You're listening to episode 4, the 4 pillars of defensibility from the network effects masterclass Pete on the NFX podcast. This episode is hosted by NFX general partner, Pete Flint, as he walks you through the other forms of defensibility, including network effects. To watch the course, visit nfx.com/masterclass. So I first realized the power of network effects from my experience at last minute.com.
So last minute.com was a late 90s web 1 Flint o company Beller joined as part of the founding team in the travel space, and we were providing a travel marketplace for everything from flights to hotels to tickets to car hire. At the end, it was a phenomenal success, it sold for over a $1,000,000,000 in 2005. So I moved to Silicon Valley after lastbin.com and and to attend Stanford and really stumbled across the real estate industry.
And ended up attending a real estate conference and driving back, that day, I started to connect the dots and see how what had happened in European travel was going to happen to the U. S. Real estate industry, where there would be a a marketplace that would provide transparency to the consumer as well as provide a platform to help the supply side market that goods and services.
So I set about to build a marketplace in the US real estate industry that became truly a and really thought about it from the principle of, like, how can I amass as much supply as quickly as possible and then track consumers on top of that? Like, how do you find this fragmented supply in this high value transaction and build a better user experience on top of that? And help consumers to find exactly what they need.
So my entire career frankly has been about network effects, for 3 James, all of them fundamentally being network effect companies, 2 unicorn companies, and then within effects, hoping to invest and help the next generation of phenomenal network effect businesses. So the partners at NFX are focused on giving you the power of network effects, the insights, the tactic, the hidden secrets to enable you to incorporate those ideas into your startup from day 1. So defensibility really means resilience.
And the fact that companies can survive against what the reality will be of any successful business is an onslaught of competitors or substitutes. And understanding how you can build that defensibility early on means only you can have a a successful company but also you can have one that can dominate the category that is executing in. So you should really care about defensibilities from the early stage of building a business. There's so many things as a as a startup founder you need to focus on.
And looking at how do you not just build an interesting product or an Morgan company, but frankly, one that doesn't have substitutes at scale. And thinking about the different types of defensibilities you can build in in a startup to ensure that you have the opportunity to become a category leading company and to dominate your industry. So there are 4 major defensibilities in the digital world. Of course, there's network effects, but beyond that, there's brand, embedding, and scale.
And we'll walk through these. So of course, you can build a really interesting business. There's not number 1 that doesn't have network effects. But the real opportunity is if you're able to incorporate these network effects early on and find industries where they can have massive defensibility at scale. That's the way to build category defining companies with ultimately, huge market valuations, but it's critical you think about network effects from the beginning.
It's so much harder to add those in a later stage, and picking businesses and markets and products that can have that network effect in the beginning is critical to enabling you to incorporate those later on. So brand arises when consumers or companies understand who you are and what you do. And it drives this psychological switching costs. You have this natural preference over one company or one brand over another, and that's really critical.
To enable consumers to be drawn to your product not only do they pay higher prices for it, but you end up getting lower customer acquisition costs for the product or service. In many ways, brand is a proxy for trust, and consumers are risk averse. And so to to have a well known brand and more defined brand enables start ups and companies to bring over customers and retain them that they would otherwise not.
And today in a society and media, which is the so many distractions and so many interruptions. Having a brand is critically important for a combative rise rise above the noise of all the potential substitutes in that market. So early stage founders You really need to think about this from the earliest days. How do you define your brand? How do you stand out? How do you have consistency in what you do? And have high visibility in the brand that you're creating.
So to build a successful brand, at the earliest age, you don't need a lot of money. You don't need TV ads, but you do need to ensure that your brand stands for something. The most powerful brands in the world have a specific purpose and specific mission. And by repeating that again and again, alongside a clear visual identity that's consistent and then amplifying that across as many media channels as possible will create an efficient, but important platform to build a long term successful brand.
The best early stage brands are often ones that are surprisingly quite controversial. They stand for something. They make an impact. They make you think. And that can be quite uncomfortable.
But to have an early insight, which makes you stand out in that marketplace, backed up with a consistency, a repetition, clarity of message that you you don't confuse the message of your your, your, your company and your brand enables you to build that platform on which to build a significant brand Beller time. Go to nfx.com/masterclass to watch this course with a full video experience alongside transcript show notes and additional reading.
The NFX Master class tracks your progress and allows you to move at your own pace through the material. We will also be adding new seasons to this streaming form, so be sure to register so you can gain early access to new material from NFX. And now back to the episode. So as an example, take the smartphone industry, you have Apple and Android, which have functionally similar very, very similar products.
Whereas Apple with its much stronger, stronger brand is able to charge a much higher price than the Android phones. And the US, you've seen how in the luxury Morgan, Apple has dominated.
It's, you know, internally, it seems that they think of it very much as the kind of luxury fashion industry, whereas Android and Google is seen as much more of a utility, certainly is a phenomenal component to their business, but they perceive very differently, and each of them have define their brands quite differently, and they dominate each of those different segments in that market. So brand is particularly important in categories where there's like many options.
