Venmo: Building direct network effects and then…nothing happened?
Venmo has grown with strong direct network effects, but has been unable to crack the indirect network effects.
Venmo is a bit of a paradox: it was able to grow via direct network effects, but its trajectory has seemingly stalled because it has been unable to tap into indirect network effects that everyone assumed it would be aiming for.
Venmo, which was acquired by Braintree in August 2012 for $26 million, is at its core a peer-to-peer money transfer app. It provided massive convenience for users in at least two major ways. First, it provided a new money account for users, one which was more liquid than a checking account and less cumbersome than cash or credit cards with respect to peer-to-peer money transferring. Second, it created a great and convenient mobile experience just as mobile usage, especially in its target demographic of college students and young adults, was taking off. These were key pillars of their value creation proposition.
Perhaps the biggest source of value creation, however, was in the direct network effects: Venmo is an easy way of transferring money between you and your friends, but only if everyone has a Venmo account. To grow its user base, Venmo had a number of strategies, such as including a social element where your Venmo account would paste to your Facebook wall when you made a transfer, or a $1 referral bonus for getting one of your friends to sign up. What was perhaps most compelling, however, was the word-of-mouth. Every expense-splitting moment (e.g. at the end of a restaurant meal, every month when splitting rent, etc.), some millennials began asking “Do you use Venmo?”, and if the unfortunate friend answered negatively, there probably was a conversation extolling the convenience of the product.
The more users which were on Venmo, the more convenient it became for all Venmo users, as it became a solution to the need to transfer money between friends more and more often. From this value creation, Venmo has to date not captured too much of the value – it makes money mostly off of charging fees for users who connect their Venmo balance to a credit card (connecting it to a bank account or debit card, however, is free). Venmo seems to have consciously decided not to charge more for its popular product, probably to keep the barriers to adoption minimal.
It was also probably hoping to be able to monetize via a different channel: charging a percentage off of business-to-consumer transactions. Herein lies a paradox of Venmo’s growth: despite having a large and growing user base, it has surprisingly been unable to get businesses to sign on as partners and use Venmo as a payment method.
At first glance this is somewhat surprising, as one might expect strong indirect network effects: the more users who use Venmo, the more businesses are likely to want to offer the feature of allowing payment via Venmo. This would especially be true if Venmo charged fees lower than credit card companies.
However, Venmo has been unable to grow its business user base. Perhaps it is unable to charge lower fees than credit cards because it doesn’t have the same scale as credit card processors. Or, perhaps users aren’t clamoring for “pay by Venmo” because they are already accustomed to use credit and debit cards. Or, perhaps “pay by Venmo” doesn’t integrate well with businesses’ existing POS systems. Whatever the reason, being unable to crack the B2C payment link bodes poorly for Venmo’s future impact, which is probably why they sold themselves relatively early.
And this is not for lack of trying: Venmo has tried to make its product more of a platform by offering the Venmo API. Moreover, this API seems relatively full-featured: developers can request or send payments to Venmo users. However, developer adoption of the API seems poor. Venmo has just been unable to crack the payments space, and instead stays firmly rooted in the friend-to-friend money transferring use case.
The direct network effects in the C2C transfer space are undoubtedly strong, and consequently numerous players have tried competing with Venmo. In general, other independent players (e.g. Square, Google) have failed because they have been unable to overcome the gain enough initial momentum to compete with Venmo’s established user base. Banking players (e.g. Bank of America, Chase) have come out with similar products, but they generally only work well between two users who are both members of the same bank, which destroys a key value of the network effects. Thus far, we have seen that direct network effects have made it very difficult to compete head-on with Venmo. One potential way Venmo could be brought down is if someone is able to offer everything Venmo does, plus a new feature that solves another key problem for users – perhaps this could be the B2C payment link. But until that happens, Venmo seems to be stuck in the strange position of having built an amazing product with amazing direct network effects…but maybe not knowing what to do next.
Do you think an industry partner might be a method for Venmo to solve this problem?
Consider OpenTable and their successful penetration into businesses. As they’ve been able to get businesses to adopt OpenTable for managing restaurant reservations, do you think it would make sense for the two to form a partnership? People could make a reservation via OpenTable and just pay through Venmo automatically in one simple process?
Perhaps the problem is the sheer number of pieces of technology permeating into the role of restaurant management.
Maybe adoption of technology is just harder for restaurants, and the bar for them to change the way they do things is just higher?
Maybe by integrating with something they already use, Venmo can make the transition feel less painful.
Thank you for the well though out post, Allen! I completely agree with you that Venmo has done an excellent job of building a huge user base and in-turn now has a strong network effect. The fact that they are not moving fast enough to sustain this through building their indirect network effects is quite scary!
While I do believe that a business model like Venmo displays strong network effects, I don’t believe that they have a strong business proposition to protect them from competition. The few players who tried to compete with them and failed do exist, but they have not faced a stiff competition yet from competitors who already are present on users mobile phones (the way Venmo payments happen). When a PayPal or Facebook or Whatsapp, who themselves are players who display strong network effects, decide to focus on this market, the network effects cannot alone help Venmo beat competition. The network effects have so far helped them against players who did not have similar network effects (Google you can argue has network effects but that is only in the search space which happens a lot lesser on mobile).
What’s interesting for me in Venmo’s case is two-fold. Direct network effect players need to expand and build further defensible models through indirect network effects. A player like Venmo who has direct network effects can be beaten by a player who has similar direct network effects but operating in a different space – the winner will likely be determined by who provides more utility to the user.
Amazing post!!! Thanks for helping me understand what they are actually doing.
My question is: how can they enter markets, where users are suspicious of this kind of banking? Markets, where both, the regulation is tough and customers are not used to this form of banking (thinking specifically of Germany). How can you still build your network? I guess, once you have a critical number of users, the trust is easier to build. But how do you start??
To the last point above, I agree that Venmo’s value proposition may differ by market — not only in terms of user acceptance or suspicion, but also in terms of existing alternatives. In the US, from my experience there is often a fee to make a wire transfer, particularly to other banks, so people wouldn’t want to make transfers for minor things like paying a friend back for a meal. Services like PayPal and Venmo have helped people find an easier and cheaper way to transfer money regularly. But in other countries (I’m thinking specifically of France), transfers are free and relatively painless (I have to input a friend’s account number once into my bank’s mobile app, and after that sending over money is free and quick — so I use it for many minor payments, much like I use Venmo in the US). While the system could be made even more streamlined, I wonder whether something like Venmo would have enough of a value proposition to capture network effects and a large user base in a market like that.
Yeah, great post Allen! This reminds me of the winning strategy in the simulation to set zero cost for the service and capture as much market share as possible. Value capture is ruined for every player in the market until someone can figure out how to create a complimentary business model. However, as you point out very well, that is easier said than done. Just building the capability definitely doesn’t mean they will come.
Here’s a potentially interesting thought — if and when Venmo gets businesses to sign on, they should be able to offer substantially lower processing rates than credit card companies, not because of scale, but because of tiny (near zero) expenses from fraudulent charges. One of the reasons why merchants like restaurants and shops pay such high processing fees is because of the high incidence of fraud. It costs credit card companies much more to process ‘swipe’ transactions because it is very easy for a criminal to steal the physical card and use it at one of these locations. On the other hand, if customers pay with Venmo, it should be much more difficult to use stolen phones for these transactions (especially as TouchID rolls out across Venmo’s user base).
Let’s also not forget that after Venmo was acquired by Braintree, Braintree was in turn acquired by Paypal, which already owns widespread relationships with merchants. Maybe they’re just biding their time, after all…