keep your eye on. I think it’s a very compelling business model to think about and how you do healthcare in Asia. Cause that is a big opportunity in terms of like, hey, where’s the big money? Well, we know it’s in media and communications and advertising and it’s in retail and e-commerce. And we can see education is moving and we can see FinTech banking. But right behind that is healthcare. It’s a major sector. for digital transformation and marketplaces. And this is an interesting solution to that problem. Okay, the key ideas for those of you who are subscribers, for this one, the key ideas, which I’ll put the links below, are marketplaces for services. That’s one of the concepts in the concept library. And then how to think about B2B transactions, necessary versus critical versus strategic. Those are the two important concepts for this. And SoYoung International goes under the company library. at jefftausen.com. All right, let’s go into network effects. So network effects, super important. Everybody talks about it. Oh, and reminder, the question I’m going to ask you, how would you measure a network effect? Like what number would you put? If you had two companies and both said we have network effects, how would you determine which is stronger and by how much? Now, network effects, like all the concepts I’ve sort of… put into these lists, which are obviously the concept library. These are all kind of like tools. They’re sort of like phenomenon that certain businesses can have. But they’re very different depending, you know, I’ll use an animal analogy, which I don’t know if these are helpful. If you say, oh, we like animals that have claws, OK, claws would be an idea. It’s a tool. It’s an aspect of the animal, just like a network effect might be the aspect of this company. of a particular company. But that doesn’t, I mean, that’s just the highest level of thinking, because if we say, okay, claws, what does that mean? Well, hawks have claws. They use them to swoop down and grab stuff. I don’t know, rabbits, fish in the water. Tigers have claws and they use them basically to kill stuff with one swipe, which is pretty impressive. Cheetahs have claws, but they don’t use them to kill stuff at all. They use them as cleats so they can run faster on the ground. They don’t retract, which is kind of interesting. Leopards? Well leopards use claws to climb trees because they like to kill baboons and they like to kill things and then carry it up the tree and eat it there. They use them. you know, for climbing as much as anything else. So it’s all clause, but depending what you’re talking about, it’s very different. Network effects are the same way. There’s different varieties of them. There’s different strengths of them. They are used for different purposes in different situations against certain types of customers. And you need to take it down to that level and sort of tease it up. And there’s a whole world of thinking there. And that’s how… That’s really what you want to be. You want to be the person who looks at a concept like a network effect at a company like a SoYoung and can see it on one, two, or three levels in a way that everyone else is seeing it at one, because that’s when it generally becomes an investment opportunity. Everyone’s going to know it’s got network effects, but you know it’s better than they think, or you know it’s worse than everyone thinks. It’s that second order thinking. Everyone said Uber. Oh, Uber’s got network effects for a long time. And a lot of people like, the smart people are like, no, it doesn’t really. It’s got local network effects, but it’s not what, you know, it ain’t Alibaba and it ain’t Amazon. Different. So you wanna think about it at that level. And then also you kinda always wanna think about when these ideas break down. Okay, you had a network effect, but now it’s gone, or it’s decreasing, or it’s fading away, or it’s easily, you wanna know when the phenomenon has sort of a border. so that you can see when something is changing and others can’t. Anyways, there’s a lot there beyond, oh, it’s got a network effect. Now your standard definition of a network effect, which is pretty solid, is it’s when the value of the product or service, not the economic value, the perceived value to the user of the product or service is… Increasing with increasing number of users and or activity Now that’s actually a little bit different It’s a network right so the simplest version is I have a phone Other phones, let’s say landlines other Phones where the line is going into a house each one of those phones is a node in a network So there’s the node and the linkages between the node Every time you add more nodes the value to a user of one of those nodes, the phone, goes up because I can call more people. So that’s one where the perceived real or imaginary value of the product or service to a user increases with the number of nodes. I can call more people. Now that was kind of the old way of thinking about it. Now, as things have gone digital, we’ve started to sort of conflate the idea of nodes with people. Okay, the more people on Facebook, the more valuable it is to me as a user of Facebook because I can connect and communicate with more people. So