The Exchanges

Q We teased earlier that we were going to talk about the difference between network effects and network economies. And this is something that David and I have flubbed on a few episodes where I think I've conflated them in our power section. And I'm curious, what are some telltale signs of a company that has network effects, but did not develop network economies power?

A So I think network effects in the types of things that we've been talking about in this episode are Common. You know, it's when a driver joins Uber, he makes the platform more valuable to passengers because more efficient route structures are now enabled, right? And that's a network effect. So the things that happen there are somebody joins the network, that's the network part, that's the new driver joining, and something happens to somebody else in it that has a value implication, that's the effect, that's a network effect. So the question is, what would you like to call network economies? That sounds like an odd thing to say, but that's really the question. And you could say anything that their network affects and there's power, you could call it, that might be one choice. And Chen, you and I are currently debating this. And so there's another choice, which is the one that I'm currently going down, which is that it's when there's power from direct network effects. And a direct network effect is where your joining has an immediate value impact on somebody that's sort of on the same side. So I joined Facebook because I'm your friend, and those effects are strong because they're additive. So another friend's join, it doesn't substitute for the one that just joins, it adds to it. So, and it's those kinds of effects that do more lead to winner take all kinds of situations. So my n…

AI assessment note: “if there's power as a result of direct network effects, and that's a network economy”

Q and how is the right time for a company that finds themselves with a large power opportunity as a platform to start capturing that value? Famously, everybody thought that Google was nuts with YouTube because it lost billions of dollars for more than a decade. And in retrospect now, perhaps that was a brilliant strategic decision by Google. Uh, how do you all think an operator should think about that?

A For me, the key thing here is to remember that the product market fit and power questions are different questions, and one doesn't necessarily answer the other. In fact, often doesn't. And that it may be that When you have a business model that gets you to product market fit, there may be a power opportunity embedded in that, and there may not be. And so those are two very different problems. One is the problem of capitalizing on an inherent potential for power, and the other is trying to figure out what are you going to do that will get you power in something that currently doesn't have it. And that second is a very hard problem, right? It's a second invent that's every bit as hard as the product market fit invent. So think of Steve Jobs trying to figure out where to take Apple when the PC business turned out to not have any power, right? Um, here's the most brilliant innovator of our generation. And yet, uh, he couldn't solve the problem and he ended up losing his job.

AI assessment note: “remember that the product market fit and power questions are different questions”

Q the customers to manufacture their chips, and it's a very intentional strategy, and they believe that that's sort of a long-term view that they have in order to do that. I'm curious as investors how you think about, from the perspective of maximizing enterprise value for a firm, What should a company do? Should they be maximally extractive to their ecosystem, or should they leave some surplus on the table?

A Yeah, it's a great question. Before commenting specifically on TSMC, one of their primary competitive interfaces, obviously, in terms of fab technology and getting ahead in that is Intel, and I just, just a caveat about both those businesses are amazing and well-managed and successful, and the fact that TSMC seems to be gaining ground is also a A reminder to everybody that power is not forever, because I use Intel in my book, and that's the way life is, you know, technology's changing, competition changes, and for me, you know, one of the longest term power things I've ever observed is that of elite universities and being able to maintain, and which is ironic that it's not even in the private sector. So I think on a pricing question like that, Pricing may well be tied to a strategic goal, but it's tactically available to anyone. So it's justification has to be tied to underlying fundamentals. And essentially what you're doing is in this case of TSMC, what you've cited is they're sort of giving up current profits for something in the future, right? And presumably it's sort of future revenues. So they either get retention through customer loyalty or acquiring new customers. So that leads you to ask, will more customers, more revenue in the future give you more differential returns? And that gets you down to ask about scale economies. Do they have it? And I would argue, yes, but i…

AI assessment note: “Pricing may well be tied to a strategic goal, but it's tactically available to anyone.”

Q Okay, so ride sharing is an example platform where you get to the end of the questions, and maybe there's still kind of a question mark about the industry and the companies within it. Could we walk through an example of a company or an industry where you get to the end and you conclude, oh wow, this company, this platform has a lot of power?

A So David, before we leave ride share, I Think of the moving parts here. One of the moving parts is what does that ride efficiency curve look like? So as you scale, how quickly does it start to slope down? Because that's going to be critical. If it's a straight line and you're two times relative market share, you're home free. If it tails off pretty quickly at an early stage with two times relative market share, you could be an attractive relative cost position. And once the business is scaled, it's no longer true because you're into the flat part of the curve, right? So it's the shape of that curve. It's your size relative to somebody else. Let's say you have that advantage. What's to keep it from not being arbitraged out. So you want to turn to people like Ben and say, don't offer that app.

AI assessment note: “So David, before we leave ride share, I Think of the moving parts here.”