The Business Of

Sharing | Airbnb | Network effects

Morning All!

TGIF! Hope everyone’s got nice weekend plans! But before we get there, we’ve got one final newsletter to round off The Business Of Airbnb. Let’s have a quick recap of some of the fun, surprising things we’ve learnt about Airbnb this week…

• Luxury Cereal - Early on, with Airbnb struggling to stay alive, the founders turned to selling cereal to save them! And they were pretty good at that too!

• Luxury Salaries - An astonishing ~2,000 software developers work at Airbnb. And they’re hot in demand… the average Google developer makes $279k.

• Luxury Stock Sales - Joe Gebbia - Airbnb’s co-founder - sold a mammoth $890 million worth of shares in the first half of 2023!

So, we’ve got a cracking (I think/hope) newsletter today. Where we’ll be looking at one of the main phenomenon that allow Airbnb’s business model to work so well. And that phenomenon is network effects!

We’ll also see how the world’s most popular YouTuber - Mr Beast - is an absolute expert at network effects! So without further ado, let’s crack on…

Network Effects Aren’t Always Positive…

Okay, so first off – what even are network effects?! Well, network effects is the phenomenon whereby an increasing number of users improves the value of a good or service. What do I mean? Well, let’s start with the basics and look at Facebook.

Why do people go on Facebook? Well, generally, it’s to connect with one another. Mainly their friends. But also, with the thought of possibly creating new friends. And so, as more users join Facebook, does the value of Facebook go up or down for an existing user? It goes up! More users means more chances to create connections. And this was what allowed Facebook to grow exponentially at the beginning, back when it first started in uni campuses around America.

Now, it’s not always this straightforward because the value of a service can differ between users. Let’s think about LinkedIn. Someone – let’s call her Rachel – might be using LinkedIn to build connections and expand her network. Whereas another person – let’s call him Ross – might be using LinkedIn to find a job. How does the value of LinkedIn change for Rachel and Ross when more users join?

Well, for Rachel, the value increases! She wants to connect with more people and grow her network so she’s happy when more users join. Positive network effects. But what about Ross? Well, he’s looking for a job and if more users join (who may also be looking for a job), it decreases the chances of him being successful in the job hunt. And so increasing users, actually decreases the value of LinkedIn to Ross. These would be negative network effects.

Same-Side, Cross-Side, Direct and Indirect!

Okay, so we’ve had a little intro to network effects. And what we’ve looked at so far is same-side network effects. This is because the users at Facebook and the users at LinkedIn are on one side of the network. And advertisers are the other side of these networks. The graphic below illustrates this.

But now let’s look at Airbnb and cross-side network effects. And cross-side network effects are when an increasing number of users on one side of the network leads to a change in value for the users on the other side. What do I mean?

Well, take Airbnb. As more homeowners list their properties on Airbnb, something happens. It makes the Airbnb platform more valuable for guests because guests now have more choice of rentals. And it works the other way too. As more guests go to the Airbnb platform to find properties to rent. It makes the platform more valuable for hosts as they have a higher likelihood of getting a renter! So Airbnb has super positive cross-side network effects.

Okay, but what about the same-side? Surely, that’s negative right? Because let’s say I’m an Airbnb guest. As more guests join Airbnb, it increases the competition for bookings. And it’ll make it harder for me to get the booking I want at a good price. And yes, that’s correct. Airbnb actually has negative ‘direct’ same-side network effects. And the word ‘direct’ is important here.

Because yes, whilst more guests increases competition for me. It also has an indirect impact. As more guests join Airbnb, it increases the probability of bookings and so incentivises more hosts to list their homes. Which is actually a positive thing for me as a guest – I have more choice! And so this positive indirect impact softens some of the negative impacts from same-side network effects. Phew!

Alrighty, so that’s basically how network effects have worked for Airbnb. And it’s hard to down play how important these network effects are for platform businesses. In fact, network effects are often considered one of the 5 key sources of ‘moat’ a company can have.

For those wondering what on Earth ‘economic moats’ are - I recommend giving this article a read. And for those well versed in the topic, I came across this article on network effects which is a really great read.

Mr Beast: The King Of YouTube Network Effects

Alrighty, so to close for today I want to do something fun. I think a high % of readers will know who the chap in the photo above is. It is of course Jimmy Donaldson (AKA Mr Beast) - the owner of the number one followed account on YouTube (187 million subscribers)! According to Forbes, Mr Beast reportedly made an astonishing $82m in earnings last year from his YouTube channels! And guess what? A huge part of Mr Beast’s success can be attributed to network effects!

What do I mean? Well, let’s explore now. And to start off, let’s look at the graphic below. Where instead of guests and hosts, we’ve got subscribers and advertisers.

Okay, so what are the network effects at play here? Well, let’s look at what happens when there’s an increasing number of subscribers. As more subscribers follow Mr Beast’s YouTube account, sponsoring Mr Beast’s content becomes more valuable for advertisers. Because they have more eyeballs to reach. And so we see positive cross-side network effects. Similar to what we saw at Facebook.

But we also see positive same-side network effects. Mr Beast’s subscribers get value from his channel by watching his content and being a part of his community. They can talk to other Mr Beast fans about the videos and build relationships. And so when more subscribers are added, the community grows and value increases!

By the way, for those interested, this is the most popular MrBeast video… 505 million views!

But now, let’s flip it around and look at advertisers. And this is where the genius of Mr Beast comes through. Because usually, when advertisers and users are on opposing sides, the cross-side network effects are negative for users. More adverts on Facebook or Instagram usually isn’t what adds value for users. In fact, it can usually hurt the user experience. But with Mr Beast it’s different…

… because yes, more sponsors means Mr Beast makes more money. But what does Mr Beast do with all that money? He invests it into his content! And what do bigger giveaways and crazier contests mean? It means increased subscribers!

Now, if Mr Beast didn’t invest in his content so much – the impact of network effects would be much more limited. Most YouTubers take their sponsors’ money and do little to improve their content – which hurts the network effects phenomenon.

But Mr Beasts’ content investments means that there is that connection. More sponsors = more revenue = better content = more subscribers. And this is no real secret – Mr Beast himself acknowledged that this was his strategy in a video he did back in 2018. In that video, Mr Beast gives his mum $100k. And his mum kind of refuses to accept. And what follows is this exchange…

‘If I don’t give it to you, I don’t have a viral video’. Mr Beast understands network effects! To have a viral video, Mr Beast needs great content. And how does Mr Beast create great content? By giving away loads of money!

29th Sep 2023

Nigel Jacob CFA