Zoom’s Fatal Flaw

In exchange for viral growth, the video conferencing startup left itself open to copycat competitors

Photo: Allie/Unsplash

Over the past couple of months, the coronavirus pandemic has led to a dramatic increase in the demand for remote work tools. Zoom has been one of the biggest beneficiaries of this shift, with daily active users growing from 10 million in the last quarter of 2019 to a staggering 200 million in the first quarter of 2020. This has also led to a surge of investor and startup activity in the remote workspace.

As an investor and adviser, I’ve received numerous questions lately about Zoom from entrepreneurs and other investors. The main question I receive is how strong are Zoom’s network effects? A network effect describes the increasing value of a product as more users begin to use it. Network effects tend to be one of the strongest forms of defensibility for a product because the presence of more users on the network helps prevent churn. In the case of platforms like Airbnb, a strong network effect creates defensibility by forcing rivals to challenge them at a much larger scale (in the case of Airbnb, on a global scale).

In other words, people were asking me if the new surge in user adoption on Zoom made it more a valuable product, which in turn made it more difficult for competitors to copy or challenge. While this is an interesting topic to explore, it is the wrong question to ask about Zoom. The right question is this: Does Zoom even have network effects?” And if it doesn’t, then what makes it defensible from the competition?

Zoom isn’t the new Slack

Zoom’s business model is often conflated with Slack even though they are distinct products. Slack’s business model has a lot of similarities with Github in the way it combines SaaS (software as a service) and network effects. Slack also has two different forms of network effects that come into play at different stages of its customer adoption cycle.

Slack’s adoption cycle often begins with individuals within a team who use the free version of the software to collaborate with each other. If only one collaborator signs up for Slack, it has no value because they cannot use it to communicate with anyone else. If two collaborators sign up, they can use it to communicate with each other. If all team members sign up, Slack becomes a valuable, intrateam collaboration network. In other words, Slack becomes more useful to the team as more collaborators sign up.

Shared channels extended network effects to Slack’s paid product as well without any organizational boundaries.

As adoption continues to grow, it eventually reaches collaborators who work cross-functionally. These collaborators act like network bridges within the organization, helping Slack spread organically across teams. At this point, the structure of Slack’s network effects resembles social networks like Facebook but is restricted within the boundaries of the organization. Since so many teams in the organization already use Slack, it becomes very difficult for individual collaborators or teams to use a different communication network. The effect is similar to trying to move to another messaging app while your social circles remain wedded to WhatsApp. This effectively locks out Slack’s competitors while its adoption continues to grow.

Increased adoption of Slack’s free product within the organization increases the incentive to upgrade to an organizationwide paid plan. At this point, all employees in the organization are mandated to use Slack and users expect to be able to communicate with everyone in the organization. The addition of each individual new employee to Slack no longer improves the value of the product for the organization at such a significant scale. This triggers the end of intraorganization network effects, and Slack becomes just another SaaS product.

Until recently, the defensibility of Slack’s paid product relied on creating switching costs, much like traditional SaaS products. Switching costs are the combined monetary and nonmonetary costs (such as time and effort) of moving from one product to another. In Slack’s case, paid customers would lose message archives and existing integrations if they moved away from Slack. Then in 2017, Slack announced a beta program to allow collaboration between organizations. This feature, called shared channels, was exclusive to paid plans, so all collaborating organizations had to be paid Slack customers. If a paid Slack customer partnered with another paid customer, they could use this feature to collaborate with each other. If all of an organization’s partners were paid Slack customers, Slack would become an invaluable cross-organization collaboration network. So as more organizations signed up for Slack’s paid plans, the more useful it became for all of them. In other words, shared channels extended network effects to Slack’s paid product as well without any organizational boundaries.

The adoption of shared channels has grown from 15% of paid Slack customers in January 2019 to nearly 30% in January 2020. Adoption of shared channels among its largest customers (those paying more than $100,000 a year) is now a staggering 89%.

Image: Sameer Singh

Slack’s free product has network effects between individual collaborators, but these are limited to the boundaries of the organization. When organizations become paid customers, network effects within the organization end and a new network effect between organizations kicks in. This results in strong defensibility. While competitors like Microsoft may attempt to clone Slack’s feature set and UX to limit churn among their customers and persuade new users to sign up, it’s a much harder task to steal Slack’s existing customers.

