Platforms are the new fool’s gold

Platforms are all the rage. In the modern digital economy many organisations are looking to create platforms, rather than simply building a traditional value-chain driven company (otherwise known as a ‘pipe’).

In this context, a platform is a business model designed to facilitate exchanges between interdependent groups; as opposed to a pipe, which is centred on the sourcing, production and distribution process. The successful companies of the past focused on controlling distribution (something which is increasingly difficult in our highly-interconnected digital world), while it’s thought that successful companies in the future will focus on controlling access to customers (which they can do by creating a platform that attracts the best customers).

Platforms are where the smart money is going (particularly if your platform is seen as scalable). There’s even a Platform Strategy Summit where you can learn the tricks that will make your platform successful.

This recent obsession with platforms raises some concerns though, as it seems to confuse cause and effect.

Are platforms worthy of all the hype?

Platforms are simply a tool, an enabler, and we’re falling into that old trap of becoming so enamoured with our shiny new hammer that everything is starting to look like a nail.

It’s pretty clear that the business landscape is changing, with many pundits talking about the digitisation of business. Its also assumed that platforms will play an important role in this new era, which is not surprising as “platforms” have been a key element of the IT world for a long time.

One of the significant trends that is changing the business landscape is the shift from consolidation to fragmentation.

In many areas of the economy we’re finding that the low cost and ubiquitous communications provided by digital technology are shifting the benefits from centralised solutions (firms) to distributed solutions (multi-sided markets) for many resource management problems. A consequence of this is the fragmentation of the consumer landscape, with mass-market products and monolithic firms supplanted by niche products provided by specialist firms.

As we mentioned in that earlier post:

If communication and coordination costs are high we create a firm, as formalising and standardising our processes reduces communication costs at the expense of a one-size-fits-all approach to creating solutions.

If costs are low, then we create a multi-sided market, trading higher communication volume for the ability to draw a wide variety of options and thereby create better solutions.

Apple’s iTunes Store is a market, with sellers providing product and setting the price, and buyers selecting between the various products on offer. Similar things could be said for KickStarter (when the product is “projects”), Elance and Upwork (piecework), Zaarly (home maintenance), Etsy (art and crafts) and AirBnb (rental accommodation).

Markets typically need a place to live: an exchange on Wall Street, the town square, a local coffee shop, or simply under the shade of a convenient tree. This place is the platform on which the market operates.

Market vs. platform

If we consider this shift from pipes to platforms (the effect) as a shift from firms to markets (the cause), then a few obvious things pop out.

1) Many of the commonly written-up platform businesses are not markets

Uber, for example, defines the product, sets the price, and allocates driver to passenger, so it’s clearly not a market (platform); it’s a pipe (process). Similar things can said for many of the “service on demand” firms – such as Instacart (grocery delivery), Homejoy or GetMaid (house cleaning) – and firms that consider themselves as part of the sharing economy – Flexicar and GoGet (car rental).

While these firms have built their operations on digital infrastructure, their business models are not significantly different from contractor-driven operations of the past.

2) If you want your market to be scalable then you need to ensure that the supply and demand communities that the market is intended to address are as large as possible

99designs, for example, connects a global audience wanting design work done to a global pool of designers. On the other hand, Zaarly connects homeowners in a small geographic area (a city) with maintenance services in the same area.

99designs manages one large market while Zaarly manages a large number of small markets, which is an important distinction.

Zaarly’s position is less scalable. Like other start-ups that grow city-by-city, Zaarly needs to build operations teams in each new city. In many cases these city-by-city startups also need to invest in local infrastructure.

Zaarly’s position is also less defensible as the main benefits of aggregating these markets are global brand awareness and the ability to serve the very small proportion of individuals who regularly find themselves in different cities. Uber, for example, has a market-leading solution but it is a solution that operates at the scale of a single city and which is easy to replicate, which might explain Uber’s aggressive approach to marketing.

3) Not every market needs a “platform to function

Building your market around a central location – a single place – simplifies the problem of introducing buyers and sellers, but it is not the only approach that works.

It’s possible to build markets that do not rely on a central location. Contract Net, a 30-year-old piece of technology, shows us how to build a market via a distributed protocol without relying on a central platform to manage buyer and seller interactions. Ripple is a more recently developed distributed payment protocol, created by Ripple Labs and emerging from the cryptocurrency movement, that enables “secure, instant and nearly free global financial transactions of any size with no chargebacks” without the need for a central clearing house or ledger to record and manage transactions.

Platform vs. Protocol

While they may seem similar, the distinction between platform and protocol is important. All markets require a protocol – a pattern of interactions between buyer and seller to manage the process of exchange – even if the protocol is defined socially or informally. However, it is possible to create distributed protocols that don’t require a platform, a central location for buyers and sellers to gather. This is what Contract Net and Ripple represent.

The main point is that it is fairly straightforward to monetise a platform. Monetising a distributed protocol is a much murkier process.

If your market relies on a platform, then you can charge for access to that platform, or to skim a few percent off the top of each transaction that passes through.

Your options are much more limited if your market is only represented by a protocol. Ripple Labs chose to solve this problem by retaining 25 billion of the XRPs (the default currency of the Ripple protocol) created and relies on the XRP increasing value as its only source of income. Another obvious approach is to use intellectual property (IP) laws to extract licensing fees from each market participant (something that could be challenging if the market participants are domiciled in a range of different regulatory regimes).

So when is a platform approach best applied?

Platforms are a better implementation approach than pipes in many situations and as digitisation continues to change society we can also expect more sectors of the economy to favour platforms over pipes.

However, simply rushing to convert your business from a pipe to a platform might not be the wisest move. Creating a successful market is very challenging, and history is littered with examples of failed markets, from app stores through carbon exchanges, where the market’s sponsor was unable to attract a critical mass of buyers and sellers, or where unaccounted for externalities drove the market into dysfunction and ultimately failure.

The trick is to find those sectors of the economy (or those areas of your business) where falling communication and coordination costs mean that a distributed, market-based solution will be more efficient than the existing centralised, firm-based solution. There also needs to be a clear understanding of the limits of the market being addressed and how best to shape the behaviour of market participants to ensure that it is successful.

We can find these sectors by using a hammer to hit every problem that arises in the hope that a few of them might actually be nails. This might work for the economy as a whole, but it is impractical for individual firms and management teams.

A better approach is to create a business strategy that enables organisations to understand when a particular situation tips (or can be tipped) from favouring a centralised solution, to a distributed solution. Platforms are only enablers and don’t replace having a clearly defined strategy in the first place. Only then can we be sure that the gold in front of us is the real thing.

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