Platform Revolution: How Networked Markets Are Transforming the Economy and How to Make Them Work for You: How Networked Markets Are Transforming the Economy―and How to Make Them Work for You

by Geoffrey G. Parker

Their Harvard Business Review article “Strategies for Two-Sided Markets,” coauthored with Harvard professor Thomas R. Eisenmann, laid out what became one of the most widely taught theories of Internet business, one that is still taught in MBA programs around the world.

Whereas the leanest traditional businesses ran on just-in-time inventory, new organizational platforms run on not-even-mine inventory.

By contrast, traditional pipeline firms rely on mechanisms of control—editors, managers, supervisors—to ensure quality and shape market interactions. These control mechanisms are costly and inefficient to grow to scale.

Because the bulk of a platform’s value is created by its community of users, the platform business must shift its focus from internal activities to external activities. In the process, the firm inverts—it turns inside out, with functions from marketing to information technology to operations to strategy all increasingly centering on people, resources, and functions that exist outside the business, complementing or replacing those that exist inside a traditional business.

Similarly, information technology systems have evolved from back-office enterprise resource planning (ERP) systems to front-office consumer relationship management (CRM) systems and, most recently, to out-of-the-office experiments using social media and big data—another shift from inward focus to outward focus.

Strategy has moved from controlling unique internal resources and erecting competitive barriers to orchestrating external resources and engaging vibrant communities.

By contrast with supply economies of scale, demand economies of scale take advantage of technological improvements on the demand side—the other half of the profit equation from the production side. Demand economies of scale are driven by efficiencies in social networks, demand aggregation, app development, and other phenomena that make bigger networks more valuable to their users.

The problem is that price effects are evanescent. They disappear the moment the discounts end or another firm offers a better price. Typically, only 1–2 percent of customers convert from free to paying. Thus, as David Cohen, CEO and founder of the venture incubator Techstars, says, you need to reach millions of customers before the giveaway model becomes profitable.

In some cases, the growth of a platform can be facilitated by an effect we call side switching. This occurs when users of one side of the platform join the opposite side—for example, when those who consume goods or services begin to produce goods and services for others to consume.

Positive same-side effects can also be found on the producer side. For example, consider Adobe’s all-but-universal image production and sharing platform. The more people who are creating and sharing images using the PDF platform, the greater the benefit you get from using the same platform for your own image production needs.

In every such exchange, the producer and the consumer exchange three things: information, goods or services, and some form of currency.

Some platforms have more complicated models, but the basic structure remains the same: Participants + Value Unit + Filter → Core Interaction

When designing a platform, your first and most important job is to decide what your core interaction will be, and then to define the participants, the value units, and the filters to make such core interactions possible.

To begin with, platforms need to solve a chicken-or-egg problem that pipeline businesses don’t suffer from: users won’t come to a platform unless it has value, and a platform won’t have value unless users use it. Most platforms fail simply because they never overcome this problem.

But innovation can easily lead to excessive complexity, which makes the platform more difficult for users to navigate. Needless complexity can also create enormous technical problems for the programmers, content developers, and managers who are charged with updating and maintaining the platform.

Second, a platform ecosystem can evolve faster when the core platform is a clean, simple system rather than a tangle of numerous features. For this reason, C. Y. Baldwin and K. B. Clark of Harvard Business School describe a well-designed platform as consisting of a stable core layer that restricts variety, sitting underneath an evolving layer that enables variety.12 Today’s best-designed platforms incorporate this structural principle. For example, Amazon Web Services (AWS), the most successful platform for providing cloud-based information storage and management, focuses on optimizing a handful of basic operations, including data storage, computation, and messaging.13 Other services, which are used by just a fraction of AWS customers, are restricted to the periphery of the platform and provided through purpose-built apps.

It’s inevitable that participants will use the platform in ways you never anticipated or planned.

In similar fashion, Airbnb works to lower the hurdles for its member-hosts by regularly conducting events and programs designed to illustrate and teach its best practices. Uber works to remove economic barriers that might discourage would-be drivers by providing financial incentives like sign-up bonuses.

