Platforms are powerful business models — but pitfalls await the unwary

In the first post in my series on business ecosystems, I discussed what ecosystems are, why they matter, and what opportunities and challenges they present for leaders. In this instalment, the focus shifts to platforms—a word that is often uttered in the same breath as ecosystems, where the two are often conflated. But they are not the same.

An ecosystem is a network of companies and, often, individuals connected by flows of data, money, products and services. A platform is a kind of business model that takes advantage of ecosystems, facilitating transactions between large networks of users such as sellers and buyers, drivers and riders, hosts and guests.

The dramatic digital advances that make ecosystems an increasingly viable way to coordinate economic activity also make platforms possible. These business models are transforming a range of industries by taking advantage of digitisation, computation and connectivity.

Still, not every ecosystem has a platform operating within it and not every company that takes advantage of ecosystems has a platform business model. Ecosystems are ubiquitous and offer clear and present opportunities to transform how firms work; they deserve broad consideration. Building a platform business, however, is a big bet. While the returns can be fantastic, it is far from easy, and platforms are facing scrutiny from regulators who are increasingly sceptical of platforms’ competitive tactics and the risks that these business models present to the societies across which they operate.

Here are some opportunities and challenges that platform business models present to leaders. First, let’s look at the upside.

Platforms allow users to do amazing things

Airbnb is a classic example. It lets guests look across an entire city and see into all of the available places for rent at any given time (there are 189 such places in the Lower East Side of Manhattan as I board my flight for New York). Guests and hosts can coordinate with each other, book a stay and settle up, all without leaving the platform. On an average night, more than two million people are staying at an Airbnb.

Or Amazon, which offers small businesses all that they need to get up and running, everything from web services, business analytics and logistics to fulfilment, payments and lending in one place. The draw—access to Amazon’s 200 million plus unique visitors every month.

Platforms are able to deliver amazing results for two broad reasons. One, they are organised around the user experience—what a user is trying to achieve—and meeting their needs by coordinating and integrating products and services from across an ecosystem of producers. Two, platforms minimise users’ transaction costs to such an extent that they become negligible. This comes in part from indirect network effects as the platform achieves scale (the value of access to Amazon’s 200 million unique visitors or Airbnb’s five million hosts) but also from the smart use of data to consummate the match between users in insightful, efficient ways.

For businesses that succeed by the strength of their customer relationships, a platform business model can be a powerful attractor.

Platforms are valuable to own

Seven of the world’s ten most valuable companies are platform-based businesses.¹ This value comes from three things:

One, they create and shape their own big markets. Platforms cut across, connect and subsume different industries, growing into the markets that they are able to define. Airbnb has expanded from stays to trips, creating a marketplace that now includes experiences; currently about 30,000 unique experiences are available around the world.

Two, platform-based businesses create and capture value very differently from traditional business models. Platforms are asset-light; they own neither the means of production nor the products that they sell, but instead leverage users to create value for other users.² Accordingly, they grow by acquiring users—network capital, in essence—until achieving a critical mass whereby the network effects kick in. When these are internalised, the value created on the platform grows geometrically whereas costs increase linearly.³ At scale, capturing this value can happen via a number of different commercial models.

Three, platform businesses enjoy unique economics as they grow. Whereas traditional businesses need to achieve supply-side economies of scale, these economies start to break down as the businesses try to capture the long-tail of their market. For platforms, most of the cost and complexity associated with meeting the long-tail of customer demand are borne by users in the platform.

For businesses that can connect their customers to create a true network, the potential for value creation is incredible.

Platforms are formidable competitors

Once they’ve achieved scale and network effects have kicked in, platforms are tough to displace. Network effects create high barriers to entry and the data that platforms amass about their users both increase their switching costs and decrease their transaction costs.

