Want to read an overview of The Cold Start Problem by Andrew Chen? What is the network effect and how can it help your business?
In The Cold Start Problem, Andrew Chen explains how to build a startup that uses the network effect to compete with the established giants in your industry. In the book, Chen offers tips on building a network-based business from scratch.
Read on for an overview of Andrew Chen’s book The Cold Start Problem: How to Start and Scale Network Effects.
The Cold Start Problem Overview
If there’s a secret to success in the tech industry, it’s a thorough understanding of the network effect: The more users you gain, the more valuable your product becomes and the easier it is to profit and grow. But if bigger equals better, is it even possible for a company starting from scratch to compete with established tech giants? In The Cold Start Problem, Andrew Chen—a venture capitalist and former Uber executive—explains how to do exactly that: build a billion-dollar tech company from the ground up.
In particular, this approach will help you avoid the most common pitfall for tech startups, what Chen calls the Cold Start Problem: When your network is small, it’s extremely difficult to grow. We’ll discuss this in more detail later.
To research The Cold Start Problem, Andrew Chen conducted over 100 interviews with some of his most experienced professional contacts, including the founders of successful startups such as Instagram, Tinder, and Airbnb. In the book, he condenses their wisdom into a detailed roadmap describing what tech startups need to do to evolve into industry titans.
Background: What Is a Network-Based Business?
Before explaining the first step in founding a tech startup, we need to establish some basic background information about network-based businesses. According to Andrew Chen’s The Cold Start Problem, a network-based business is any product or service that involves interactions between users and gains value as more people use it. For instance, the more users a social media app has, the more likely it is that you’ll have friends who use it, and the more connection and enjoyment you’ll get out of using that app. Therefore, the more valuable the app is to you.
Step #1: Create Your First Subnetwork
In The Cold Start Problem, Andrew Chen argues that the first step of creating a business at the massive scale we just described is to create a single network that’s as small as possible and still functional. Different types of businesses will require different sizes of networks to meet this threshold: Products that only involve isolated one-to-one interactions can function fine with just two users, while products focused around group interaction and networking may need a few dozen people interacting before the experience becomes satisfying enough to function well.
Tip #1: Attract a Group of Users All at Once
First, Chen asserts that you need to get a group of users to join a subnetwork all at once to achieve network stability quickly. Otherwise, that subnetwork is doomed to fizzle out and fail. As we’ve seen in earlier examples, the minimum number of users you need to have a functional subnetwork differs depending on your product. Chen refers to this minimum number of users as your subnetwork’s “Tipping Point.”
(Shortform note: Chen uses the phrase “Tipping Point” to describe two similar, yet distinct ideas. The first, as we’ve established, is the point at which a subnetwork has enough users to function well. The second, which we’ll cover later, is the point at which you have enough subnetworks accelerating the growth of your whole network to dominate the market. For clarity, we’ll use the term “subnetwork stability” to describe the former idea and “Growth Explosion” to describe the latter.)
Tip #2: Keep the Product Simple
How do you design a product that makes users want to keep using it and form subnetworks? In The Cold Start Problem, Andrew Chen advises you to make your product extremely simple—simple to understand, simple to use, and simple to explain to others. In particular, your product should perform one simple function perfectly rather than aim to do many things well.
Why focus on a single function? Chen states that keeping your product simple makes it easier to attract and retain users, expanding your network and vastly increasing its value. Maintaining simplicity makes it clear exactly what your product does, and users who easily understand what a product is are more likely to use it. Further, making the product simple to use increases the likelihood that they’ll learn how to use it and continue to use it. Finally, making the product simple to explain increases the chances that users will share it with each other.
Step #2: Repeatedly Replicate That Subnetwork
Once you’ve built a functioning product and established your first subnetwork, Chen explains that the next step is to do the same again—start another subnetwork and repeat. With each new subnetwork you establish, your next subnetwork will be easier and faster to build, creating exponential growth toward your goal of establishing the biggest network in the market.
Chen asserts that once you hit a certain number of subnetworks, you’ll begin growing fast enough to become a legitimate competitor to the current industry leader—this is the Growth Explosion (as mentioned earlier, Chen refers to this stage as the “Tipping Point”).
Chen notes that while you’re trying to reach the Growth Explosion, the strategies you employ to build subnetworks don’t have to be scalable or cost-effective. After growth takes off, you can cease unprofitable strategies and recoup this early heavy investment by leveraging your large, profitable network. Although these unprofitable strategies can be risky, they can empower you to dominate an entire market extremely quickly.