they would say, oh, the network effect is about the increasing number of users. Not true. User is just kind of a node, like. A user is someone who’s staring at their smartphone screen. It’s not necessarily about the number of people. You can look at it at two levels. If you’re looking at a physical network, everyone talks about the physical nodes. If you’re talking about digital, sometimes you’ll kind of mix the language and they start talking about people and not nodes. But a network is made up of nodes and linkages. That’s really what it’s about. But it’s fine to think about users most of the time. More people are using this app, therefore the value of each user is going up. That’s a network effect in the user language as opposed to nodes. However, there’s the number of nodes or users, or you can think about it in terms of the activity. You know, if you add a bunch of people on Facebook in Uruguay, that doesn’t increase the value to me. Doesn’t. If it’s a phone system and you add Uruguay, that also doesn’t help me because I don’t really call anyone Uruguay. So you have to sort of think, look, not all nodes have the same perceived value to all users. This is why Metcalfe’s law, which I think is kind of dopey, is not true, because it assumes the bigger the network, the more valuable. Not true. Certain nodes are more valuable than others. WhatsApp was very popular and took off very quickly because it connected you with the people you most wanted to talk to, your friends and family. And those are the most valuable. They said that, they call that a clustering. So you can measure the nodes, you can measure the clustering, all of this. You can also kind of measure the activity level. Look, I can be connected to a bunch of people, but it’s really the people I’m talking to most frequently. It’s the number of interactions. If I’m on a marketplace and there’s a ton of merchants, but each merchant only has one or two items posted and there’s not a lot selling, that’s not as valuable to me as five merchants who are always putting up new content or whatever. So you could also say maybe it’s the activity level that increases the value, not the number of nodes or not the number of sort of clustered nodes. I mean, there’s different ways you can tease this out. Also, if we’re talking about a platform business model with two user groups, you have to think about the perceived value to each user group. If I’m on SoYoung and I’m looking for someone to do a nose job on me, the value of that platform to me, as a product or service is going to increase with the number of choices up to a point. If I’m living in Shanghai and it connects me with 30 plastic surgeons in Shanghai, I don’t necessarily need another hundred. So the value to me is going to increase with each marginal merchant provider to a point and then it’s kind of flat line. However, if I look at it from the provider point of view, the perceived value, the network effect to the provider is pretty much linear. If I’m a plastic surgeon in Shanghai, the more people in Shanghai on this platform, the more valuable it is to me, full stop. It just keeps going up because I can do more and more business. So you have to look at the network effect, the perceived value to each user group differently. And then final bit on the introduction to this thing is, how does it behave over time? Does it flatline? Does it go up? Does it accelerate? The shape of the curve matters for each user. And then there’s this idea of direct and indirect network effects. Direct network effect is we’re the same user group. The more people on WeChat, the better it is for everyone on WeChat. Indirect network effect, often called cross-side neck-way right, is the other side of the platform. I’ve gone through this many times. The more merchants doesn’t help the merchants, but it helps the consumers. The more consumers doesn’t help the other consumers, but it helps the merchants. So indirect cross-side network effect versus direct network. effect. Okay, now why does this get I think confused? Because when you have a network effect you have three effects happening that are different. They’re all good but they’re different. So you will hear arguments like, well a network effect is a competitive barrier. Once you have it, once you’re DD, it’s hard to break in. As a network effect starts to take off it will accelerate. You know the more users you get the more valuable it is to everybody. Therefore, you’ll pull ahead and the market will quickly collapse to one to two players. VCs talk about that all the time. Now, all this is, well, once you get someone on a network effect and they’re locked in, you can have a lot of sort of profitability there unless they can multi-home. Like, DD drivers can multi-home. Well, not DD, but Uber drivers can multi-home with Lyft. You’ll hear sort of all these various effects. I think it’s kind of confusing the way people talk about it. Basically, I think it’s wrong. I think there’s three separate things happening. So here’s the first one. The first one is a network effect, whether in a early stage, just growing company or a mature, stable market, stable company, it is a competitive advantage. It is a competitive advantage on the demand