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by $500 a month on average,” and were allowed to do so by clicking a single button. This took serious technology skills—unlike many platforms, Craigslist doesn’t have an application programming interface (API) that allows other software to interact with it—but it was technology innovation for the purposes of distribution innovation, not product innovation. “It was a kind of a novel approach,” Airbnb founder Nathan Blecharczyk said of the integration. “No other site had that slick an integration. It was quite successful for us.”

      Leveraging an existing network can have downsides, of course. What the existing network gives (or unknowingly allows to be taken), the existing network can also take away. Zynga, the leading social games company, achieved great success leveraging Facebook for distribution, but had to dramatically reengineer its distribution model after Facebook decided to stop allowing people playing Zynga games to post their progress to their Facebook friends. (Disclosure: I am a member of Zynga’s board of directors.) Zynga founder Mark Pincus was farsighted enough to build a strong enough franchise to survive the change.

      In contrast, so-called content farms like Demand Media that leveraged Google’s search platform to generate website traffic and advertising revenues never recovered after Google tuned its algorithms to deprioritize content from what it called “junk” websites.

      Despite these dangers, leveraging existing networks can be a critical part of a business model, especially if these networks can provide a “booster rocket” that is later supplemented with virality or network effects.

       B) Virality

      “Viral” distribution occurs when the users of a product bring more users, and those users bring additional users, and so on, much like an infectious virus spreads from host to host. Virality can either be organic—occurring during the course of normal usage of the product—or incentivized by some kind of reward.

      After launching LinkedIn, the team and I devoted significant time and energy to figuring out how to improve organic virality; that is, how to make it easier for existing users to invite friends to use the service. One way we did this was to refine what have become some of the standard tools of virality, such as address book importers. For example, we built software that allowed LinkedIn to connect to our users’ Outlook contacts, which made it very easy for them to invite their most important connections.

      But equally important was an unanticipated source of virality. As it turned out, users wanted to use their LinkedIn pages as their primary professional identity on the Internet. Having a page like this to point others to—with all the details of their professional life together in one place—generated value not only for the user, but for the people viewing the page, and it made viewers realize that they should get their own LinkedIn profile. As a result, we added public profiles as a systematic tool to boost both the member value proposition and our viral growth rate.

      At PayPal, we combined organic and incentivized virality. The payment product was inherently viral; if someone e-mailed you money using PayPal, you had to set up an account to get paid. But we enhanced this organic virality with monetary incentives. If you referred a friend to PayPal, you got $10, and your friend got $10. This combination of organic and incentivized virality allowed PayPal to grow 7 to 10 percent per day. As the PayPal network grew, we reduced the incentives to $5 and $5, then finally eliminated them altogether.

      Incentives don’t have to be monetary; like PayPal, Dropbox used a similar combination of organic virality (as users share files with nonusers) and incentivized virality (Basic account holders get 500 MB of extra storage per user they refer; Pro account holders get 1 GB) to grow. Even though Dropbox invested in partnerships with leading PC makers like Dell, Drew Houston credits virality with driving the company’s rapid growth, helping it double its one hundred thousand users at launch to two hundred thousand users just ten days later, then skyrocket to one million users just seven months after that.

      If your distribution strategy focuses on virality, you also have to focus on retention. Bringing new users in through the front door doesn’t help you grow if they immediately turn around and leave. According to Houston, Dropbox discovered this truth the hard way, when activation rates revealed that only 40 percent of the people signing up were actually putting files in their Dropbox and linking them to their computers. In an interview for my Masters of Scale podcast, Drew described a scene reminiscent of the television show Silicon Valley (but with a happier ending):

      What we did is we went on Craigslist and offered $40 to anyone who’d come in for half an hour—a poor man’s usability test. We’re like, “All right, sit down. This is an invitation to Dropbox in your e-mail. Go from here to sharing a file with this e-mail address.” Zero of the five people we tested succeeded. Zero of the five even came close. This was just stunning. We’re like, “Oh my God, this is the worst product ever created.” So we made a list of like eighty things in this Excel spreadsheet, then just sanded down all these rough edges in the experience, and watched our activation rate climb.

      Virality almost always requires a product that is either free or freemium (i.e., free up to a certain point, after which the user has to pay to upgrade—Dropbox, for example, offers 2 GB of free storage). We can’t recall a single instance of a company that grew to a massive scale by leveraging the virality of a paid product.

      One of the most powerful distribution innovations is to combine both strategies. Facebook was able to do this by harnessing the organic virality of a social network (where users invite other users to join them) and leveraging existing networks centered around campuses by rolling out the product on a college-by-college basis. We’ll discuss Facebook’s rollout strategy in greater depth when we consider network effects.

       GROWTH FACTOR #3: HIGH GROSS MARGINS

      One of the key growth factors that entrepreneurs often overlook is the power of high gross margins. Gross margins, which represent sales minus the cost of goods sold, are probably the best measure of long-term unit economics. The higher the gross margin, the more valuable each dollar of sales is to the company because it means that for each dollar of sales, the company has more cash available to fund growth and expansion. Many high-tech businesses have high gross margins by default, which is why this factor is often overlooked. Software businesses have high gross margins because the cost of duplicating software is essentially zero. Software-as-a-service (SaaS) businesses have a slightly higher cost of goods sold because they need to operate a service, but thanks to cloud providers like Amazon, this cost is becoming smaller all the time.

      In contrast, “old economy” businesses often have low gross margins. Growing wheat is a low-margin business, as is selling goods in a store or serving food in a restaurant. One of the most amazing things about Amazon’s success is that it has been able to build a massive business based on retailing, which is generally a low-margin industry. And even Amazon now relies heavily on its high-margin SaaS business, Amazon Web Services (AWS). In 2016, AWS accounted for 150 percent of Amazon’s operating income, which means that the retail business actually lost money.

      Most of the valuable companies we’re focusing on in this book have gross margins of over 60, 70, or even 80 percent. In 2016, Google had a gross income of $54.6 billion on sales of $89.7 billion, for a gross margin of 61 percent. Facebook’s gross income was $23.9 billion on sales of $27.6 billion, for a gross margin of 87 percent. In 2015, LinkedIn’s gross margin was 86 percent. As we’ve already discussed, Amazon is the outlier, with a 2016 gross income of $47.7 billion on $136 billion in sales, for a gross margin of 35 percent. Yet even Amazon’s gross margins are greater than those of a “high margin” traditional company like General Electric, which in 2016 had a gross income of $32.2 billion on sales of $119.7 billion, for a gross margin of 27 percent.

      High gross margins are a powerful growth factor because, as noted below, not all revenue is created equal. The key insight here is that even though gross margins matter a great deal to the seller, they are irrelevant to the buyer. How often do you consider the gross margin involved when you make a purchase? Would you ever choose Burger King over McDonald’s because Whoppers are lower margin than Big Macs? Typically, you focus solely on the cost to you, and the perceived benefits of the purchase. This means that it’s not necessarily any easier to sell a low-margin product than a

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