All these business [Facebook, eBay, Oracle] rely heavily on the network effect: Their product is more attractive than the competition because of their market share. […] Do you know what kind of software doesn’t have the advantages of the network effect? Ours. One Highrise user doesn’t give a hoot whether we have 10,000 or 100,000 customers. Jane Doe doesn’t benefit if we sign up any other customers this year. As long as there’s a sound business behind the product, she doesn’t care about anyone else. In other words, there are no network effects.
Do you know what other kind of software isn’t affected by the network effect? Bug tracking. I don’t care who else is using Trac as long as it’s great software. It doesn’t benefit us to know that the Shopify guys are using it too (short of just sharing tips and tricks). Again, no network effects.
This is an oversimplification of the debate. There are several ways that you can lose in a market if your competitors has way more customers than you do.
First, you simply will not have the resources to keep up with the development schedule of your competitor. If they have 10 times the people and the money, they will keep crunching out new generations of their software while you are still fixing bugs from a year ago. If the price points remain the same and any prospective customer does a comparison of the products in your space, you will lose.
Second, you cannot keep your biggest customers from jumping ship to your competitor, when and if the other software becomes much better than yours. Those customers will have the resources to migrate necessary data to your competitor. You will be left with smaller customers and lower profits.
Third, you will find hiring and retaining employees difficult. They will want to work for the market leader if they have a choice. And the market leader will want to steal them if your company is on their radar screen. So once again, you are at a disadvantage. Not only are you resource-poor, but your quality of resources is also weaker than your competition.
Fourth, if for some reason, you pose a threat to the sales of the larger company, they have the resources to beat you to gain important customers. Maybe they undercut prices or offer custom services. If they really want to get a client, a large company will go to lengths that you cannot afford. Gaining and keeping enterprise customers is a very tough job.
In short, there is a vicious cycle where, regardless of where you stood before the surge by the competitor, you are losing on all fronts – sales, marketing, programming, customer service, quality, etc.
Once there is a big gap between your competitor and you in terms of sales and size, usually the game is over, but it takes a while for it to sink in. Entrepreneurs are sometimes too full of hubris to admit defeat. They imagine themselves in a David-vs-Goliath fight where they use their strategic brilliance to make a spectacular comeback. The problem is that the geniuses are all working for the other side.