side. So people often call this part of it demand side economies of scale, which is parallel. to supply side economies of scale. If I have a factory and I’m three times bigger than the factory down the road, I have a cost advantage because of the difference of size, size by meaning volume of production, versus that one competitor due to the size. So I have a, they can’t produce widgets at my cost, they can’t. So that advantage, which is a cost side advantage, is specific to one competitor. It’s my size versus theirs, scale versus theirs. And it depends on the difference. They can’t do what I do. So if you look at my digital competition pyramid, this is the green, this is the highest level. This is like, look, you may be able to break into my business, that would be buried into you, talk about that in a minute. But once you’re in there, you can’t beat me because I’ve got a cost advantage on you. This is the same thing. Because my platform business model for surgeries or whatever is 60% of the market and your platform is 25 or 30 You can’t offer the same service. I can I have more providers. It is a better service. That is a hard competitive advantage BAM just like the big factory versus a smaller factory however, that advantage is only specific to my smaller competitor and if they get the same volume I have then my advantage goes away. They can match me in terms of the service they offer. Now, what’s interesting about this is it kind of bleeds into the idea of economies of scale. It’s like, okay, but what if I’m a chicken restaurant and I’m bigger than my competitor, I’m KFC, and I’m four times bigger than my competitor. Okay, now my product or service, the chicken, is not better. because more people ate at my restaurant than that restaurant. But don’t I have some kind of advantages? Like I got more money, maybe I’m doing more R&D, maybe my stores are nicer, maybe my stores are in better locations because I can spend more. I mean, isn’t just being bigger in any form, to some degree, start to become a better service or product? Maybe on Walmart, maybe because… I’m bigger than my competitor, I can buy goods cheaper at purchasing economies of scale. Isn’t that kind of a better service as well and I’ve got a bigger store? And that’s true, that network effects, demand side economies of scale do tend to sort of bleed into the idea of just economies of scale in general. But I think you can draw a hard line and say, no, I mean, this is a sub case. Think about is the product. service dramatically better because of your demand side volume difference. Bam. Don’t let people do these two or three step arguments. Well it’s like well because I’m bigger I have more money and because I have more money I can spend more on R&D and because I have more R&D my product don’t don’t let them take two or three steps down the road. It’s got to be direct. I have more merchants on my platform my platform’s better. Bam. Okay you can also tease this apart a little bit by okay what do you mean by better? How is SoYoung better than a smaller marketplace platform? Well, you wanna be able to explain that. Well, maybe it’s better at finding matches. Uber and Didi are better at finding matches for a ride within four minutes to get me a ride than a smaller service. That’s true. Is the service better once I get in the car? No. Their advantage is mostly on the matching aspect. But when I’m actually looking for a different service, like I’m on Amazon or Alibaba, it’s the variety of the merchants that is better, not the matching. I can hunt around for a long time. I want the wider spectrum. That’s what’s valuable. WeChat is more about enabling communication. Maybe it’s about providing better comfort, like I can stay at Airbnb because I trust. You wanna be able to sort of describe the nature. of the network effect. Why is it more valuable? The better language you have here, the better you can think about it. Now let me give a little credit here. Some of these examples I’m giving you right now, there’s a professor named Andrea Hagiau, H-A-G-I-U, who writes about this, some of his thinking about the nature of these, this is his thinking, so I don’t want to take credit for that. Most of it’s mine, but that bit’s his. Okay, when you take apart the competitive advantage aspect, you want to think about what is the, you know, is it differentiated or is it a commodity? A company like Airbnb and Expedia with hotels are a lot better because hotels are differentiated. So the more of them you have, the more valuable it is because they’re all different. Maybe you want a hotel on the beach, maybe you want it on this street, whatever. If it’s a commodity service and a differentiated service like a ride, the network effect tends to be weaker. That’s true. If it is global versus local, global tends to be much better because I want a network of hotels everywhere because that’s how I travel. I only want to ride in my town, tends to be local. Local tends to be easier to copy. And generally speaking, and this is what I think Ant Financial speaks to very, very well when they talk, your network effect is not static. It’s not like you offer a service and that’s it. You have to continually innovate. on both sides of the platform