Learn about the moat that grows with every user…

From the desk of Miles Everson:

Investing has provided many individuals with the opportunity to gain financial independence for decades.

That’s why every Wednesday, I talk about this activity in the hopes of helping readers achieve financial security.

Today, let’s focus on a concept that’s enabled many companies to enjoy long-term growth and stability.

Continue reading below to know more!

Buying something on eBay required a leap of faith during its early years.

Users mailed a check or money order to a stranger, and the seller didn’t ship anything until the payment cleared, which could take days or even weeks. If something went wrong, users had no recourse.

The system worked until it didn’t… and that’s when a handful of engineers and entrepreneurs saw an opening for digital payments.

Most of the early attempts failed. Services like DigiCash and CyberCash promised futuristic systems built on heavy encryption and experimental currencies.

However, as much as users wanted speed and reliability without changing their habits, they weren’t willing to give up the credit cards and bank accounts they already trusted.

So while the rest of corporate America tried to reinvent the wheel, a certain startup found a better way…

A Better Way of Moving Money

PayPal, founded in 1998, let users send money to anyone with an account.

All a user needed to register for an account was an email address, and the money he or she sent could come from a bank or credit card.

To grow its user base, PayPal gave new users USD 10 for signing up and linking a bank account, and another USD 10 went to anyone who referred a friend.

The campaign spread fast. By March 2000, the startup was handing out USD 10 million a month just to bring new users in. It was a genius marketing play. However, the company didn't just stop there.

While competitors struggled to find users, PayPal benefitted from eBay. Many eBay sellers were part-timers and weekend entrepreneurs who loved the idea of getting paid instantly, and they steered their buyers towards PayPal.

Every successful auction became a mini sales pitch. Sellers encouraged buyers to pay through PayPal, buyers signed up to get their purchases faster, and each new user brought in more.

Between January and March 2000, PayPal's user base exploded. Growth hit 7% to 10% daily.

Less than a year earlier, eBay bought Billpoint to serve as its own payment processor. But users weren't interested in eBay's in-house payment system.

PayPal had the scale and customer trust, and once people started using it, they had little incentive to leave.

PayPal went public in February 2002 and churned out profits within months. Meanwhile, in summer of that year, eBay acquired PayPal in an all-stock deal worth USD 1.5 billion.

So, what was the secret to PayPal’s early success? Surely, there’s more to the marketing strategy it deployed.

According to Professor Joel Litman , Chairman and CEO of Valens Research and Chief Investment Officer of Altimetry Financial Research, by reshaping how online payments worked, PayPal became the trusted layer for Internet transactions. In essence, it built a “network effect” that enabled it to grow as more and more people used it, making it even harder for existing users to leave the platform.

What’s more?

This has led to the creation of some of today’s biggest companies!

The network effect PayPal used to dominate the payments space is being used in different industries today:

• Social Media- Meta is a classic example. The more popular its social media platforms are—Facebook, Instagram, and WhatsApp—the more users want to join them.
• Payments Processing- Credit-card network operators Visa and Mastercard process a huge volume of the world's payments because nearly every merchant accepts their cards. The same logic applies:

  The more places those cards can be used, the more people want to use their cards, and the more attractive it is for merchants to accept them.

• Tech- Even chip-designing giant and AI darling Nvidia benefits from the “network effect.” Its proprietary CUDA software has become the industry standard for building AI models.

  As more developers build on CUDA, its library of tools grows richer, which draws in still more developers and enterprise customers. Since CUDA only runs on Nvidia chips, every new CUDA user also means more chip demand.

The bottom line for investors?

Businesses with sustainable network effects tend to enjoy long-term stability, with their stocks typically reflecting the popularity of their respective networks.

This means if you can find a business in the early stages of building a network effect, it has a high chance of beating the market.

Hope you’ve found this week’s insights interesting and helpful.

Stay tuned for next Wednesday’s The Independent Investor!

In the world of business, empires rarely collapse with a dramatic BANG.

Learn more about why today’s “Taxi King” is doing things differently in next week’s article!