But the great advantage of Auto Trader was simply that the product improved as it garnered more customers, both buyers and sellers. Buyers wanted the greatest choice of cars, so they went to the publication that had the most ads. Sellers went where most buyers were looking. It was easy to mimic the Auto Trader photo-classified magazine format, but you couldn’t match the usefulness of its product because you weren’t starting with the same numbers of buyers and sellers. And it was impossible to attract them from scratch–even by offering a free service–because they already knew the best place to buy or sell used cars. Of course, they were not prepared to abandon that and go instead to a thin and illiquid market place.
Auto Trader was a great network, where the customers attracted each other, to the point where a near monopoly was created. Once created, such a network is a great asset for its owners, unless or until a new technology disrupts everything. Auto Trader is also a profound example of a network effect, where the collective action of users becomes part of the strength of the product or service itself. The customers sow the value, and the network owner reaps it.
Bill, with a newspaper and branded-goods background, was a stellar operator of this type of business. But when you examine the performance of Auto Trader in all its territories, the way they were managed may have had less influence on its success than you might expect. Bill held the Toronto franchise, but he had not invented the business. Stuart W. Arnold had the original idea, in Florida in the 1970s. The market for used cars is, of course, local, defined by region or large metropolitan area. Stuart didn’t want to traipse all over North America, recreating a local Auto Trader business in each big city, so he sold about thirty franchises. The ticket price was $25,000. Stuart didn’t care who the franchisees were, as long as they had the money. He sold franchises to his nephews, uncles, accountants, dentists, journalists, housepainters–you name it–as well as to established business people. In fact, most of his franchisees had no business training and some of them were manifestly unfit to run anything.
Now, you might assume that some of the franchises went to the wall while others prospered.
Wrong. No matter how unqualified the franchisee, not one franchise failed. They all became successful and worth at least a few million dollars; sometimes, as with Bill’s franchise, a few hundred million. The network forces were so strong that once an Auto Trader franchise became established in any region, it was impossible for a competitor to overtake it. Managerial incompetence could make the franchise slightly less of a gold mine, but it would always remain the local market leader.
A British holiday-maker in Florida in 1975 also saw the potential of Auto Trader. When he went home, John Madejski started Thames Valley Trader, which sold houses, cars and much else besides. But the cars sold best of all, and soon Madejski renamed his title–wait for it–Auto Trader, focusing exclusively on vehicles. He sold the business in 1998 for £174 million. Since then, he has given a lot away–he was knighted in the UK Honours List in 2009 for his philanthropy–yet the Sunday Times reckons he is still the 222nd richest person in Britain.74 Just like Anita Roddick and the Body Shop, John Madejski had linked up with a distant American idea that had already proved itself.
Auto Trader, in its various forms, had a clear thirty-year run, during which time several great fortunes were amassed. Then the playing field finally shifted–the Internet ended the dominance of the photo-classified print format and allowed other competitors, such as eBay Motors, to barge in. Auto Trader is still alive and well online, but it is no longer guaranteed to be the leader in every local market.
So what is it about network stars that makes them so much better than the plain vanilla star?
Network stars are the business world’s beneficiaries of the phenomenon observed by Barabási and Albert–the inexorable concentration of networks. They outgun normal stars due to what we’ve come to term ‘network effects’–instances where a product’s value for any single user becomes correlated to the total number of users. The more users it has, the better the product. The consequence is a natural tendency to ‘winner takes most’ or ‘winner takes all’ end games, resulting from the insurmountable product advantages of the leading player. A network star can grow enormously, become the dominant player in its market, and sustain fat margins. The combination of growth, high profitability, dominance and sustainability results in an enormously attractive business, such as Betfair.
This logic is very different from the traditional view of why star businesses are attractive. BCG based its perspective on costs and economies of scale. For sure, a business with lower costs than its rivals has a strong hand. However, a determined challenger with a lower cost of capital, or with the willingness to invest heavily to gain market share, can match the leader simply by accepting lower profits. Cost advantage does not guarantee victory, because a rational rival can buy market share and hence overturn the leader’s advantage in costs and experience. Cost advantage can be offset by throwing money at the problem or just by growing faster. When Raymond Ackerman started with four Pick ’n Pay supermarkets in Cape Town, Checkers was a much bigger chain; but Raymond knew that he had to become the biggest in South Africa to be able to buy groceries cheaper than his rivals, so he ploughed back in all his cash flow to open new stores faster than Checkers.
But network advantage is not so vulnerable to price cutters or expansion through heavy investment. Cost advantage does not explain why Auto Trader, Betfair, Google, Microsoft or Facebook has become so dominant. The most stunning market concentrations, and ensuing increases in wealth, are not driven by economies of scale. They come about because of product advantages created by networks that are fiendishly difficult for a competitor to duplicate. If Checkers had been in a strong network market–where the existence of many more stores made the groceries taste better–then Raymond wouldn’t have stood a chance. But groceries, of course, do not work like that.
The more users a network has, the greater its value–and that of the product or service it proffers. The more buyers and sellers that use Auto Trader, the greater the choice, and the more likely you’ll be to sell your car. The more people who congregate in cyberspace to bet through Betfair, the bigger the betting, the narrower the spreads, and the greater its value to all the gamblers. You can try to compete with a network star, but you don’t have the best product until everyone switches to you. And why would they do that unless you had the best product? You can throw money at this problem, but you’ll get nowhere.
This ‘bigger is better’ phenomenon applies to all networks.
Because the value of using a network keeps rising, the number of users increases alongside the extent to which each member uses it. Usage breeds usage. In the jargon used by network scientists, there are ‘positive feedback loops’–every new participant on a betting exchange improves it for everyone else; and there are ‘positive network externalities’–we all benefit from network growth without having to pay for it.