The fundamental flaws of "Swapping Networks" (most of them anyway)

It became clear to me a few years ago that I wanted to get involved in start-ups. In the long run I knew I wanted to start my own company, but in the short run I was open to cutting my teeth at a start-up in progress. Last November / December I began a long process of thinking through three really important things:

1) What types of businesses excited me
2) What types of businesses have a proven track record of big time success
3) What opportunities were at the intersection of 1 & 2 that had yet to be built

I quickly found the intersection of my interests and a key success factor... it was all about Network Effect for me. A network effect business is a business whose value to end users is directly related to the number of other users using the service / product. The classic example of a network effect is the Fax Machine... not all that useful if you are the only owner of a fax machine... more useful when there is another owner, and incredibly useful if there are millions out in the world. More recent examples are products like Instant Messaging, PayPal, YouTube, and eBay. (note that 2 of these examples are eBay business...which is why last September I stated that eBay was actually in the "Network Effect Management" business)

Ok, so now I knew I wanted to get into the "Network Effect" business... but many of the "obvious" network effect opportunities were already being built out:

Communications - Done (IM, Skype, etc.)
Payments - Done (PayPal)
General Purpose Marketplace - Done (eBay)
Social Network - Done (MySpace)
Job Network - Done (LinkedIn)

Yet, despite this situation I really wanted to find a network effect business to build, and I felt as though eBay's General market place could be attacked potentially by "niche" community sites focused on creating a marketplace for goods. Around this time two things happened:

1) I started brainstorming ideas with my friend Josh Hug
2) I discovered Peerflix, which is the DVD trading marketplace.

At first I thought Peerflix was a GREAT idea and thought about ways to go after similar markets (such as CDs, Video Games, etc.)... but Josh & I quickly realized two things:

1) Product specific swapping sites were bound to become CROWDED markets.

We figured there would be 2 or 3 CD swapping sites and at least 2 or 3 video game swapping sites popping up. This analysis was pretty close to dead on... LaLa.com (CD trading) launched earlier this year, and Swaptree (a generalized trading platform for CDs, DVDs, Books, Video Games) has launched in closed beta.

2) All of these sites suffer from a number of fundamental Economics 101 flaws:

- Supply won't meet demand and you will end up with market failure: When a new product hits the market there simply won't be enough supply of this product (DVD, CD, etc.) to meet the demand of the users.

- Consumer are collectors of content they like and traders of the content they don't like:

People love to collect the books they read and put them on their bookshelf for their friends to see. Even though they are likely to never read the book again, they aren't all that interested in parting with the book if they liked it and believe that by displaying the book it says something about who they are.

Movies, unlike books, are often consumed more than once. I must have watched the movie Caddie Shack 100 times in college. If you really like a movie, you are holding onto it.

Now because you can basically "copy" a CD by ripping it, and then burning the content onto a CD, this specific issue is less of a problem for CDs.

3) Another problem of swapping networks is setting "Fair Market Value". Does my Ferris Bueller DVD really have equal value to The man who cried as Peerflix would have you believe (each are worth 2 peerbucks). In the Swaptree world it gets even harder to figure out fair market value because I could send out my Ferris Bueller CD to someone and get in return the best selling book Freakonomics. Is this a fair trade? I don't think consumers are going consistently feel like they are getting fair market value for their goods.

Here is the last fundamental flaw for trading sites... there is already a trading site that exists that solves ALL the problems listed above, it is called eBay! But wait you say... eBay isn't a trading site, it is a marketplace where goods are SOLD, not swapped. I believe that PayPal accounts have turned eBay into a trading site, where you get Fair Market Value for all your products (because you have a critical mass of buyers and sellers) and you take that value and dump it into your PayPal account. Then you use that same PayPal account to "purchase" a new item, like a book, DVD, CD, or whatever you want.

So for those people looking to get rid of the books, DVDs, CDs, and video games that they don't want... there is already a perfect trading site... eBay.

All this analysis brought Josh and I around to a different idea. That idea is Shelfari. We believe that Shelfari will meet the needs of an under served market, and of course, but product has numerous network effects.

Over the coming weeks I will be posting more about Shelfari, and why we think it is a great product that consumers will love. We are rapidly approaching our closed beta period, so if you are really interested and want to test it out let me know. Email me at Mark @ Shelfari.com.

I should also note that Kevin Beukelman joined Josh and I in our brainstorming and was instrumental in process of thinking through the idea.