{"id":506,"date":"2018-12-20T22:06:48","date_gmt":"2018-12-20T22:06:48","guid":{"rendered":"https:\/\/mattersgraph.com\/?post_type=insight&p=506"},"modified":"2026-04-09T01:29:59","modified_gmt":"2026-04-09T01:29:59","slug":"commercial-due-diligence-and-value-generation-via-network-effects","status":"publish","type":"insight","link":"https:\/\/mattersgraph.com\/ar\/insights\/commercial-due-diligence-and-value-generation-via-network-effects\/","title":{"rendered":"012: Commercial Due Diligence and Value Generation via Network Effects"},"content":{"rendered":"

Many attractive investments are predicated on network effects \u2013 these are businesses that\u00a0connect<\/em>\u00a0users, buyers, and\/or suppliers. Companies like Visa, eBay, and LinkedIn have famously enjoyed the benefits of network effects to accrue immense, highly durable value. Outside of software, businesses such as recruiting, retailing, media, health provider networks, and many others, enjoy network effects benefits.<\/p>\n\n

Understanding where network effects will hold and where they may break down is critical for evaluating a deal. Target companies in network-effect markets face two major risks:<\/p>\n\n

    \n
  1. Being overtaken in a hypercompetitive market where network effects are strong; or<\/li>\n\n\n\n
  2. Being intermediated in markets where the network effects are muted<\/li>\n<\/ol><\/div>\n\n
    \n\n

    How do you know if a market is \u201cjust right\u201d? We have found that investigating a few questions can suggest the answer.<\/p>\n\n

      \n
    1. Do perceived\u00a0switching costs<\/strong>\u00a0for users increase the more they use the service?<\/li>\n\n\n\n
    2. Does the service get better with\u00a0each new user<\/strong>?<\/li>\n\n\n\n
    3. Is there\u00a0growth headroom<\/strong>? (see our pieces on\u00a0conducting diligence on adoption\/ growth<\/a>\u00a0and\u00a0effective market sizing<\/a>)<\/li>\n\n\n\n
    4. Are the\u00a0habits<\/strong>\u00a0associated with the target company\u2019s service easier for a user to form than those associated with a potential aggregator? Ben Thompson has a\u00a0thought-provoking aggregator definition here<\/a>.<\/li>\n\n\n\n
    5. Are\u00a0customer acquisition costs\u00a0<\/strong>low?<\/li>\n<\/ol>\n\n

      Repeat these questions for each side of the market. Each \u201cyes\u201d increases the value of a network strength in the market.<\/p>\n\n

      \"Number<\/figure>\n\n

      Facing hyper-competition in a market with strong network effects:<\/strong> These markets can create a hypercompetitive space where winner takes all. At breakthrough moments, it may be just one product\u2019s subtle change that unlocks easier habit formation, and these small changes can change the market overall. Myspace was a hit, until Facebook made it irrelevant \u2013 new habit formation around the \u201cnews feed\u201d altered social network usage dramatically. Social networks are at least a \u201c6\u201d on our scale: buyer beware markets where winner takes all \u2013 they may be great to win but are disastrous to lose.<\/p>\n\n

      Being intermediated in a market with weak network effects<\/strong>: The relatively slow growth coupled with <\/em>low barriers of entry for food delivery services like Seamless or Grubhub (founded in 1999 and 2005, respectively), left ample room for new delivery companies \u2013 Delivery Hero, Deliveroo, Foodpanda, Postmates, Uber Eats, Door Dash, Amazon Restaurants, etc. The resulting complexity can confuse consumers or service providers and create the opportunity for something like Google Maps to gain position as an aggregator. With Google, you simply search for a restaurant and discover which services deliver for that restaurant. Which habit is easier to form: searching Google Maps once or opening multiple food delivery apps? Today, we score food delivery apps around a \u201c2\u201d on our scale.<\/p>\n\n

      Network effects are important diligence items, but these same considerations can be used by investors in a variety of sectors to enhance the value of services and products they own or manage today. Can you build in greater switching costs or easier habit formation for your customers?<\/p>","protected":false},"excerpt":{"rendered":"

      Many attractive investments are predicated on network effects \u2013 these are businesses that\u00a0connect\u00a0users, buyers, and\/or suppliers. Companies like Visa, eBay, and LinkedIn have famously enjoyed the benefits of network effects …<\/p>","protected":false},"author":[82],"featured_media":0,"template":"","meta":{"featured_image_background_position":"","promoted":false,"promoted-priority":0,"footnotes":""},"sector":[],"topic":[83,71,50,80,67],"audience":[],"insight-category":[140],"class_list":["post-506","insight","type-insight","status-publish","hentry","topic-customer-loyalty","topic-disruptors","topic-growth-rates","topic-organic-growth-tactics","topic-value-development-generation","insight-category-value-creation","author-jeff-merkle"],"yoast_head":"\n012: Commercial Due Diligence and Value Generation via Network Effects - GRAPH Strategy LLC<\/title>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/mattersgraph.com\/ar\/insights\/commercial-due-diligence-and-value-generation-via-network-effects\/\" \/>\n<meta property=\"og:locale\" content=\"ar_AR\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"012: Commercial Due Diligence and Value Generation via Network Effects - GRAPH Strategy LLC\" \/>\n<meta property=\"og:description\" content=\"Many attractive investments are predicated on network effects \u2013 these are businesses that\u00a0connect\u00a0users, buyers, and\/or suppliers. 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