So it could be commodity products or services. Because it helps consumers to shortcut the decision making process and choose the brand or service that's right for them. And also enables our company to have, you know, easier customer acquisition and higher prices. The other end is those that are really high consideration purchases. Where trust is paramount.
If you're going to choose an investment bank to make you go public, you don't want a no name organization, you want the strong branded, trustworthy service. The similar James goes for enterprise software. We're building a thoughtful brand, that's trusted, well known, is critical for the success of that organization. So embedding is another defensibility that can work with network effects to increase defensibility.
So what embedding is is it's deeply integrating your product or service into another customer's operations. So it's just deeply wound into that and bound into their organization, making it very hard to remove thus increasing the switching costs of that product to service into the into the others Morgan. So people think of when people think of embedding, they often think first of enterprise software. Think of the Oracle or ERP systems that are kind of embedded into a corporate IT infrastructure.
But where we are today, we see these, this embedding in in all sorts of forms, whether that's cloud services, APIs, take Stripe, for example, Stripe provided a simple, e commerce payments platform that will enable developers to quickly add that service into their websites.
They focused early on on small, fast growing companies, that enable them to scale, scale over time, frame rates significantly to become a massive Morgan, same with Twilio, providing APIs to communication services, something that was traditionally very hard. They've made very, very easy.
They made that embedding very, very simple for developers who incorporate into their websites, enabling an example would be Uber, to provide send text messages very efficiently, and this Uber grew twilio benefited from that. So we see embedding as a really important, defensibility that really increases the the switching costs of your product, thus creating significant defensibility.
So if you're pursuing an embedding strategy, It's really important to understand who the decision maker is in the organization. So traditionally, embedding was employed by enterprise software companies that would higher expensive salespeople that would go after, selling into the CIO or the CFO, and and that still works today. For certain types of platforms. Many other companies are focused on identifying who is the decision maker in the organization could be a developer.
And building a community, and a brand focused on those developers and giving them the tools and the documentations to make it incredibly easy. Taking out the friction of the service and and building a highly scalable platform that they in court can incorporate into this service.
So if you're pursuing this strategy, you really need to understand who is a decision maker and how do you take as much friction out of the process as possible, and figure out a way to target those decision makers so they become familiar with this product or service that you're offering. In other words, embedding directly heightens the switching costs by the organization adopting the product.
In effect, it's practically impossible to rip these services out at scale because they become so mission critical to the company organization that that the leadership just doesn't want to focus on changing it and we'll we'll keep that service or product in the organization. Sascale is another important defensibility.
So by scale effects, we really mean economies of scale in that the at scale a an organization is able to reduce the unit cost of a particular component or services providing so to provide these economies of scale to enable that product to be done cheaper or better than could be done otherwise by a smaller competitor. So as an organization scales, they build that inherent cost or functionality advantage as they get bigger. We often see scale effects exhibiting a flywheel effect.
In that, take, for example, a company that's manufacturing the the more they manufacture, the cheaper the cost of those individual components are to manage manufacture. Thus the, cheaper the entire product or service that they're building is that attracts more customers than those enable them to buy the component materials at a cheaper price. And so the flywheel continues. This is quite different from network effects. It can be often confused.
But that flywheel effect is a key driver of startups that get velocity to provide this economies of scale or the scale effect. So Amazon has many, many defensibilities, but it clearly has a significant scale effect. So let's take the economy to scale of the warehousing. The bigger the warehouses, the more warehouses they have, the more efficient they are to operate, thus enabling you to get your goods at lower prices faster.
They also have, massive scale effects in their AWS business, providing computation or storage at lower prices, than competitors because they have built this huge infrastructure. So another example of a company that's really used scale effects to provide its primary defensibility today is Netflix. They actually started much more as a marketplace, defensibility, and network effect business, providing third party content, to a subscriber base.
And then over time, to really reduce the multitenanting that they saw on the on the supply side of content really trying to be in all the key places that focus on building and creating proprietary content or shows that they would invest heavily in, that they'd amortize their cost over their large and increasing subscriber base.
So where they are today, they have 1,000,000 of millions of consumers paying subscription fees, they'll be able to use that to build this and fund this proprietary content thus to Flint, thus building the scale defensibility within their platform. So while scale effects are interesting, We generally discourage early stage startups from focusing on scale effects. They really become beneficial at scale.
And at the earliest stage, there are other forms of defensibility, which are much easier to get going and provide much more defensibility. There are 4 major defensibilities in the digital world.
But in certain categories, we also see IP as a defensibility, particularly in science and bio, and our focus on tech bio companies, we see IP defensibility being a often a critical component, helping and and finding these novel scientific innovations with really proprietary IP can be a form of core defensibility. So all these defensibility is absolutely not mutually exclusive. Many of the largest startups and and companies have a combination of these defensibilities.
They build a brand, they have embedding, and they have core network effects. So they work absolutely in console. The Currier stage startups, we generally prefer an early stage focus on network effects because they're digitally native, because they scale so quickly, and be they're often the most capital efficient to get going. And then over time, companies can can incorporate other defensibilities such as brand, such as embedding, and at larger start ups that can provide scale.
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