Author: Mahomed Ibrahim, Analyst, Perpetua Investment Managers
“Platforms” have become a buzzword lately with new companies like Uber, AirBnB and Snapchat springing up at a frantic pace around the world.
So what exactly is a platform?
A platform simply facilitates transactions between two or more groups of users. In this way it increases efficiency by matching users who would otherwise have had difficulty finding each other. It also improves productivity via more efficient use of assets. This makes them highly disruptive to industries.
Physical and virtual platforms
Historically, platforms were mostly physical. Examples include the London Stock Exchange which is more than 300 years old (connects investors, traders, brokers and companies), the telephone network and even shopping malls.
More recently, these have been virtual, driven by rapid advances in the internet, microprocessors, software, mobile broadband penetration and the cloud.
How do they create value?
It is tempting to dismiss these new virtual platforms as part of a new tech bubble as many sell products and services for less than cost and do not charge users. This makes them unprofitable giving them stratospheric valuations. However, the successful ones are building strong network advantages and loyalty where users beget more users, creating momentum and self-reinforcing growth. Amazon founder, Jeff Bezos calls this the ‘Flywheel Effect’. These platforms have discovered that if one side of the market is incentivised to join (via free or discounted products or services for example), the flywheel can move faster.
Large numbers of users result in scale economics with higher revenue, reach and scale potential. The companies generate revenue from this through advertising, charging a small fee or making a small profit margin on a very large revenue base. They can also increasingly address more of their users’ needs by selling more products and services to them.
Using Amazon’s Marketplace as an example, investments by Amazon in customer experience (e.g. price and selection) drives customer traffic. Sellers are attracted by this traffic, increasing selection for customers. Amazon earns a commission for the resulting transaction and uses this to further invest in price repeating this cycle. The flywheel effect is shown below:
Closer to home, Uber is another example of a marketplace in action. The taxi app increases convenience for customers which increases traffic. This attracts more drivers improving convenience further and the loop repeats. Uber charges a commission for this traffic and becomes more valuable as this increases.
Types of platforms
Platforms can be broadly split into three types
- Transaction platforms facilitate transactions between individuals and organisations, e.g. Uber, eBay, Gumtree.
- Innovation platforms provide technological building blocks which are used as a foundation on top of which a large number of innovators can develop complementary services or products, e.g. Android’s Play Store or Apple’s iTunes which allow the development of apps by 3rd parties or SAP which allows companies to build their own systems on top of their program. This is a powerful method for a company to create an innovation ecosystem with an unlimited pool of external innovators attracted to a network of users. This in turn will accelerate innovation.
- Integrated platforms are both transaction and innovation platforms, e.g. Google (Marketplace and Android), Amazon (Marketplace and Publishing).
Source: Global Platform Survey, The Center for Global Enterprise
Note: The size of each bubble represents its market cap as at the beginning of 2016
Which will last?
It is incredibly difficult to build successful, pervasive platforms as they require critical mass of two groups of participants who in turn gain value only with access to the other group. It may therefore take many years of investing to expand network advantages before profitability. Furthermore, competition is usually fierce both from other platforms and incumbents in an industry. As incumbent firms realise the disruptive effect, many are also trying to build their own platforms of loyal users.
The most successful ones will be those that have the greatest enduring appeal to users and lock them in for a long period of time. Ultimately however, platforms are usually disrupted by more innovative versions.
Click here to download article