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Virtuous Cycle of Network Effects!

On Friday last week, 4 tech darlings (Amazon, Microsoft, Alphabet and Intel) added market cap equivalent of IBM's market cap (close to $150 Billion) in one DAY! It reminded go-go days of dot com era. Almost exact same happened on Flashback Friday back in Apr 2015. So is it different this time compared to 2000? Are these astronomical gains sustainable? One common factor which makes it different this time is: Network Effects.
Network Effects: The network effect is a phenomenon whereby a good or service becomes more valuable when more people use it. We see it in many services or goods we use. For example: land-line phones (more people used these when more people had phone connections), Internet, Social networks, Streaming networks, Costco membership and so on.
The virtuous positive cycle which gets triggered due to network effects is what is in play for many of these technology companies. Let's look at some of them.
Amazon: Back in July I wrote about Amazon "jungle". After that it expanded further by acquiring Whole Foods. Its just a matter of time when Amazon brown boxes would have your prescriptions delivered to you at cheaper prices and before you know you need to refill them. Within Amazon, two examples of network effects at work are: AWS and Prime Membership. AWS is rock-star in Amazon's myriad businesses. At nearly $18 Billion annual run-rate, it's growing 40% annually. That means as standalone business it would be worth more than tech stalwarts like IBM, Oracle, Intel and many more (could be in top 25 most valued companies). More companies use AWS, better and cheaper it becomes which prompt many conventional businesses to move to AWS and virtuous cycle continues. Same goes for Prime membership. Amazon keeps on adding value to Prime membership (I have been member for many years now) like free shipping, Amazon video, music, unlimited photo storage, special discounts, prime day and so on. More members join Prime, the better it becomes. (Amazon must have borrowed this idea from Costco). 
Google: Same network effect is at play at Google. The more people use Google for search, maps, videos the better these services become (which bring in more advertisements). Google cloud platform is not still at scale where network effects have kicked in virtuous cycle. However with hybrid cloud slowly gaining momentum, there is still time for it to pick up (Cisco/Google partnership could help both companies).
Facebook: Facebook is direct and prime example of network effects at play. Many articles have been written on these so I won't repeat them. But what Mark had done is even extra-ordinary. When it sees another platform which could start gaining due to network effects, he does not hesitate to buy it outright (WhatsApp, Instagram, tried to buy Snapchat). Facebook wants to become company of "platforms" of network effects!
Microsoft/Apple: These companies do benefit from "network effects" indirectly. The more people use their products, the better they become. Both had excellent opportunities in leveraging close to Billion users of their products. But now only they have started looking into how they could leverage this into creating "network effects". iTunes had 500 million accounts even before Facebook reached that milestone. But Apple could never create network effects around these (remember doomed ping?). Microsoft bought Skype but could not create the magic. These companies failed to create network effects because of their model of extracting value before it was created. I still wonder why Apple had not realized that charging for iCloud storage (above 5GB) is forcing die-hard iphone users like me to use Google and Prime photos for backup!
So which companies are next value creators by leveraging "network effects". Here are some  predictions: Uber, Slack, Venmo/Paypal and of course Amazon, Facebook and Google!
Next week should be another interesting week with GOP releasing details of their tax cut plans, Trump potentially nominating Powell as next Fed chairman and blowout earnings by Apple and Facebook. With GDP started growing again at 3%, its all clear now till new year for markets to continue doing what it has been doing for this year!
Have a great and safe Halloween!



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