Separating the asset from the value it creates can drive the utilization rate to 70 or even 90 percent, producing incremental revenue for the machine’s owner.

The reality has proven to be somewhat different. Across numerous industries, platforms have repeatedly re-intermediated markets, introducing new kinds of middlemen rather than simply eliminating layers of market participants. Typically re-intermediation involves replacing non-scalable and inefficient agent intermediaries with online, often automated tools and systems that offer valuable new goods and services to participants on both sides of the platform.

While traditional intermediaries relied on manual efforts, platform intermediaries rely on algorithms and social feedback, both of which scale quickly and efficiently.

Thus, while platforms displace large and inefficient intermediaries, they empower small and nimble service providers who leverage the platform to provide services to end users.

What can incumbents do to respond? Are entrenched companies that operate familiar pipeline businesses doomed to capitulate as platforms reshape and ultimately take over their industries? Not necessarily. But if incumbents hope to fight the forces of platform disruption, they’ll need to reevaluate their existing business models. For example, they’ll need to scrutinize all their transaction costs—that is, the money they spend on processes such as marketing, sales, product delivery, and customer service—and imagine how those costs might be reduced or eliminated in a more seamlessly connected world.

Data acts as an integration glue to make all these products and services perform in concert.

As a rule, platform designers must avoid discouraging the spread of value units. The act of sending these units onto an external network like Facebook should not distract a creator from using the platform; instead, it should fit integrally into the workflow of the platform. The more closely this is aligned to the main use of the platform, the more likely the platform is to go viral.

Successful platforms use one of eight proven strategies for solving the chicken-or-egg problem: the follow-the-rabbit strategy; the piggyback strategy; the seeding strategy; the marquee strategy; the single-side strategy; the producer evangelism strategy; the big bang adoption strategy; and the micromarket strategy.

As it happens, research by Randal C. Picker of the University of Chicago Law School has called into question the traditional story of Gillette and the razors-and-blades pricing strategy. Picker found that the timing of price changes for Gillette razors and blades, as well as the expiration date on the patent covering Gillette’s unique razor design, seems to undermine the notion that the company was employing the razors-and-blades strategy as commonly understood.

Charging one side while subsidizing another. Some platforms are able to charge members of one category of users (call them A) provided they allow members of another category of users (B) to participate for free—or even subsidize or incentivize them. This works when users from category A highly value the opportunity to make contact with users from category B—but the feeling is not equally reciprocated.

Instead, when transitioning from free to fee, strive to create new, additional value that justifies the charge. Of course, you must ensure that, if you charge for enhanced quality, you control for it and guarantee it. Critics have assailed Uber for charging a Safe Rides fee to pay for drivers’ background checks and other safety measures while apparently cutting corners on those same steps.

A well-managed platform can create excess value in four ways: access to value creation, access to the market, access to tools, and curation. Monetization is about capturing a portion of the excess value created.

Techniques for monetizing a platform include charging a transaction fee, charging users for enhanced access, charging third-party producers for access to a community, and charging a subscription fee for enhanced curation.

Yet the obvious solution—to close down the model and institute strict controls over participation—has a huge downside. Increasing the friction involved in actively using any platform inevitably reduces participation and can even destroy the value-creation potential of the platform altogether.

A platform is “open” to the extent that (1) no restrictions are placed on participation in its development, commercialization, or use; or (2) any restrictions—for example, requirements to conform with technical standards or pay licensing fees—are reasonable and non-discriminatory, that is, they are applied uniformly to all potential platform participants.

He wasn’t completely wrong: it’s true that, the more open a system becomes, the more fragmented it becomes. An open system is also more difficult for its creator to monetize, and the intellectual property that defines it is more difficult to control. Yet openness also encourages innovation.

There are three kinds of openness decisions that platform designers and managers need to grapple with. These are: • Decisions regarding manager and sponsor participation • Decisions regarding developer participation • Decisions regarding user participation

The lesson? If, like Sony, you choose to fight a standards battle in quest of proprietary control of a market, you’d better win it—and win it fast, before the next big thing supersedes the very technology you seek to dominate.

