Creating a gravitating platform with millions of users is still one of the most attractive business propositions in the tech industry, but as Matthew put it centuries ago; “For many are called, but few are chosen”. So, what does it take to make the grade of creating a successful platform business? And what separates the good from the great?
Some of the most successful tech companies are platforms. It´s probably not a coincidence that three of the “big four” are platforms and even Apple has a substantial part of their revenue coming from platforms like AppStore, iTunes and Apple Tv. Facebook, Google and Amazon of course have non-platform business areas as well, but the core of their business is their platforms.
The five factors
Being in the platform business myself, as CPO for the ID platform Freja eID, I´ve given this topic quite a lot of thought, both from the product perspective but also from an investors point of view. So, if you are aspiring to build a platform business or looking into investing in one, here are five factors to evaluate in order to assess the potential.
1. Stickiness
Stickiness is basically about two things; user retention and frequency. To make a very far-fetched example, the e-service at the Tax Authority is extremely sticky on the retention side – I´m forced by law to hand in my tax return once a year – but five minutes once a year does not score very high on frequency.
User retention can be created either by a high degree of either relevance or reward. Google is probably the most obvious example of relevance; the service solves the problem of finding information better than anyone else. Facebook is much less of a relevant utility in that sense. Yes, your life would probably be a bit more boring without the social network but you´d still be able to connect with your friends or find news. But the dopamine reward you get from getting a bunch of likes or from discovering something interesting while scrolling the feed keeps you coming back for more.
Frequency is about the total time the user spends on a service. This can be achieved by either many short sessions – like Google – fewer longer sessions – like Facebook – or both. Snapchat has tuned every inch of their UX around frequency, most notably with their streaks feature where you build a score by snapping at least once a day with a particular friend. If you miss just one day, your streak falls. Services like Pinterest and Instagram are building heavily on dopamine rewards by the way they present images and stories in the bottomless scroll feature.
2. Positive interaction
A platform needs to have a value proposition for both sides and what you should be looking for is a positive interaction between the two. In a platform like AirBnB, both sides benefit from the total growth; each host that joins the platform adds a value to the tenants and each tenant that joins adds a value to the host.
Facebook on the other hand has a negative interaction. The more users that join the platform is extremely beneficial for the other side, the advertisers. However, from a user’s point of view if the four million advertisers that are currently using Facebook increase to five million, it is not necessarily adding to a positive user experience. It´s more likely that the opposite is true.
3. Margin
There is a general assumption that all platforms are extremely profitable by default, as long as they are digitally scalable. But when you look into the details you will discover that there are huge differences in the potential profitability for different platforms.
Spotify is as much of a poster boy in digital disruption as it gets. The current market cap of 28 billion dollars assumes that there is a lot of money to me made here. Still Spotify has, with few exceptions, been losing money quarter after quarter since its inception in 2006. The losses accumulate to billions of dollars. And when you crunch the numbers it not very surprising. For each dollar in revenue that Spotify generates, 75 cents walks straight out the door to the record labels and artists. A 25% gross margin is not very impressive in any digital business and obviously not enough to make Spotify profitable.
Google on the other hand has a close to 100% gross margin. So, if you click on an ad word like “Casino” you would generate 55 dollars in revenue for Google, where pretty much all stays within the company. For Spotify to generate 55 dollars in gross revenue, you would have to pay a premium subscription for about two years.
This is not black or white and if you are looking at a low margin business, you should investigate whether there are ways to increase the margins. Netflix, that basically has the same model as Spotify, shows gross margins of around 35%. Why? If you wonder why they push their “Netflix Original”-content so hard, you´ll find the answer; owning the content adds hugely to the bottom line. My personal guess is that Spotify´s move towards podcasts is a strategic move along the same lines; I would not be surprised if the rev-share to podcasters are substantially lower than to record labels.
4. Moats
The fact that many of the businesses in the digital era is characterized by a winner-takes-all evolution does not mean that the winner takes it all for ever. Before Facebook there was a Swedish social network called LunarStorm that had a close to 100% penetration among teenagers in Sweden. When Facebook came, they lacked moats to keep the competition at bay – in their case the predominant reason being the focus on Swedish users.
In general, having a dominance in terms of users is a pretty effective moat. For me to change from Facebook to a competing network would mean that the network would need to convince all my friends to move as well, in order for them to be on par with Facebook.
Product excellence is an effective way to keep competitors at bay. Google taking over the search market and keeping the leadership is all about product superiority.
Forming habits is another moat building on our human aversion of change. I know that my bank is not offering me as good a service as many competing banks, but I´m just too tied in to my habits to do something about it.
In a sense, stickiness and moats are two sides of the same coin. Dependency is a great example. As long as we are using Skype within our company for video calls, I will keep it, whether I like it or not. On the other hand, as soon as IT decides to change to some other service, the moat will instantly dry out.
A very rigid moat is regulatory compliance. The reason why you don’t see competitors to MasterCard and Visa making a run for their margins is regulations. Becoming PCI/DSS compliant is no trivial thing and if you add the obstacle of integration with payment terminals on a global scale you´ll find that the two giants have created a pretty deep moat.
5. Scalability
Discussing scalability in tech without separating China from the equation is like discussing Einstein´s general relativity without separating it from quantum physics. Google ticks off more points on the platform scoreboard than any other company, including the scalability factor – if we disregard the blocking from China. However, China is not the only country that limits the space for platforms based on regulation and – just like quantum physics – we will just have to live with regulations even if we do not understand them.
So, if we focus on the observable tech universe there are some interesting factors underpinning the overall scalability of a platform. The first one is physical limitations. A platform like Uber cannot offer more ride services than there are individuals prepared to be an Uber driver in a certain geography. The Same thing goes with AirBnB; the number of hosts are limited to those individuals who are willing to sublet their home to strangers.
Disregarding regulatory constraints, platforms like Instagram, Facebook and Snapchat – where the content is co-created by the users – are scalable without constraints. The only limiting factor is the number of users with a smartphone. However, the revenue side of the business has constraints as there is likely a limit for any user on the amount of targeted advertising he or she can cope with. A service like Netflix does not face these limitations, not even factoring in the current cultural constraints, where the content of today is aimed at a predominant western audience.
Finding the opportunity
Applying the factors above to an investment or to your start-up is a good guidance to assess the basic platform qualities of a business. Obviously there are much more to factor in to make a fair evaluation of the company´s potential, such as management skills, market potential and funding.
Of course, factors can change over time. Today Google is one of the most profitable companies in the world but in the beginning they struggled to find a source of revenue. It was not until they introduced AdWords in 2000, two years after the company´s inception, that they figured out how to make money.
This is an important lesson in terms of the approach you will need to hace when starting or investing in a platform; you need patience. As opposed to, lets say a software company where you can genereate revenue from the first day you ship your product, a platform can only start generating revenue when a critical mass of players on each side has been established. This means that platform busniesses normally need a longer runway to take off.
On the other had the potential gain is enormous if you manage to create a digtially scalable platform with a critical mass on both sides. And to find that potential, the five factors is a pretty good place to start.
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