Greg Linden’s eBay, scammers, and self-governance brings up a good point. . . that the whole idea of community contributed value (content, commerce, social, etc) scaling infinitely is somewhat of a myth.

There was a time in my life, that I looked at eBay’s buisness model longingly (5 years ago before I joined) and thought that if one day we could just achieve critical mass, We would be PRINTING MONEY and I could just retire and watch the zero’s grow . . . boy was I wrong. . .

Yes the margins are great, better than the traditional one-to-many business models. But it does bring up a whole slew of other unexpected issues that threatens to negate network effects . . .

Here is a simple test that almost all company fails . . . if value added for a company is truly networks effect driven the difference between its cost of capital and ROI should increase ALMOST exponentially and infinitely. Put it another way (without stupid finance speak) Gross Margins should not only increase infinitely but exponentially as well. There not one company on this earth that has done this yet . . .

Even Google has seen its margins decrease and cash flow growth slow; further more, as much as people think Adsense/word is this self sustaining monster, there are thousands of cute/hot/buffed Stanford undergrads doing menial adwords tech support/filtering/placement etc . . . . just for a chance to date Larry (ok low blow . . . but mommy and daddy didnt mortage the house and get you into Stanford so you can attach one of the phone headsets to your head all day) .

Myspace is just beginning to run into this issue as well. To police its community it hired a Chief Whatever Officer to safequard the community from . . . itself . . .

Digg, with the whole issue of selling ID, digging for money etc, will eventually discover that there are certain things algorithm cant solve for and people will be needed to handle the exception cases.

I guess the summary is that nature has a way of finding balance. . . no one organism or company can grow unchecked forever. . . eventually the very thing that made it successfull will created some sort of negative externality and brings balance back into the world. (hmm isnt this in the pre-amble to Star War VI?). . . eBay with trust, youTube with hardware costs, MySpace with sex, and Google with too many Stanford undergrads . . .

If network effects can creat a platform which enables certain drivers to create value exponentially it can just as easily enable other drivers to destroy value exponentially.

I had argue eons ago that eBay is THE first web 2.0 companies - that eBay’s most important asset is not hard assets (buildings, computers), nor its employees (certainly not me), but its community . . . and THAT is the defining characteristic of a web 2.0 company.

eBay’s “travails” with its own community are now beginning to be repeated in other companies as web 2.0 startups begin to gain critical mass. In an ironic way, these events validates and empowers the past direction, decisions, and strategies of eBay and further proves that scaling a network effects is not as simple as just seat back and let the community grow.

Jeff Nolan alerted me to user revolts at youTube over heavy handed management of its community. Miel, a power user of YouTube has “quit” youTube. In his own words.

Okay. I’m out of YouTube. I refuse to use the service any longer. Recent changes made it very obvious they don’t want users with large archives. The site is very very slow and I have over 30 pages of videos. Browsing to page 28 took me exactly 12 minutes, whereas before the interface update I could just click the page I wanted to see. Turns out a few of my uploaded videos were rejected due to inappropriate content, which I totally don’t get, because nobody got killed, no nudity was shown and no dirty language was in it. It didn’t feature any stolen music and I didn’t sing. Then why is it inappropriate? Because some puritan mind flagged the movie in the hopes it would make the world a better place? Well I’ve had it with these random rejections. I don’t take it anymore. There is totally no way to defend you against this, you get no warning at all if a clip has been flagged, you just have to come to the conclusion whilst browsing your video archive. This particular clip was uploaded in September last year. It’s been on there for months, and all of the sudden the content isn’t appropriate anymore?

more here

Ofcourse Miel’s buddy, Nathan, joined in as well and thus the ripple grows. . .

Don Dodge has a really good analysis of MySpace’s and youTube’s problems from a very “technical” (and important) perspective. However, from the community perspective, the issues are much more holistic and emotional. To the community, it is a matter of OWNERSHIP rather than moralitie, ethics, or legalities. It is about the community believing their contribution to the success of the company entitle them to a say in the directions and decisions of the company.

Many of these companies can learn much by studying eBay’s past. That these web 2.0 communities will

1) “unionize” to gain greater influence
2) Increase heterogeneity and fragment to create conflicts between groups (which companies will have to manage)
3) An “elite” class of power users or influential mavens will develop
4) Community will increase sophistication of their method of influence to the company relying on press, lobbies, and other media (beyond venting on BBS’s or blogs)

And, these web 2.0 companies will respond in many the same way that eBay has.

1) integrte the “voice” of the community into the producment development process
2) create far reaching and powerful customer councils to influence and guide company decision making
3) “co-opt” hopefully in a good and productive way for the community these leaders through customer councils or even hrie them as employees
4) Build entire departments to do community outreach as big as many companies scale their PR/Media departments
5)and ofcourse, repeatly screw up by attempting to “manage” the community rather than listen, enable, and scale

And in the end, there will always be times when the best interest of the community conflict with that of the company. When that happens, (at least once a year) the true mettle of the company will be proven.

(Unfortunately, as mentioned by Adam Nash in the comment section of a previous post, by tightly integrating yourself into a particular segment of you customer base, it leaves open opportunities for competitors to target underved, small, and but rapidly growing segments to gain marketshare)

Building network effects is hard . . . but once a startup has gathered traction, network effects can also reverse itself pretty quickly. Its not all rosey, sit back, and collect the money. . . Case in point. . . Miva networks.

The company generated 219 million paid clickthroughs during the quarter. That’s a 13% reduction from what it produced a year earlier, despite growing its base of advertisers by 20%. This isn’t a mixed bag — it’s just bad. Revenues falling faster than clicks means that the company is generating less money per click.

Found it on Motley Fool this morning while checking on my portfolio. . .

These guys was one of the pioneers of the PPC ad network model. However somewhere along the way, “bad” sites got into their network and they are caught in a situation where they are unable to sacrifice critical mass for quality. And thus, the downward spiral begins. . .

1) bad sites join network
2) low quality traffic click through ads
3) low conversion for advertiser
4) bids for words goes lower
5) high quality sites leaves cause they can get higher monetization somewhere else
.. . 1) more bad sites join network that got kicked out of google/overture

So even though partners are increased at 20% word pricing droped significantly more . . . this is a cautionary tale for all the web 2.0 plays out there. . . if you attract the wrong kind of community initially, you are building the wrong kind of network effects that could quickly deterioate. . . . for example, if Digg attracted spammers when it was initially launched, they would not have become what it is today. . . if craigslist was over-ran by best-buy when it first launched, no one would go there . . . chose carefully where you launch your site. . . not all traffic is good. . .