You're listening to episode 5 focused on network bonding theory from the network effects master class Pete on the NFX podcast. This episode is hosted by NFX general partner, James Currier, as he uncovers concepts behind your startup as a network and that your goal to found her is to bond people to that network. This will allow you to see that any person or asset that you bring to your startup network is bonding to that network in an implicit mathematical equation.
To watch the course, visit nfx.com/masterclass. Okay. So now we're gonna talk about network bonding theory. And I know that sounds a little bit boring, but this is actually the heart of how networks get Morgan. Now, years ago, we could see the effects of network effects, but we couldn't see exactly how they were constructed like Legos or piece by piece. But now we can, because of web 3, we've been able to see the software and the math and the people and the nodes of the networks all interacting.
And now that we can see it, we can put language to it, and we can describe it and make it a tool for us to build our startups. Alright? So network bonding, Look. Software used to be the hard part about your startup. Software is getting a lot easier. What's hard now is community building is building the network is getting people and other things to bond to your networks, which is how to bond people to the network of your company because your company itself is a network. Okay?
And companies have forever made implicit decisions about what to compensate Pete, how to pay nodes to bond to their network, right, particularly in the form of shares and salary compensation.
And at the beginning of a company, you will pay someone a lot more equity to cause them to bond the network, and then you pay less and less, you know, really a power law sort of geometrically declining rate at which you give out equity in your company because once that network gets bigger and stronger, more and more people will join to that network. Now what I'm proposing is that by being able to language it and see it and understand it, we can now make it a tool for building your companies.
We wanna take these historically implicit calculations that networks are are making and make them explicit so that we can see them. And let me walk you through that right now. So there's a mindset shift that you need to have in order to see what I'm talking about. Which is you've gotta go from the idea of a single player game to the idea of a multiplayer game. And so if you're building a game you know, of solitaire. That's a single player game.
If you're selling a SAS tool to an enterprise company, they buy your tool, they use it for their data, that's it. That's all it all it is. But if you think about how to turn everything you're doing into a multiplayer game or think of how what you're doing is a multiplayer game and you didn't see it that way, you will start That's the easiest way I've learned to help founders start to see what I'm talking about, which is how do I add other Pete?
Into this game sit arrangement we have with each of the nodes in the network we're bonding into this multiplayer game. Okay. So just keep that in mind as we walk through the examples I'm talking about how we can turn everything into a multiplayer game, particularly your company. Let's talk about a network that you're familiar with, which is your startup. Okay. So you've got people you want to bring in. Employees, You've got customers you wanna bring in to your company.
You want recognition from a press or social media talking about them, and you want investors. Want people to bring capital into the business so that you can grow it. Okay? So these are 4 nodes. There's more, but let's just say, look, you've got 4 different types of nodes that you are trying to bond to your network. Call it a company, but it's really a network. Right? And at the beginning of that process, you might find a co founder and you split the company Pete.
So you've basically given 50 percent of the company to the very first node that's willing to join with you. Now the next person that comes along who's sort of the 3rd person how much equity do you think you're gonna give them? Maybe 8%. And then the 4th person, what do you give them? 4? 5th person, what do you give them too?
So you've got this asymptoting sort of declination of your willingness to pay people to join onto your network, then you go to an investor and you say, I need to raise $2,000,000. And that investor gives you a seed check. And for 2,000,000, maybe they buy 15% of your company. But the next firm that comes along, they might give you $6,000,000 for 15% of your company. And the next firm might give you $25,000,000 for 6 Pete for a 15% of your company. Okay?
And, again, you've got a geometrically declining amount of equity you spend in order to get that new investor node to bond to your network. Right? And we've been doing this implicitly forever. But let's make it explicit. Let's understand that that is a process you're going through.
And I believe that over time, we're gonna have software spreadsheets that will help us measure the value impact of every new employee, every new customer, every new investor, every new press release we get that gets published around, and we're gonna be able to calculate what we should be willing to pay and when to walk away from a deal or bring a new node into your network. I mean, this is true, as you know, with your customers.
If you were to land Nike as a customer, you'll be able to tell everybody else. Nike is a customer. They've made the decision to work with our software. They've made the decision to join our network. That's gonna help you land other customers. You know there's a value there. Nike knows it too, and they kinda want you to charge them less, or but we don't have a formula for it. Okay?
