By Jan Keim
Maybe you have heard the following statement by Tom Goodwin already: “Uber, the world’s largest taxi company, owns no vehicles. Facebook, the world’s most popular media owner, creates no content. Alibaba, the most valuable retailer, has no inventory. And Airbnb, the world’s largest accommodation provider, owns no real estate.”. Clearly, when looking at the many examples of platforms disrupting industries, there is something interesting going on. Let’s dive deeper into the logic behind the so-called platform economy.
Traditional business models are designed around buying some sort of raw material, manufacturing a product and selling it to customers, or gathering people to deliver services. When looking at digital business models, this logic does not apply. Multisided platforms, or “matchmakers” as they are sometimes called, provide one or multiple groups of people with access to other groups of people and facilitate the interaction. At least one group of people perceives the facilitation of the interaction with another group as value they are willing to pay for. For example, Uber drivers can earn money by getting connected to riders via a platform, a service both groups value. Drivers benefit from the frequency of rides, and riders benefit from availability, transparent pricing, and transparent quality due to the rating mechanism.
The interdependence of demands has long been ignored in business, until Geoffrey Parker and Marshall Van Alstyne published the first peer-reviewed article on this topic in 2000. Since then, many platforms have emerged and pushed the boundaries of different industries, including hospitality, retail and transportation. But what exactly makes such platforms better than traditional businesses?
Network Effects, Curation and Excess Value
As middlemen, platforms benefit from the value created by letting groups of people with specific needs interact with each other to satisfy those needs. This means that platforms facilitate the exchange of goods, services or social currency (e.g. “likes”). For multisided platforms, network effects are crucial to their business models. There are two types of network effects that either can be positive or negative: same-side or cross-side network effects.
- Positive same-side network effects come into play if an increase in participants on one side creates additional value for the same side. An example of this is WhatsApp, where users benefit from more people they can chat with.
- Negative same-side network effects happen if additional players on the same side have a negative impact on the others, e.g. on a marketplace like eBay where people try to sell substitute goods to the same customer group.
- Positive cross-side network effects happen when one group benefits from an increase of participants on the other side. Marketplaces such as Amazon create value for customers not only because of the delivery of goods, but also because the selection of goods is much bigger compared to traditional retailers.
- Negative cross-side network effects, while rather rare, refer to a decrease in value for the opposite side should an additional player enter the other group. An example of negative cross-side network effects is advertisement, where more advertisers may have a negative impact on the user experience.
Network effects, in fact, are so important to a platform business that some companies are willing to pay one side to attract the other side. For example, companies like Sony (PlayStation) or Microsoft (Xbox) sell their gaming consoles at a loss. However, the more people own a certain console, the more attractive game development for those consoles becomes, which represents a main revenue stream for Sony’s and Microsoft’s gaming divisions.
Because effective matchmaking is the key to generating value, curation is a core competency in the platform economy. Curation refers to a mechanism that ensures successful matchmaking. Such mechanisms may consist of rating systems, filters or algorithms. Curation ensures that a customer on one side finds the right partner on the other side. If a platform business fails to ensure effective matchmaking, chances are high that the business fails. Imagine what would happen if Airbnb keeps failing at showing you available rooms that match your budget and location preferences, or if Amazon kept showing you irrelevant products without the possibility to filter based on what you are looking for.
Multisided platforms rely on technology for value creation. The technology enables platforms to deliver four sources of value that would not exist without them, so-called “excess value”. Customers benefit from access to value created on the platform (e.g. videos on YouTube), producers benefit from access to a community (e.g. Airbnb), and both sides benefit from tools and services that facilitate their interaction (e.g. Kickstarter) as well as from the curation mechanism that enhances the quality of their interactions.
The Chicken-and-Egg Problem
When deciding on building a multisided platform, there is one key challenge that many start-ups fail to overcome: the chicken-and-egg problem. Each group on a multisided platform depends on the presence of the other group(s). Without both groups on the platform at the same time, the value proposition cannot be delivered. Therefore, when starting off, a platform business needs a strategy on how to attract all relevant sides so that effective matchmaking can take place. There are different strategies a platform business can use to overcome this dilemma, for example:
- The Micro-Market Strategy: By making the platform accessible to Harvard students only, Facebook overcame the chicken-and-egg problem by targeting a tiny market of members that already interacted with each other on campus.
- The Big Bang Adoption Strategy: Tinder launched at a frat party at the University of Southern California. Within a short period of time, the company was able to attract a high volume of sign-ups immediately.
- The Follow-the-Rabbit Strategy: Amazon started off as an online retailer to build a database of users and producers. Later, the company pivoted into a platform that helped producers and consumers match with each other.
What the Future Holds
Looking at the success stories of platform businesses, it is not far-fetched to assume that further disruption of industries will take place in the future. Traditional businesses should ask themselves how they can react and possibly benefit from platforms in order to avoid being pushed out of the market. In fact, some big and traditional brands have already started implementing platforms to create additional value for their customers, such as Nike with its NikePlus platform, or Under Armour with MyFitnessPal and Endomondo.
This article is based on the content delivered by Conor Foley during the Digital Business Models module at Trinity Business School. Conor is studying for a PhD in the area of digital business models. His particular area of interest relates to multisided digital platforms and the way in which they achieve sustained competitive advantage and accelerated growth.