In order to scale, platforms have to be open–accessible and easy to build off. When they are, innovation happens faster around a platform than in traditional business. Amazon has more than 10,000 APIs and mashups (using Amazon data to drive new, third-party services) to facilitate the size and density of its ecosystem. Walmart, by comparison, has about ten APIs at time of writing.

For businesses that are ready to be open, a platform business model can enable resilience and can be an engine of innovation.

Author

Matthew Locsin

Global Head of Innovation

With reward comes risk

For one, platform-based businesses are facing regulatory headwinds in many markets around the world. Regulators are taking a long, hard look at the economic and social costs of having platforms at scale.

The issue is that the line between achieving minimum scale to be self-sustaining and a winner-take-all business can be very fine. Platforms have been called out for pricing out, locking out, and buying out would-be competitors. There have already been several massive fines imposed for anti-competitive behaviour (in the EU, Google has been hit by nearly $10 billion in fines) and regulatory scrutiny is intensifying worldwide.

Recent legislation in India, for example, restricts companies from selling their own products through marketplaces that they own. To comply, Amazon has had to pare back sales of its Echo speakers and Amazon Basics range. Similarly, cities around the world have created new requirements and challenges to slow the spread of services like Airbnb. In Europe and elsewhere, data privacy legislation such as GDPR is challenging the lack of transparency and effective governance over how platforms collect and use data, as well as what kind of data they ought to allow.

How regulation and enforcement will play out is still to be determined. There are calls for some platforms to be broken up. But it is clear that the risks to these business models are real and likely to grow.

As with ecosystems, platform strategy is new and most leaders are not yet equipped to tackle the big questions of whether to build a platform or not, how to build one, and how to become such a company.⁴ Effective strategies will need to address some big shifts, such as those from:

Closed to open
This includes thinking about how to create the technical architecture to support connections and interactions between a huge number of users, the policies needed to move risk intelligently around an ecosystem and how to develop the strategies and tactics needed to attract and incentivise users to create value for others. But beyond the mechanics of being open, this shift cuts to the core of how leaders think about competition, cooperation and the borders of the firm.
Product to community
Traditional firms are organised and work to optimise internal resources in product production and distribution. Platforms must work to optimise external resources in order to facilitate value creation outside of the firm and deliver a holistic user experience. Beyond different operating models, this is a profound shift of organisational competencies and the way that firms think about assets and how to account for them.
Linear to exponential
The forces of digitisation, computation, connectivity, and communication that are enabling platform businesses are advancing at an exponential rate. Yet most leaders’ mindsets and decision-making are tuned to a history of linear progress. Their strategies and planning competencies employ backward-looking analysis. In the long term, they routinely overestimate the value of their current competencies and assets while underestimating the disruptive potential of technologies and businesses built to take advantage of them.

As with ecosystems, platform business models are going to become more common, not less. Leaders need to develop the tools to contend with them, whether they intend to compete, cooperate or build one of their own.

Footnotes:

Source: https://www.inc.com/business-insider/amazon-google-most-valuable-brands-brand-finance-2018.html
We might think of pure platforms as those that truly don’t own the assets that they leverage. Tom Goodwin’s famous observation that Uber is the world’s largest taxi company yet owns no vehicles highlights this idea. In many other platforms, companies actually operate a ‘hybrid’ model; integrating their own products into the marketplace that they operate (such as Amazon) or by integrating the marketplace into their product universe (such as Apple).
This argument has been well evidenced by Ray Sten and cited many times as he explains how, in direct network effects, the cost of connecting users increases linearly but value to all users increases geometrically. In multi-sided markets, different growth rates in cost create a much greater degree of complexity. These platforms often have to subsidise one side of the market in order to catalyse growth of the other. Some companies have managed this after years of spending money to acquire share (network capital). Uber, by contrast, seems to be stuck in subsidising both sides of the market as it fights off competitors in many markets.
Not every industry is ripe for platform disruption. Van Alstyne, Parker, et al have identified four characteristics of industries that distinguish the susceptible from the protected.