🗞 One Of The Strongest Network Effects In the World

Happy Sunday! 👋 

Today we’re taking a look at how one of the strongest network effects in the world was built — Airbnb.

Let’s dive in!

Featured Story

“You Guys Are Crazy”

In October 2007, two unemployed roommates in San Francisco were struggling to pay rent. Brian Chesky and Joe Gebbia, both graduates of the Rhode Island School of Design, noticed that a design conference was coming to town and every hotel was booked. Their solution: inflate three air mattresses in their living room, offer breakfast, and charge conference-goers $80 a night to sleep on their floor.

Three strangers showed up. The experiment worked.

They brought in their friend Nathan Blecharczyk as a technical co-founder and, in August 2008, officially launched Airbedandbreakfast.com. What followed was not a meteoric rise, but instead, two years of near-failure.

Investor after investor turned them down. The receptions ranged from polite skepticism to outright alarm. In fact, according to the book The Airbnb Story by Leigh Gallagher, one VC wanted to stay as far away as he could:

They pitched fifteen angel investors in their first round. All either rejected them or never responded.

Pressed for cash, they resorted to some crafty marketing by selling limited-edition presidential election cereals ("Obama O's" and "Cap'n McCains") which gave them just enough money to keep the lights on.

That scrappy fundraiser caught the attention of Y Combinator co-founder Paul Graham, who invited them into the accelerator's January 2009 winter cohort in exchange for $20,000 and 6% of the company.

Asset-Light Scales Fast

What made Airbnb's model so unique compared to the traditional hospitality industry was that it owned none of the inventory it was monetizing. Standard hotel operators had to spend billions acquiring, constructing, and maintaining physical properties. Meanwhile, Airbnb focused all of their time, effort, and resources on building the best digital platform for listing and finding available rooms/homes.

While it might sound simple, it took excruciating attention to detail in order to build a website that was intuitive and inviting enough to help guests overcome their concerns of staying in a stranger’s home. Here were a few of the minor details that made a big difference in the early days:

• High-Quality Photos: When the site was failing to gain traction in 2009, the founders realized that many listings featured poor-quality, grainy photos. So, encouraged by Paul Graham, the co-founders went to New York to meet a bunch of their hosts in person. They went door to door with a camera, photographing properties to improve their listings and gathering feedback.

• “The 3 Click Rule”: Leveraging their design backgrounds, Brian Chesky and Joe Gebbia applied the Steve Jobs inspired principle that no user should ever be more than three clicks away from their end goal (making a booking). This constraint forced them to simplify the interface and remove all unnecessary friction.

• Two-Way Review System: Unlike traditional travel sites, which only allowed for user reviews of the property, Airbnb also allowed hosts to review guests, creating a system of "checks and balances" that kept both parties honest.

• Secure Escrow Payments: In the early years, payments on Airbnb were awkward and risky. Guests and hosts had to negotiate cash or PayPal transfers offline, which created friction on both sides. To address this, Airbnb introduced a new payment system in 2008 that is still in place today. Now, when a guest books a stay, Airbnb charges them the full amount immediately, and they pay the hosts 24 hours after the guest’s scheduled check-in. Acting as the middle man created far more trust for both parties.

• Hearts not Stars: In the earliest versions of Airbedandbreakfast.com, they built a star icon for users to indicate which listings they liked. Early user testing showed that this made users feel like they were “rating” a listing instead of “saving” a listing. So they decided to switch from a star icon to a heart icon, and added a “Wish List” that aggregated all their favorite listings. This simple shift increased engagement significantly, and reportedly increased bookings by 30%.

While some of these details – like hearts instead of stars – might seem trivial, it’s the little features like these that make all the difference in the aggregate. By March of 2009, the platform had reduced friction enough to finally start gaining traction. They had amassed 10,000 users and 2,500 listings, and a few months later, decided to shorten the name to Airbnb.

Following the rebrand, Sequoia Capital recognized the potential of Airbnb’s asset-light model and decided to make a $600,000 investment. This investment not only helped put Airbnb on the map for hosts and guests, but the sheer association with Sequoia attracted other venture capital firms as well.

With a little more money in their pocket and the kinks of the platform ironed out, Airbnb began to take off. By 2013, having raised a total of ~$326 million, Airbnb was home to more than 300,000 total listings.

From there, the network effect of their 2-sided marketplace was beginning to emerge. As more hosts joined the platform, the variety of stays increased and prices dropped due to increased listing availability. This attracted more guests, which in turn, incentivized more people to become hosts. And on, and on the flywheel went.

Crisis as a Catalyst

Airbnb was planning an IPO for early 2020. Then, in March of that year, a global pandemic shut down travel overnight. Within two weeks, Airbnb’s revenue dropped by more than 70% YoY.

The company was logging more cancellations than new bookings. CEO Brian Chesky described the moment as "the most harrowing crisis of our lifetime."

Airbnb had to cut 25% of its global workforce (approximately 1,900 employees), slash their marketing spend, reduce executive salaries, and raise $2 billion in emergency debt financing. They also quietly shut down virtually all their non-core ventures: a transportation division, a magazine, a hotel expansion, and many more.

This forced focus on their core business was brutal, but also revealing. As the world slowly opened back up, Airbnb realized that they didn’t have to sacrifice growth for profitability. As hosts and guests naturally flocked to the platform, profit margins soared.

With profitability improving and travel coming back, Airbnb decided to go public in December of 2020 in what would become the biggest U.S. IPO of the year.

Shares of Airbnb more than doubled on the first trading day, with the company’s market cap at one point eclipsing $100 billion. For a company that was generating just over $3 billion in revenue at the time, that valuation came as a surprise to many, including Brian Chesky himself.

Fast forward 6 years, and shares still remain below that initial offering price.

That’s all for this week. 

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