Why did Naval Ravikant suggest considering network effects in investment?

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Why Does Naval Ravikant Value Network Effects So Much? Because It's the Strongest "Moat" for Startups

Hey there. The question you're asking really hits the core of Naval's investment philosophy. He doesn't emphasize "network effects" just to sound smart; he does it because he sees the massive, almost "unfair" business advantage behind it.

Let's break this down step by step, so it's crystal clear.

First off, What Exactly is a "Network Effect"?

Don't let the term scare you; it's actually super simple.

Think about the very first telephone. What was it? A useless metal box. Because who would you call? No one else had one.

But when the second person, the tenth person, the ten-thousandth person bought a phone... magic happened. Its value exploded exponentially. Your phone didn't change, but the more people you could connect with, the more useful and valuable it became to you.

In plain terms: A network effect means a product or service becomes more valuable to each user (both new and existing) the more people use it.

WeChat is the classic example. If you were the only person using WeChat, it would just be a notepad app. But precisely because all your relatives, friends, and colleagues are on it, it becomes an essential communication tool you can't live without. Its value comes from the network itself.

So Why Are Investors, Especially Ones Like Naval, So Obsessed With It?

Because companies with strong network effects basically operate on cheat mode. Mainly for three reasons:

1. They Build a Nearly Unbreakable "Moat"

This is the biggest one. The term "moat," coined by Warren Buffett, refers to a company's ability to fend off competitors. And network effects create the widest, deepest moat of all.

Take WeChat again. Imagine a company today launches "SuperChat" – a messaging app objectively better than WeChat in features and design. They give it away for free. Would you switch?

Probably not.

Why? Because your entire social network – your family group chats, your work groups, your hundreds of friends – are all on WeChat! The cost of moving is just too high. Even if "SuperChat" is technically better, without your friends on it, it's worthless to you.

New competitors, no matter how technically advanced or well-funded, face a massive hurdle trying to convince an entire network of users to move en masse. This creates a huge barrier, allowing the leader to become virtually unbeatable. For investors, this level of certainty and safety is the dream.

2. They Enable Winner-Take-All Exponential Growth

For a normal company, growth is often linear: sell one product, make some money; gain one customer, gain some revenue.

But a company powered by a network effect is different. Its growth reinforces itself.

Users Attract Users: You use DiDi (Uber equivalent) because it's convenient – you can always get a ride. Why are rides always available? Because there are lots of drivers. Why are there lots of drivers? Because there are lots of passengers using DiDi. It's a self-reinforcing "flywheel" that spins faster and faster.
Hitting the Tipping Point: Early on, growth for a network-driven company might be slow. But once the user base hits a critical mass (the Tipping Point), its value skyrockets, attracting massive numbers of users and enabling exponential growth. This kind of growth curve is what makes those 100x or 1,000x investment returns possible.

3. Extremely Low Marginal Costs and Supercharged Profits

For many internet products like social apps or marketplaces, once the core system is built, the extra cost (marginal cost) to serve 10 million users instead of 1 million is often negligible.

But because of the network effect, the platform becomes more valuable as more users join. This allows the company to command higher fees (like transaction commissions or advertising rates). On one side, you have near-zero added cost; on the other, you have soaring value and revenue. Just imagine how crazy the profit margins can get!

Some Examples to Make it Concrete

Social Networks (Facebook, WeChat, Instagram): You are where your friends are. The value is the network.
Marketplaces (Taobao, Airbnb, Uber): This is "two-sided network effects." More buyers attract more sellers; more sellers (offering better selection) attract more buyers. Both sides fuel each other.
Operating Systems (Windows, iOS, Android): The more users an OS has, the more incentive developers have to build apps for it; the more apps available, the more users the OS attracts.

To Sum It Up

So, when Naval talks about looking for companies with "network effects," he's essentially searching for the "holy grail" of business models. He's not just betting on whether a product looks slick or a team is smart; he's betting on the creation of a self-sustaining growth engine that, once established, becomes almost impossible to dislodge.

Investing successfully in such a company isn't about making a small profit; it's about capturing an era-defining, unbeatable giant. That's the kind of life-changing, asymmetric payoff he aims for.