to each user group to continually add more and more value. It’s not a, if you just stand still, here’s my network effect, I’m Airbnb, someone eventually is gonna copy you. And Airbnb has been very static. And financial, if you read their IPO filing before they pulled it, they talk about, we have a network effect, but that network effect is critically dependent on sustained innovation that creates value for our user groups. They’re always pushing that curve because they know people will catch them. Okay. All right, so that’s the first big effect of network effects. Think about it as a competitive advantage, just like in my chart, look at my pyramid, the green level near the top. I’m gonna finish up here quick as I’ve been going for a while. Second effect we see is a barrier to entry or another type of competitive advantage or soft advantage. If you look at all my digital strategy pyramid, competition pyramid, that’s the light green. which is the next level down. People always conflate these two, they mix them together. I have an advantage, I have a moat, and they start talking about two things. They talk about competitive advantage, which is a long-term structural advantage versus a barrier to entry. Hey, it’s hard to jump in this business. Some businesses have both, some have one or the other. Have Coca-Cola, no barrier to entry. Very easy to get into their business. But once you get in there, they have a massive competitive advantage. You can’t beat them. Opening a hospital up in the mountains in a small town, very significant barrier. You have to pay a lot, it’s hard to get the land, it’s hard to get market share because it’s a small town, the existing competitor has it. There’s a barrier, but if you can pay the price, get over it, once you’re in there, they don’t have an advantage over you. Sometimes you have both. Network effects also get you this. So the easiest version of this is chicken and the egg problem. to launch a platform business model is hard. They also call it the cold start problem. To get the merchants, I gotta get the consumers. To get the consumers, I gotta get the merchants. That first step is hard to get going. That’s a barrier to entry. Now you can pay your way in and you can, you know, if you already have one user group, you can add another. There’s ways around it, but that’s a pretty good barrier that people talk about, especially if there’s an incumbent. if it’s very difficult to get this platform to go because what you’re coordinating is difficult. It’s actually fairly easy to coordinate ride sharing. You know, I just need a driver, I just need a rider. If I can get them on the same platform, they’ll find each other and do the deal. It’s much more complicated to coordinate a transaction between a plastic surgeon and a consumer. There’s more, there’s the content, there’s the social media, there’s the user-generated content, the professionally generated, there’s a lot more there. the coordination is more difficult to pull off, therefore it’s more difficult to replicate. You could think about this as a Professor Hagia, I think I’m saying his name wrong, idea which is synchronous versus asynchronous matching. It’s harder to synchronize a match that has to happen in real time. I’ve got to get a rider with a driver now, otherwise it doesn’t go. So that means I have to have more of them on the platform at any given moment because it’s synchronous. An asynchronous thing, look, there’s a merchant on, but they’re not online right now, they’ll be back at five. You can still buy stuff from them, it’ll just happen over time. So an asynchronous platform is harder to replicate than an asynchronous one. Difficulty of coordination’s an issue, chicken and the egg problem’s a thing. And then the other side is like, okay, that’s a barrier to entry, but you can also just think about other types of competitive advantages that aren’t network effects. You can think about switching costs. which people call lock-in. I can lock in the drivers on DD, I can give them long-term contracts, therefore if you wanna take them, it’s much harder. And that can play out at the barrier to entry level and it can also play out at the competitive advantage so it can play both. So oftentimes you’ll hear people who talk about network effects talk about multi-homing. I don’t really think that’s worth thinking about very much. It’s just switching costs. I’ve given a lot of talks on switching costs. That can play out in both sides. You can build in other competitive advantages. to both user groups that lock you in even more, that do other things. So that’s kind of, let’s say two or three effects of network effects. It can be a competitive advantage, it can be a barrier to entry, and it can be another type of competitive advantage that’s not a network effect that might, you know, that kind of ties in. That’s three. Last one, then I’m gonna let you go, I promise. Last one, which I guess is either number three or number four is you can get a flywheel. virtuous cycle. This is a different thing. This is the argument, hey we’re a young platform, we’re just getting going, but as we get more users the service is getting better. There’s more merchants you can buy from. Because it’s getting