Virality versus network effects

Unlike Slack, Zoom’s primary appeal has always been its external uses. A free or paid Zoom user can initiate a video call by simply sharing a link without requiring the recipient at the other end to have a Zoom account. This makes it especially useful for sales calls (or any meetings with external stakeholders), removing the need to exchange personal account information (which is the case with Google Hangouts or Skype). This not only removes a key element of friction, but it also increases the chance for virality, where users spread the word about Zoom in the process of using it.

Competitors for Zoom are still in the mix, and users can just pick the product that provides the best experience for their needs at any given time.

Zoom’s ability to go viral has helped it grow rapidly. However, it had to sacrifice network effects in order to accomplish this. As I described above, Zoom’s core value proposition is built on enabling frictionless communication with users who are not in its network. This means that the value of Zoom’s product is always the same, irrespective of whether a user is communicating with another user or a nonuser. As a result, Zoom has no network effects.

Image: Sameer Singh

Crucially, this remains the same whether Zoom is used as a free product or a paid one. Zoom’s primary triggers for free-to-paid conversion involve the limitations of free meetings, such as the number of meeting participants or removing time limits on group video calls. While this follows the same bottom-up sales strategy used by Slack, it relies on the virality of its free product and is not affected by compounding network effects. Zoom is still valuable even if it has just one free or paid user because that user could set up video calls with any number of participants (internal or external) who do not have Zoom accounts.

That functionality does not change even if all employees in an organization or all members of a friend group have Zoom accounts. However, any participants that a Zoom user calls would then become aware of Zoom and could consider creating an account to set up video calls themselves. This built-in virality has helped Zoom scale its base of free users, which is its sales pipeline. However, the primary reason for newly aware participants to get Zoom accounts is its functionality — i.e., the ability to call anyone and not just those with Zoom accounts. As a result, the consideration for users is purely related to Zoom’s functionality and user experience compared with its competitors. Competitors for Zoom are still in the mix, and users can just pick the product that provides the best experience for their needs at any given time. In other words, Zoom does not lock out competitors, and free-to-paid conversion becomes a function of product preference.

In another contrast with Slack, Zoom’s core value proposition also prevents it from creating a cross-organizational network effect. This is because functionality on Zoom’s paid plans is defined simply by the meeting host, not all attendees. In other words, a paid Zoom customer can initiate a video call without any restrictions, with any number of noncustomers. This is a feature, not a bug — Zoom has willingly sacrificed network effects to unlock virality at this scale. This gives Zoom a major user experience advantage over competitors, but it’s at the cost of long-term defensibility. Since the presence of other users or customers doesn’t improve product value, it makes sense for customers to keep using Zoom as long as it retains this advantage. This gives competitors an opening to clone Zoom’s feature set and user experience; this is exactly what Microsoft, Google, and most recently Facebook have been working on. As a result, despite the current hype, Zoom is exceptionally vulnerable to cloning attempts from competitors.

This isn’t to say that Zoom has no defensibility whatsoever. In the absence of network effects, Zoom has attempted to build defensibility by integrating third-party apps much like Slack has done. For example, Zoom users can integrate Calendly to automatically generate Zoom conference details for scheduled meetings. Customers who use multiple Zoom integrations would find it more difficult to switch to another video conferencing product because they would need to set up their integrations all over again. That said, this form of defensibility is linked to extensive, not sporadic, use of integrations. Evidence of this is limited as Zoom’s app marketplace is still in its early days.

Growth versus market dominance

What can entrepreneurs learn from this? Sacrificing network effects at the altar of virality can certainly result in near-term growth as Zoom’s performance has shown. Zoom has proven that you can scale and take a company public purely based on product superiority and virality. However, the likelihood and sustainability of this growth is not entirely in Zoom’s control. Rather, it is a function of how long its competition remains ham-handed, even after Zoom has shown them the roadmap to a great customer experience. If entrepreneurs want to control their startups’ destinies, then it would be prudent to follow Slack’s path and link the value of their products to user adoption in order to incorporate defensibility into their models.

Network Effects Advisor & Investor, part of the Atomico Angel Program. Please direct all pitch decks and consulting requests to sameer@breadcrumb.vc.

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