Elon Musk’s acquisition of Twitter may end up being one of the worst business decisions of all time. There is already a book to be written about on the subject – a chapter on flawed financing strategy, one on pricing, and multiple chapters on human resources. There have been mistakes all over the place, but there is one specific area I am curious about: network effects.
In fact, Twitter may be on the cusp of entering a negative feedback loop due to network effects and a dysfunctional business model. Let’s unpack what is going on…
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What are Network Effects?
A network effect is the idea that a product or service is valued based on the number of people using it. Most products have inherent usefulness or value – a hair dryer is just as useful to you no matter how many other people have one. Products with a network effect break this rule. Take the example of the phone:
- If no one else owns a phone, buying a phone would be valueless.
- If everyone owns a phone, they are extremely valuable.
But you run into a problem – how do you get from “no one has a phone” to “everyone has a phone?” There is no incentive to be the first person to buy a phone, so the value of the network is never proven. How do we break out of this situation?
The Cold Start Problem
This dilemma is known as the “cold start problem,” which is explained in a book by the same name. The book is by a former Uber and current a16z bro and has several flaws, but it understands many essential features of networks well (or at least better than Musk does).
There are several factors for getting over the cold start problem, but one key ingredient is understanding who is unusually valuable to your network. If you can find a way to get “the hard side” of the network operational, you may be able to build some momentum and growth.
In the case of Uber, the “hard side” was dedicated drivers. Cities with enough full-time drivers for riders to usually get a lift relatively quickly would thrive, while those without a core of active drivers would not get traction. Once this was realized, Uber’s early efforts in new cities always focused on driver acquisition, including huge bonuses.
For chemists, you can think of the cold start problem as an activation energy. The “networked” state may be more favorable but getting there is a big challenge. Until you can overcome that activation energy, you are just stuck with a product that seems like a dud, which risks the small user base losing interest in the product that is not delivering the expected value.
Twitter and Network Effects
Twitter relies on network effects to deliver value to users. If you have been on the platform, you know a limited number of accounts are doing the heavy lifting to generate content. Top journalists, influencers, publishers, and commentators of all stripes are the true core of the platform.
These content creators are “the hard side” of the network. They have something interesting to share and are willing to share it for free on Twitter. You need to design your product to reward these creators and make them happy.
This is where verification comes in. Let’s use an example of a famous journalist. Having the blue check is nice, but the real benefit is you are harder to impersonate. Anyone pretending to be you would not have a blue check.
Or at least that was the case before you could be verified for $8 a month. It is WAY easier for people to impersonate you. People can pay for verification, change their name and picture to match you, and use your reputation to share conspiracy theories and dangerous websites or make inappropriate remarks.
While the total number of people who would leave on these grounds of being impersonated is low, there will have a cascade effect. You are losing the people who fill in the “hard side” or the network. People who have liked Twitter will suddenly find none of their favorite celebs or influencers are active. This could lead to a decay in usership.
Advertisers and Network Effects
Social networks like Twitter have another fascinating aspect – they are both social and advertising networks. Advertisers pay Twitter to show ads, which are viewed by users, making it a three-sided network. The site needs all three players for the site to work, but the advertisers are clearly the “hard side” of that equation – getting people to use your free site is not as complicated as getting other companies to pay you billions of dollars.
The verification fiasco has, once again, screwed the “hard side” of the network. Let’s say I work at a multi-billion dollar company, and some random sets up a “parody” account making fun of my company. Perhaps this account jokes about past scandals or “admits” to criminal acts. While many people will realize this is a fake, it is not hard to imagine that some people may be confused. Haven’t we all been trained to see the blue checkmark as legit? With so much risk on the platform, why would you reward them with money? Will customers think less of you for giving your money to Twitter?
Even if people know these accounts are parodies, it still isn’t a great look. Tonight, I encountered a Tesla parody account that was funny. I knew it was a parody, but it absolutely reinforced negative impressions I have of the brand. The account seems to be locked when I write this, but it was active for at least a couple of hours. One would imagine Musk-related properties could be getting special treatment in terms of security, so it seems possible that some damaging content could get a lot of views before it can be taken down.
Of course, all of this may be moot by the time you read this. Musk and Twitter are wildly thrashing around, trying anything to stop losing money. The company appears to be in a tailspin. They may achieve some soft landing, but I am not optimistic. In the meantime, almost anything could happen, so I will not make any bold predictions.
And it should also be mentioned that the issues I’ve highlighted are only part of the complete gong show. There are personnel issues at every level of the company, potential legal troubles, and an owner that looks to be fiddling away as Rome burns.