The Ecosystem Effect

Notice: This post was updated into a longer-form, more complete post here.

Helpful Pre-reading:

  1. Network Effects (a16z) and Data Network Effects (Matt Turck)
  2. Full stack Startups (Chris Dixon), Full Stack Startup Index (Anshu Sharma)
  3. Stack Fallacy: Why Big Companies Keep Failing (Anshu Sharma)
  4. Disruption’s Long, Slow, Complex Journey (Steve Sinofsky)
  5. Disruption is not a strategy (Jerry Neumann)

What is the ecosystem effect?

The ecosystem effect is how to build unstoppable companies. As a company grows out from their initial product offering, they vertically and horizontally integrate (“move out”), to continue growing the company.

It’s how big companies become big.

Companies typically enter the level of the stack at the path of least resistance (easiest go-to market strategy). Build that piece well, monetize, and use money to build out long-term vision and strategy of company from there.

Building out and owning more of the process create a scrabble “double points” effect - effectively, the sum of the parts are greater than the individual parts alone (1 + 1 = 3). Building out creates defensibility in a product. This is where the ecosystem effect comes in - it’s the “lock in effect", because the experience of having all the software on platform is much better than piecing together multiple pieces of software. Creating a network of products has greater value than the products individually.

When venturing out into new markets, companies usually have solid product market for their original product, and likely have enough recurring revenue to fund "moonshots" (not the best term to describe, but it's understable). Moonshot teams get resources to build out new, innovative products from scratch. At Google, many popular products today were built during 20% time, effectively their "moonshots" of the day. Originally it targeted horizontal integration, but now that it's effectively maxed out, it's targeting diagonal and vertical integration (hence all the products [x] is working on).

There are different types of network effects. We’ve seen a few:
  • Social network effects (FB, Snapchat)
  • Data network effects (Uber, Palantir)
(social usually leads to data network effects, but that’s a different conversation)

A third is being proposed:
  • Ecosystem network effects (Google, Uber, Netflix): This is a higher-level version of the full-stack startup (defined by Chris Dixon), if you will. This is how you create data network effects on a platform itself. Original thought leading to conversation: Companies that rebuild an industry, rethink the experience, collect a bunch of data, then use this in product decision to improve their offerings and beat incumbents.
Vertical integration is understable, but doesn’t explain the ecosystem effect fully. This is vertical E2E integration.

TODO: List out assumptions (this works best for software startups, think of hardware ecosystems potentially), then explain why they were right assumptions to make.

Examples of Companies Exhibiting “the Ecosystem Effect”

  • Google
    • Initially built the search engine, on top of previous innovations in computing (mainframe, OS, internet browsing).
    • Built on top of the search engine with AdSense, ad tools to help grow and scale their ad business and revenue
    • Expanded horizontally with Gmail, YouTube, Drive, Music. In the process, built OAuth and single-login to all apps as well as slick integrations between products (ie easily embed Drive docs in Gmail). 
    • Eventually went back and rebuilt layers of stack below them (rebuilt the browser - chrome, rebuilt the OS - ChromeOS, rebuilt the PC - Chromebook, the internet - Fiber.
    • Building below and horizontally are usually moonshot projects, that with traction, become full-blown projects (ie Gmail, Trends, Adsense)
    • Google is going into other industries and verticalizing their new products
    • "No One Ever Got Fired for Buying Google" is the new "No One Ever Got Fired for Buying IBM" (credit to Zach Hamed for the comparison)
  • Netflix
    • Originally started as a DVD rental company through the mail. After seeing the potential of streaming, started investing in scalable cloud technology to efficiently deliver video over the web.
    • Now that some previous content licenses are expiring, Netflix is investing in buying shows, some new, some old, and offering them as original content (one level down in stack).
    • Eventually, Netflix will run their own studio (another level down in stack) and produce a good majority of their content.
  • Uber
    • Most recent example (company is getting to the stage where it’s becoming LARGE)
    • They started off with a simple goal - fastest way to take you from A to B. Expanded product offerings vertically with uberPOOL and uberEATS.
    • Now are integrating up to autonomous vehicles in Uber, the step to eliminating human labor from their system. After Otto acquisition, it seems as if they’re integrating on that horizontally (autonomous uber, but for commercial trucking)
    • As per Semil Shah,
      it can apply those resources [from Uber China - Didi deal] to technologies “up the stack” for a world in which your Ubers are autonomous — that could be pods or cars, sensors, robotics, mapping technologies, deep learning, and a host of other requirements to make a fully-integrated self-driving network a reality. With 80% of each fare you pay going to your driver, the company has a huge incentive to bite into that for its next big meal. [1]
  • Salesforce
    • Why did they buy Quip? Why did they buy Heroku? Seems unrelated from sales software, but they’re building an ecosystem of products.
  • Apple?
    • Apple seems to be creating an ecosystem of brands. With the recent Beats acquisition, Didi investment, and potential McLaren purchase, they want to create a collection of brands with potential collaboration between them. Apple might power the software in the McLaren, that is exclusively on Didi, and has Beats-branded audio in-car. 

Case Study: Dropbox vs. Google Drive

Why are more customers choosing Google Drive over Dropbox? Look at their individual product offerings:
  • Dropbox

  • Google

Browser (Chrome)

OS (ChromeOS)

Computer (Chromebook)

Internet (Fiber)

Notice how seamless Google’s product offerings are. Since they control almost every level of what we interact with, there’s more opportunity to offer niceties and a supreme UX. Take this example: “I used Google+ to schedule a live stream on Google Calendar, presented on YouTube using my Sheets presentation in Chrome. I didn’t once have to leave the Google Ecosystem”. This builds up a large dependency graph from the core product - the more nodes (in this case, products) you add to a graph, the more valuable the network of products become (Metcalfe’s Law). Dropbox may have some horizontal integration, but not the strong vertical (Chrome, ChromeOS, Chromebook, etc.) and horizontal integration (Drive, GMail, Analytics, Calendar, Handouts) Google has.

You could take this from a physics perspective and think of the stack as a hill. As you get to the top of a hill, potential energy increases, and kinetic energy starts to decrease. After you pass the monument of building lower in the stack (at the bottom of the hill), you’ve built up enough potential energy to build horizontally from there, since the previous infrastructure already exists. When Uber created UberEATS, a lot of work was already done, since a network of drivers already existed on the road (rather than having to build from scratch).  

Wiley and I recently recorded a podcast on this phenomena where we explain the idea in more detail + clarity:


Please reach out with any feedback or questions! I can be reached on email or @niraj.