better we’re getting more data and we’re attracting more users because they know this platform is better than the competitor because it’s a little bit bigger. Therefore they come here, therefore we get even more people, we get more merchants. It’s a flywheel, a virtuous cycle. That is not the same thing as a competitive advantage. You can get flywheels in a lot of businesses that play out over time, they’re nice effects, they’re not the same thing. Those tend to go away fairly early on. So that’s it. Three or four big effects of network effects. Competitive advantage, barrier to entry, flywheels, i.e. virtuous cycles. Different things tease them out differently. And one last point. All of, everything I’ve just said is about competitive dynamics, which is my area. None of this means you’re profitable. None of this means your unit economics are good. Generally speaking, competitive power is a prerequisite to profits, but it ain’t a guarantee. Oftentimes, you can have competitive power and the unit economics might be determined by the external environment, by the, maybe there’s a lot of free substitutes, maybe there’s a lot of reasons. where you can have a good business that’s dominant, that doesn’t make money. Oftentimes it’s just beyond your control. Can’t do it. People tend to conflate the two. Last one, virality. Virality is totally different. It’s not the same thing when your users become sales agents for you and other things, but different thing, but people always lump it together. Which brings me to the question. If I told you a company like SoYoung, or take an easier one that you’re more comfortable with, let’s say if you’re in Southeast Asia, pick Shopee. If you’re in China, pick Taobao. I don’t know if you’re in the US, pick Amazon. How would you measure their network effect versus a competitor, right? It’s always relative that this one’s stronger than this one. How would you do it? What number or two numbers would you point to? Because you want to put metrics around these things. What would you do? Let’s say it’s a marketplace model where buying and selling physical goods like a Shopee and you had two competitors and one was bigger than the other, how would you, how’d you put a number on it? Are they a lot bigger? Are they just a little bit bigger? What would you do? Take a minute, pause the podcast, take a stab at it. Anything you can think up right now, even if it’s hair brained, that’s what you’re gonna remember six months from now when this is maybe faded in your brain. The more effort you take now, the better it’ll stick. So take a minute, pause, writing it down is better. Pause now. Okay, how’d you do? Now this is actually kind of tricky because often times with a competitive advantage you can’t always point to how it works. Like you can’t show it exactly. You can generally measure the outcome, but you can’t always say how you got there. I don’t know why people like Star Wars. I don’t. I can’t put a number on that, but I can see it in the numbers at the end. I can see the result. That’s clear they’re there, but The steps that got them there, I’m not totally sure how you put a number on that. A lot of competitive advantages like that. Now the two outputs I’m always looking for are return on invested capital, your operating profits, post-tax, after cost of capital, versus a competitor. It’s a relative distinction. And that should be higher over time, although it can swing within the short-term fairly. radically depending on the market and depending what management is choosing to do right then. Look for ROIC and then I look for market share. Stability over time. You know if this company’s had 30 percent of the market for 10 years, okay they’ve got some sort of barrier. Now this is where the difference between me and say Hamilton Helmer is he’s looking at that first number of ROIC because he wants to see competitive barrier with attractive economics generating significantly higher profits. I don’t always think you get both of those things. I think there’s a lot of companies out there that have very good competitive positions, but the economics are not awesome. And so you won’t see it in the ROIC, but you’ll see it in the market share. That can be a very good, I would put that in the category of wealth preserving versus wealth generating. There’s good reasons to buy a hotel on the beach. It ain’t gonna go up in ROIC all the time, but it ain’t never gonna go down. So if you get a good price, that’s a fine place to preserve capital. And you make a bump on the margin of safety. So it’s a little different. So I look for those two outputs. Now, economies of scale on this cost side is easier to measure, and I’ve talked about this before, which is a surplus margin leader, which you can search, you can go to my concept library, I’m not gonna go through that again, where you can look at like, if I were to price my product as a bigger factory, such that my competitor who has a smaller factory makes zero money, how much extra margin would I have? So you can put a number about how big is my advantage. Harder to do that on the demand side economies of scale network effects. I’ll put a link in the show notes to something that Andreetson Horowitz does, because they