Cloud 210 Lesson 1: The Network Effect Landscape

by Tim Attinger

Cloud Payments 210 (required): Building Value in the Network

Lesson 1 Discussion Board: What is the most important driver of the network effect? Click here to respond. 

We hope you enjoyed Fall Break from PYMNTS University. Perhaps you were out enjoying the fresh autumn breeze, a change in the color of the leaves from green to bright crimson, and perhaps a raucous time enjoying a football game on a crisp afternoon. Back at the PU faculty club, your professors were planning out a compelling series of courses to keep you engaged as we fall back and the cold winds begin to blow. We’ve covered the basics of debit, prepaid, mobile, and consumer behavior at the point of transaction.

In this course, we’ll cover the basics of how network businesses operate, how they cycle for growth, and how they drive more value in that growth. To understand payments is to understand the fundamentals of how network businesses work. The way that networks grow is a fairly consistent process, regardless of the industry in which they operate. They add users, then functions, then value, and work to attract more users. Networks, particularly payments networks, must continue to grow or they will most certainly die. In this course, we will discuss this dynamic in greater detail.

Basics of the Network Effect: Networks are powerful engines for growth. Like all platform businesses, networks require two different parties to adopt the network at the same rate and at the same rate to be viable. In telecommunications, these two parties are callers and receivers. In online search companies, the Web 2.0 versions of local newspapers, these are advertisers and readers. In payments networks, these two parties are buyers and sellers. Successful payments networks are born from a strong proposition that brings buyers and sellers to the platform at a great rate, driving valuable interactions between them that cross the network, igniting a catalytic reaction at the core that begins to fuel an almost self-driving cycle of growth.

The core proposition of the network effect has been described by many observers over the years. The most readily understandable network may be telecommunications. As phone networks first began to expand service to consumer households, callers understood that the value of paying to have the lines installed and to subscribe to basic phone service came most directly from how many other people you could call on the other end. These basics apply to payments networks as well, expressed in terms of buyers and sellers. A simple summary of the network effect may be this:

 
• Positive Externality: Each incremental user drives value to every current user, attracting more users

 

• Positive Feedback Loop: Growth in product and service participation becomes almost self-perpetuating because of positive externalities

 

• Ancillary Attraction: New providers with value-added services are attracted to the network because of the large, established user base

 

The Value of the Network Effect: For a payments network to achieve a strong catalytic cycle of growth, managers of the business must understand the core values of the network effect. While the core description of the network effect is clear above, it certainly merits further description and detail before we begin to discuss how payments professionals may drive the growth of an electronic payments network and realize these effects. For further detail, the fundamental value of the network effect described above may be elaborated as follows:

 
• Participants are attracted to the system by the core value proposition of the interaction possible between them. In the case of electronic payments, the core value for consumers is convenient, reliable, and secure access to their funds any time, anywhere. For sellers, the core value proposition is access to a secure and convenient network that allows them to transact with consumers and receive funds rapidly and reliably.

 

• Participants derive value from the network from the number of other participants there. For payments consumers, this is the number of places they may use electronic instruments to pay. For sellers, this is the number of consumers with whom they may transact on the network.

 

• More participants drive more value as the network grows. In payments, the core strength of the network is measured simply by the number of consumers and sellers on the system, by the transactions they put across the network, and by the growth rate in these three core attributes.

 

• Growth drives more value as the number of participants grows. New players are attracted to the network because of the number of potential transactions available on the platform. The existing players on the network find greater value as more new participants join the network, driving greater value for everyone. This is often described as the “virtuous circle” of growth that drives the core of the network effect.

 

The fundamentals of the network effect are fairly simple. Driving a system that realizes these effects is yet another thing altogether. In our next class, we will review the basis by which the manager of a payments business can generate these network effects through three simple steps. And in our final session, we will talk about how today’s payments network businesses have challenges for maintaining growth, and how they might manage to grow through them.

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