In the future, I believe we will have formulas for all these things because we'll understand all the math about all this specific tactical network bonding that we're doing to companies. For instance, a skeleton we can use for this is is to use maybe 4 factors in determining what you should be willing to pay and no to bond your network. Number 1, time, time since inception of the company, The longer it is from the necessity of the company, the less you're going to be willing to pay.
Number 2, the promise of the node. The node has some sort of following on Twitter, they have some sort of performance they've had in the past. There's some promise to them that you could probably measure in calculating what you should be willing to pay them. Number three, is the engagement and performance they have after they bond to your network. Right?
So for instance, if we use Twitter as another example, you could pay someone with a big following to join your Twitter network to grow out the graph and to grow attention into that ecosystem. But if they don't tweet, That's a huge problem for you. People will go to their profile. They'll see that they haven't Pete, and they'll think, oh, this Twitter thing is dead. This, you know, this isn't cool enough for you know, Kobe to be tweeting.
And so without Kobe tweeting, it actually hurts your network to have Kobe having bonded to your network. So you actually wanna compensate each node for their performance after their initial bonding. And then the 4th thing to look at is there's different curves you can use in declining how much you're willing to pay somebody.
And, you know, here's a here's an example in a graphic that shows you the various options you might have But, again, these 4 elements are a skeleton toward thinking about how you build a spreadsheet or even software to help you calculate what a new node is worth to your network. And so once you've figured out what you think a node would be worth to you to bond, then you have to figure out what type of compensation to give them. And actually there's a lot of different types of compensation.
And and I'll walk through the list with you so you can see the variety that we've already been dealing with over the last 3 years in building the companies we're working with. The most obvious one is the value of using the product. So if you look at many of the network effect businesses you know of, we've all been willing to bond to their networks. Just because they give us utility. They give us status or cheaper prices or they give us fun.
So the value of your product is actually the first and and most useful thing that you can still do going forward. The second thing, you know, you could consider is giving them cash. Right, US dollars or euros or Bitcoins or whatever, they might wanna get paid to join your network. You can see this in a lot of, entertainment products with celebrities and whatnot.
Of course, you can consider giving equity shares traditionally to your employees but increasingly, people are wondering whether it should be shared beyond employees. 4th thing you consider would be just discounted fees. We've seen that. Premier placements and traffic and attention, extra traffic and attention to people. People are willing to bond to you if you promise things like that. You give them status symbols in the system.
You give them early access to various pieces or to different communities within your product. You might give them some voting or decision making, the ability to edit things Morgan change things, really power in your network. The 9th thing you might consider is giving them premier software features, you know, it's functionality like power that other people don't have. Number 10 could be, membership into this valuable click or or, access to other nodes they wouldn't normally get access to.
Another thing could be real world perks, like dinner or tickets to the ballgame. We've seen that repeatedly, certainly in the sales process. Belief in the mission let me go back. You you could also consider real world perks like dinner or tickets to the ballgame. I mean, this is a form of compensation that salespeople have been giving to customers for 100 years. Right? Another thing you can give is really a belief in the mission. This is a right brain compensation.
It's a intrinsic motivator, but you've gotta put it on your list because some of your businesses will have the ability to create belief in the various nodes who wanna who wanna join. Another thing to think of is a commitment to a set of human relationships, another right brain intrinsic thing.
And then now we're getting into, fungible tokens, right, just people are adding tokens to certain marketplaces and saying, if you continue to run your labor through our marketplace, you will earn more tokens, which will be worth money in the future. And then the last thing to consider is non fungible tokens.
NFTs so far have been mostly about art and art communities and and whatnot, but increasingly, these are just ways of owning unique things, that are digitized And so you can see that companies in the future will be compensating both customers and employees and, and users of the product with non fungible tokens as So that should go on your list. Go to nffex.com/masterclass to watch this course with a full video experience alongside transcripts 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 the streaming platform, so be sure to register you can gain early access to new material from end effects. And now back to the episode. Another big mental concept you've gotta grab is that not all nodes are created equal. In fact, they're very different, very unequal.
