The economic flywheel

Network effects are the drivers of value in Web3 business. The notion that as the number of users increases the value of the network itself increases underpins many of the business models that we see in the Web3 space.

It is important, however, to have an understanding of how that process actually works — what needs to be done in order to start the process and keep it going. One of the best tools to think about network effects is the ‘economic flywheel’.

What is an economic flywheel?

The economic flywheel as a business tool was first described by business consultant Jim Collins. It captures the idea of demand-side network effects very well and has become a very popular business tool in the Web2 and Web3 space.

Flywheels are an old technology — they were (and still are) large heavy wheels used to store and generate energy as they spin. The faster they spin the more energy they store and generate as necessary. Historically they were used in mechanical devices. In modern times they are used as a metaphor to describe how network effects operate and drive value to business.

Jim Collins explains the flywheel approach via a series of case studies. The Amazon flywheel, for example, looks like this.

Source: Adapted from Jim Collins, 2019, Turning the Flywheel.

What is important to note is that — starting at the top — we have an aspiration or goal. In Amazon’s case this is ‘lower prices on more offerings’. The immediate consequence of that aspiration is that it attracts more customers, who in turn attract more third party sellers, that results in the store being expanded, and revenues increasing, which in turn means that Amazon can lower prices on more offerings, and so it starts again. Each point on the flywheel leads immediately to the next, and the next, and the next. In the metaphor, the flywheel spins faster and faster and faster. It becomes self-sustaining.

To generalise that point — this is what a flywheel should incorporate.

Flywheels in Web3

Questions that Web3 entrepreneurs must ask themselves (and have good answers to) include:

• What is our consumer value proposition?
• What is our first round effect?
• What is our second round effect?
• What is the organisational consequence?
• What is the financial consequence?
• Why will the flywheel spin again?

When thinking about that consumer value proposition Collins argues that entrepreneurs need to be highly focused and single minded. They need to consider three issues:

• What are you passionate about?
• What are you the best at?
• What drives your economic engine?

The economic engine is the first and second effects which result in organisational and financial consequences.

Without an understanding of the flywheel within a Web3 business the entrepreneurs within that business cannot understand the network effects within that business nor understand how and why that business will be profitable.