Strategy #1: Pay Users to Use Your Product: One simple strategy Chen offers to quickly and effectively create subnetworks is to pay people to use your product. For example, freelance labor marketplace TaskRabbit offers its laborers a bonus of $25 after they complete their first task.
Strategy #2: Artificially Inflate Your Network: Another strategy Chen offers to spark early growth is for you and your employees to temporarily participate in the network to make it seem bigger than it is. This inflates the value of your product to attract users until your network grows big enough to sustain itself. For example, imagine you’re launching an app that lets users find people close to them to play
Strategy #3: Only Let Users Join by Invitation: A third strategy Chen recommends for launching new sub-networks is prohibiting users from joining unless they have an invitation from an existing user. The up-front cost of this strategy is limiting user growth, which at first seems like the opposite of what your business wants. However, this strategy encourages a more sustainable kind of growth—because users give invitations to people they know, they’re more likely to attract users who share similar backgrounds and interests. This makes them more likely to interact with one another in subnetworks, which is necessary to achieve subnetwork stability.
Step #3: Streamline and Accelerate Growth
Once you’ve successfully launched a number of subnetworks, you’ll hit the Growth Explosion. This is when across all your subnetworks, you have enough users for the network effect to kick in with gusto, accelerating growth to the point where you can challenge the market leader in your industry. In The Cold Start Problem, Andrew Chen states that at this stage, you can shift your focus away from manually starting new subnetworks and instead work to refine your product in ways that amplify the network effect. This allows you to grow your user base faster than you could ever imagine.
(Shortform note: Although Chen assumes that the readers of his book want to grow their company into an industry-dominating giant, you may want to keep your business intentionally small and simply stop at this step. In Anything You Want, Derek Sivers describes how he turned down weekly offers from firms who wanted to invest in his startup and help him expand. His rationale for doing so was that rapid expansion can sometimes distract you from giving the best possible product to your existing customers, which is the key to not only financial success but also fulfillment.)
Step #4: Push Through Negative Effects of Growth
If you’ve optimized your product to take advantage of all aspects of the network effect, your user base will skyrocket, and you’ll find yourself in a highly profitable—if not totally dominant—market position. However, Chen warns that at a certain point, extreme growth instigates a unique set of new problems. If you don’t take steps to solve these problems, they’ll degrade the quality of your product and halt your rapid growth.
Problem #1: Market Saturation
At a certain point, your network will reach a natural maximum size. Chen explains that this occurs when you’ve effectively captured the entire market: All the users that would feasibly use your product are already using it. This is called market saturation.To solve this problem, Chen argues that you must innovate beyond your original idea, creating new features or products that do one of two things: Either target new kinds of users and integrate them into your existing network, or offer new paid features to the users you already have. Both strategies allow you to tap into new revenue streams and continue growing your company.
Problem #2: Community Dilution
According to Andrew Chen’s The Cold Start Problem, another problem that occurs when your network reaches a certain size is community dilution: when certain kinds of users joining your network make it less valuable.
Depending on your product, one potential solution to community dilution is to allow users to create their own subnetworks. Then, if one subnetwork becomes diluted with people that ruin a user’s experience, they can create another one. For example, users can create private Snapchat stories and handpick which of their friends can see them.
You’ll also likely need tight moderation tools to regulate malicious users abusing your network. Since it’s difficult to manually moderate a large network, Chen suggests creating automated moderation tools as well as giving users the ability to flag malicious users for manual moderation.
Step #5: Ward Off Challengers
According to Andrew Chen’s The Cold Start Problem, once you’ve pushed through all the negative effects of growth, you’ll be a dominant market leader, earning massive profits. Chen explains that at this point, the network effect works in your favor: Potential competitors lack the benefits of your network that we discussed in Step #3, so it’s much more difficult for them to field a comparable product.
Chen notes that now, all that’s left to do is maintain your position as a market leader by closely monitoring your competitors and making sure they can’t convert substantial portions of your users. Adjust your user acquisition strategies and your product to convince users to choose you over competitors, then verify that your adjustments are effective.
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Here's what you'll find in our full The Cold Start Problem summary:
- How to build a billion-dollar tech company from the ground up
- Why you need to understand the network effect if you're in the tech industry
- How to overcome the negative effects of rapid growth