Using synthetic network effects to get their first 7 million customers.

How much money one would have made had they invested in Wayfair in March 2020?

The answer is 1,081%…X10 your money!

This is the topic of today's newsletter: How Wayfair got to their first 7 million customers? (I know, we usually cover the first 1000 or so, but this issue is unique.)

The answer to that question btw is through synthetic network effects.

We all must have heard what networks effect are: 

It is a platform or service that becomes more valuable as more users join, almost exclusive to marketplaces and social networks.

But if we analyze network effects from a purely economic perspective, we can conclude that we can, indeed, replicate their desired outcome in almost any company. 

Let's take a more in-depth look 🧐:

A few facts:

  • As a business grows, customer acquisition costs increases (as you start tapping outside of your core die-hard customer base)

  • If your business is one that exhibits network effects, this means your value/customer or "LTV" can grow exponentially with users(you spend more time on Facebook because of all the friends you have there, so they can serve you a lot more ads than if you only had a handful of friends)

  • There is a critical point where this effect starts to plateau (having 700 friends is not that different from having 600)

The power of network effects is that you can exponentially increase your LTV(lifetime value of a customer) while only linearly increasing your CAC (customer acquisition cost) for some unknown period of time. This allows companies to make massive growth investments and raise (and burn) hundreds of millions of dollars in the process 🤑, hoping it all pays off because of the sweet exponential curve

Okay, now what?

If you are bootstrapping your company and can't make that costly growth investment, how can you mimic the desired effect? How can you continue to improve your unit economics (LTV/CAC) as your company grows?

One answer would be what if you can linearly scale up your LTV and linearly decrease your CAC at the same time. That parallel improvement in both metrics would compound over time and somewhat mimic a network effects business unit economics. This precisely what Wayfair did almost exclusively to grow to $500m in revenue with virtually no outside capital!

Wayfair, known initially as CSN. A network of 270 furniture websites. Each of which sold a particular category of home goods. They launched a new "company" or website every 10.5 days.

Some of their websites:

  • EveryMirror.com,

  • RacksandStands.com

  • JustVanities.com

The recipe was simple, they identified a gap in the market, chose a product, and created a website that would be visible in Google searches. This approach was successful because consumers would somehow stumble across a CNS Store during their research. By doing so 270+ times, Wayfair or CSN at the time was able to create synthetic network effects.

  • For each new website they launched, their CAC would be significantly lower than other more mature websites. They could tap into a particular set of customers looking for a specific product (its usually much cheaper to acquire hard-core fans). The more websites they launch, the lower the overall acquisition cost is. Optimizing for SEO was just the pouring gas on the growth🔥 and allowed them to stretch the impact of synthetic network effects for seven full years.

  • They were able to increase their LTV by cross-promoting each new website to existing customers from other websites. New niche websites meant new opportunities to monetize all the different customers from all the various sites. 

It is important to note that just with network effects, synthetic network effects also plateau at some point. Because the increase in LTV is linear (as opposed to exponential with network effects), you always need to be ramping up the number of new(or size of) the "whitespace(s)" you are exploring in your domain to maintain a healthy growth rate. 

On the other side, unlike with network effects, synthetic network effects don't need a massive capital expenditure; the beauty of this whole approach is how profitable it is almost from the get-go because both metrics are moving in the right direction in synergy (see above graph).

Wayfair is not the first nor last company to do this. Stir, which recently launched, also leveraged synthetic network effects to launch and grow their business through (software) "drops." (This is a case study for another day though)

For now 

Stay Safe, Wear a mask, and Remember

There are only 31 days left to change to the outcome of your yearly wrapped Spotify list!


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