I believe that in the future, Almost all marketplaces and network businesses are gonna have fungible tokens to compensate the various nodes of the network to bond and stay bonded to their network. I'm gonna give you an example here that is a real world example we've seen in the last couple of years that demonstrates this. PSG Perry Saint Germain, the big soccer team in Paris, has recruited Lionel Messi to leave Barcelona and join them for the last years of his career.
One of the ways they compensated him was with euros. He just had a contract for euros. They didn't give him shares in PSG, but what they did do is they gave him fan tokens, millions of fan tokens that they had distributed out to the fans. The fans were buying them as part of the network to bond to the tribal network effect of this, of this soccer team. Okay. Now think about it. It's just a Saucony, but it's not. It's actually network. And in this case, we know it's a tribal network.
These fans were buying these tokens to get access to t shirts or get to go in early into the stadium. They were getting compensated for their tokens in various ways. And when it was announced that Lionel Messi was joining PSG, the value of those tokens doubled So if they gave Pete and El messy 2,000,000 tokens and those tokens were worth $4 a piece or €4 a piece, suddenly they're 8 years a piece, and they just compensated messy almost €16,000,000 with fan tokens.
Okay. That's a gonna be a significant part of his compensation. And this is just the beginning because these types of fungible tokens are just beginning. So you can imagine what it's gonna be like 10 or 20 years from now. Gonna be used more and more. Okay? Now think about did Messi get compensated enough for joining PSG? And there are some indications that he was not compensated enough.
1 would be the fact that the French league soccer league, their TV rights went from being worth $600,000,000 to being 1,200,000,000 as soon as Messi joined the What percentage of that 600,000,000 gain is gonna go to messy? Arguably, all of it should go to him because he was the instance which caused that price to jump so much. But I'm sure he did not get all of that 600,000,000, and then you were gonna have debates.
And in the future, We're gonna have very open debates about this sort of thing, and his agents will be able to trail where the network, not only is it gonna affect PSG in the value of their fan tokens and their fan base and the value of their tickets, but it's gonna affect all of the French teams that are gonna then play messy, and everyone's gonna wanna tune in. So that wider network, that bigger network, will now all lift up because of this addition of this one node.
Okay. So when you think about this sort of a thing, you've used to think about sports, but now think about it as networks. And you can start to see the ripple effects, the value causation, the value capture, how that's all gonna work, you're gonna start to need to write that into your startup just as Paris and gentlemen and all the teams around the world are gonna need to write it into their plans and how they compensate people going forward.
Think about all the other network nodes around Pete measurement. Think about the fans should they be compensating the fans to wear out outrageous outfits or to be beautiful or to be loud or to be enthusiastic or to to greet people outside of the stadium.
Well, now that they have fungible tokens that are not shares in the company and are not just outright compensation, you start to have ways of animating all the different nodes that make going to the soccer games amazing, following the team amazing, copying their stats and playing fantasy games amazing.
It's just it's gonna ripple out and out and out, and it's a huge open creative area that we've now entered into now that we have this web 3 and these ownerships, these NFTs, huge creative space over the next decades. That is gonna reveal all these businesses as networks, and it's gonna allow us to manage them as networks.
This is gonna require a bit of a mindset shift for founders because the nodes that are unequal are going to start being able to see and understand and then demand compensation for their participation in your network in ways that they haven't been able to in the past. I mean, think about shares. Right? 20 years ago, If you were living in Europe, most employees didn't even ask for shares. They didn't think about it. It was kind of a Silicon Valley thing.
And then as it spread east, it got to New York, and then eventually it spread to Europe. And now most have learned to ask for shares because they can see the shares. They've been able to track the shares. They've heard the stories of the shares. Okay? The same thing is gonna happen with tokens and with NFTs, non fungible tokens in the future. With all of your nodes expecting to get compensated for the value they bring to your network.
So it's gonna require software, spreadsheets, thinking, gonna require a different mindset from founders to manage in this new environment as everything gets revealed as a network, and we have ways of measuring and compensating people for the value they bring to those network. A lot of people are getting in all this compensation stuff and tokens and incentives. And incentives are important. In fact, I think Charlie Munger says, show me the incentives, and I'll show you the outcome.