really think about this question where they have like, I think it’s 11 metrics they look at for network effects. They look at economic results, they look at operational results, they look at cost of CAC, customer acquisition costs, because in theory, if your service is getting better and better, or your service is better than your competitors, you should have a lower customer acquisition cost. I’ll put a link, but that’s mostly for early stage stuff, not later stuff, because they’re venture capitalists. Anyways, it’s a fun question. I do try and put numbers around competitive advantages. I’m only successful about a third of the time. Generally, I’m looking at qualitative factors and I’m looking at the results. Because they’re complicated. I don’t know why people buy Coke and not Jeff Cola. I don’t know. You know, it’s subtle, it’s psychologists, a lot of stuff. Okay, I think that’s it for today. Hopefully that was helpful. I think this is kind of a fun subject. The key concepts for today for the SoYoung Marketplace for Services and this B2B purchasing necessary versus critical versus strategic both of those are in the concept library. Also the other idea is network effects. I’ve listed four well it started out as three but it turned into four effects for network effects flywheel, buried entry, competitive advantage, other competitive advantage and then I think that’s enough. So anyways those are all in the And that is it for the content. Let me ask you a question I was thinking about this morning. You know, there’s a lot of content here. And up until recently, I was sort of having seven levels where people move level to level. They read stuff. I send emails every two days. Here’s what you should read today. I pivoted away from that to more of an investment focus with the idea that I would launch a couple standalone classes you could just take. to work your way through all the ideas in a more focused short-term way. Because I think it turned out that like, slowly moving through all the content level by level over a year was just too long for people. I needed to break it down into bite-sized pieces. Like, here’s a course you can take in three weeks to get you through everything about network effects and virality. Boom. And that’s what I’m trying to do. I’m just, I have a hard time getting to it. But. If you would like me to keep sending out emails on here’s what you should be reading level by level right now, please let me know and I will do that. I don’t wanna leave anyone hanging if you’ve been working your way up and suddenly I’m not doing that. So please let me know and I’ll figure something else. Otherwise I’ll do the bite-sized courses once I can get to it. As for me, life is going pretty good. Just hanging out, lockdown is being released, removed in Bangkok. right now, hopefully it’ll be gone. I’ll probably start bouncing around Thailand a little bit, and as soon as I get a vaccine, hopefully I can get back on some airplanes. My latest sort of discovery is I’ve been doing RoV, R-O-U-V-E-Y, which is indoor cycling. You know, you sit in your apartment and you ride your bike and you stare at the TV and then you sort of tap into these online biking platform business models, really. Zwift is the one that most people use right so then you’re suddenly riding in a pack with a bunch of people from all Over the world, but it’s kind of animated not I don’t really enjoy that as much, but there’s another one called Ruby Which is basically videos taken from around the world so as I’m as I’m pedaling along I’m staring at a screen. I’m basically going through the mountain passes of northern Japan, and it’s the actual pass I mean it is camera video taken of the road so suddenly it’s like I’m I’m kind of doing little quasi exploration vacations of various places around the world and it’s been great. Yeah, the Japan one was fun. I’m gonna do Italy tomorrow. So pedal for maybe probably an hour through parts of Northern Italy and then I keep bouncing around. It’s great. I’m training, my goal, which maybe it’ll happen, maybe it won’t, is I’ve been hoping to do a long ride across Japan, probably. Not the whole island, that’s crazy. But let’s say 500 miles, which would take me two plus weeks to do, and I could get across a big part of the country in 500 miles. So that was my plan, and then COVID’s everything, and not only is it, you don’t know if you can fly, but I can’t get into the gym here, because every time there’s a lockdown, they close all the gyms. So I got a trainer for the apartment, and I’ve been doing that, and Ruby, R-O-U-V-Y.com. I’m enjoying this. immensely. I’m looking around for other rides to do. So if you know of any, let me know. Like on Ruby, I’m like, I think they have a lot in Europe. They have a lot in sort of Tour de France and where, you know, where the serious cyclists go. I’m not as, I’m a, I’m a amateur at best, but the serious cyclists, there’s certain routes they do like Maui and Switzerland and France. So I’m looking for the most popular rides. Anyways, that’s kind of my thing for the week. Alright, I’m gonna check out. Hopefully this was helpful, and I hope everyone’s doing well and having a good week, and I will talk to you next week. Bye bye.