If the platform is too closed—if it is too onerous for extension developers to hawk their wares on the site—it will lose the opportunity to provide valuable extra services to platform users, perhaps alienating participants in the process.

The king of coffee had violated three fundamental rules of good governance: • Always create value for the consumers you serve; • Don’t use your power to change the rules in your favor; and • Don’t take more than a fair share of the wealth.

In general, there are four main causes of market failures: information asymmetry, externalities, monopoly power, and risk.

Market designer and Nobel Prize-winning economist Alvin Roth described a model of governance that uses four broad levers to address market failures.19 According to Roth, a well-designed market increases the safety of the market via transparency, quality, or insurance, thereby enabling good interactions to occur. It provides thickness, which enables participants from different sides of a multisided market to find one another more easily. It minimizes congestion, which hampers successful searches when too many people participate or low quality drives out high. And it minimizes repugnant activity—which explains why platform designers forbid porn on iTunes, human organ sales on Alibaba, and child labor on Upwork.

The enterprise management platform company SAP uses a social currency like that of iStockphoto or Stack Overflow to motivate developers to answer one another’s questions. Points earned when the employee of a development company answers a question are credited to a company account; when the account reaches a specified level, SAP makes a generous contribution to a charity of the company’s choice. The system has saved SAP $6–8 million in tech support costs, generated numerous new product and service ideas, and reduced average response time to thirty minutes from the one business day that SAP promises.

Hence the seven rules presented in the Yegge Rant: 1. All teams will henceforth expose their data and functionality through service interfaces. 2. Teams must communicate with each other through these interfaces. 3. There will be no other form of interprocess communication allowed: no direct linking, no direct reads of another team’s data store, no shared-memory model, no back-doors whatsoever. The only communication allowed is via service interface calls over the network. 4. It doesn’t matter what technology they use. HTTP, Corba, Pubsub, custom protocols—doesn’t matter. Bezos doesn’t care. 5. All service interfaces, without exception, must be designed from the ground up to be externalizable. That is to say, the team must plan and design to be able to expose the interface to developers in the outside world. No exceptions. 6. Anyone who doesn’t do this will be fired. 7. Thank you; have a nice day!

Sony Corporation provides a sobering example. The Sony Walkman had dominated portable music since the 1970s. In 2007, when the Apple iPhone was introduced, Sony’s dominance of the world of electronic devices seemed unshakeable. Sony had a world-class MP3 player, it had a pioneering e-reader, and it made some of the best cameras. In the fall of that year, Sony introduced the next-generation PlayStation Portable (PSP), the best gaming device in the world. Sony even owned Time Warner movie and television studios, giving it the opportunity to offer unique content. Yet despite these piecemeal advantages, Sony never developed the vision to offer a platform.

Having a person’s name and email address on a membership list doesn’t promise success for a platform. What matters is activity—the number of satisfying interactions that platform users experience.

In particular, firms in the startup phase must track the growth of their most important asset: active producers and consumers who are participating in a large volume of successful interactions.

Once the platform has reached critical mass and users are gaining significant value from the platform, the focus of metrics can shift to customer retention and the conversion of active users to paying customers.

Metrics then must sensitively gauge the ongoing engagement of users and the degree to which they continue to discover new ways to create value on the platform. It’s crucial to measure and track the degree to which both producers and consumers are repeatedly participating in the platform and increasing their participation over time.

To define success or failure for a platform, and to identify how to improve it, there are three main metrics: liquidity, matching quality, and trust.

One reasonable way to measure liquidity is by tracking the percentage of listings that lead to interactions within a given time period. Of course, both the definition of “interactions” and the appropriate time period will vary depending on the market category.

In particular, platform managers will want to work to ensure balance on the two sides of its market. This balance can be monitored by calculating the producer-to-consumer ratio, with an adjustment to include only active platform users—those who’ve engaged in interactions on the platform at a specific minimum rate of frequency that you consider appropriate. Experience shows that this ratio is a crucial factor in the rate of interaction success achieved by the platform.