I, I just think that's incomplete. We are gonna be subject to overcompensating or over indexing, if you will, on incentive models. And we really should. We shouldn't forget the human part of this. And you see that, and if you're gonna recruit a sports person, to your team like Leon Mese, does he like the people he's gonna be playing with? Does he like the management? Does he like living in Paris? Does his wife like living in Paris?
You know, there's still human factors in compensating, if you will, these nodes to bond, and let's not forget So that being said, about the right brain needs of Pete, we are going to enter a new era about now, which is that for the last 25 years, we've watched the internet create networks that have attacked the scale effect businesses of the past. And it's been an unfair fight. It's been like mammals versus reptiles, right? Mammals end up dominating.
We've been able to defeat the newspapers and the radios and the TVs with new media. We've been able to defeat the old non, you know, the scale businesses with networks and new online marketplaces and whatnot. But going forward, as you're starting your company, you're gonna be building networks and you're gonna be increasingly competing against other networks. So we're gonna get all this network on network file gonna get network wars.
And you're gonna wanna learn tactics for how you take down those networks, and you're gonna learn tactics to how to defend your networks against other networks. So we're gonna be writing more about this and publishing it in the future, but the basic idea for the master class is this. The nodes you have are not created equal.
So you need methods for measuring and understanding who your most valuable nodes are so that you can defend or you can attack the ones that are in the other networks you need. You need to understand how to measure. Secondly, look at your take rate a take rate makes you vulnerable. Whatever that friction is that you've introduced into your network to maybe get compensated for other reasons, any friction makes you vulnerable to an attack from another network if you've got 1.
And any any any network that has a bunch of friction or too high of a take rate is an opportunity for you. The third thing is if there's network pollution. Right? So if there's bad actors, if if if the networks you're in aren't really clean, you're vulnerable. And, likewise, they're vulnerable to you if you can provide something better. And then the 4th thing to look at would be static. So a lot of networks start out pretty high status, but then they decline over time as they grow.
And when that happens, there's often an opportunity to attack from the top. And if you've gotten too big, they can attack from the top as Beller, to find a niche, to find a minimum viable cluster, and grab that from you and then build out their network around that. And so a 5th thing would be if the nodes in network are kind of fungible.
Like, if they're willing to Pete tenant, that makes you vulnerable to another network attack because they can go and try out the other network and decide they prefer it. So an example of this would be how SiriusXM went and paid a $100,000,000 to this incredible node Howard Stern to bring him over to their network, put him behind their paywall, and hopefully bring all of his customers with him.
And from that, they were able to get more people because they wanted to join the network that that node where I would turn was on. Maybe that's one example. Another one would be sushi swap. So sushi swap basically copied Uniswap, but then went after their top node sank don't trade your crypto there. Don't hold your crypto there.
Do it on our Pete, and we will compensate you with our fungible token in order to move over And when they did, when they staked their assets over on sushi swap, this was what is now called a vampire attack, where they went into the most webinars and took them away and created a lot of value. Multibillion dollar company was formed in just a few months by doing just such a network on network attack.
And that is one of the first examples that we're gonna see about widespread, network and network violence that we're gonna see again and again and again over the next 25 years and you'll be involved with. So now you've seen how not all network effects are created equal. You've seen how the defense abilities can reinforce each other, and you've seen how not all nodes are equal. But all these things need to be parsed out. They need to be measured. And then you can drive the bus.
You can fly the plane the way you need to through the various seasons of developing your company from seed to high impact giant company. You're gonna need to move to an understanding and ability to measure each of the nodes in your network, compensate them appropriately, so that they first bond your network with the network bonding theory and then stay bonded to you and stay active on your network. And that calculus is gonna be part of the core of your special sauce of your company.
And if you don't do it, your competitors will and they'll come and they'll attack. Whether it's a vampire attack or another type of attack, we're gonna see a lot of this in the future. Stay tuned to the NFX podcast. As we'll post 1 episode per week until we complete the course. You can also watch this entire master class online at nfx.com/masterclass, where you can log in, track your progress, and watch full videos, retranscripts, and find other related material.
Thanks for listening to the NFX podcast.