5.1 Fundamentals of Platform Business Models
4 min read•august 7, 2024
Platform business models are game-changers in the digital economy. They create value by connecting different groups, like buyers and sellers, and grow through . The more users join, the more valuable the platform becomes.
Successful platforms have smart architecture and strategies. They use modular designs, orchestrate networks, and expand into new markets. Understanding these fundamentals is key to grasping how platforms dominate industries and reshape competition.
Platform Fundamentals
Defining Platforms and Two-Sided Markets
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- Platforms are business models that create value by facilitating exchanges between two or more interdependent groups, usually producers and consumers
- Two-sided markets are economic platforms having two distinct user groups that provide each other with network benefits (Uber connecting drivers and riders)
- Value creation in platforms occurs by providing an infrastructure that connects users and facilitates transactions, enabling exchanges that would not occur otherwise (Airbnb connecting hosts and guests)
- Value capture refers to the platform's ability to extract a portion of the value created by the interactions and transactions it enables (platform fees, commissions, or subscriptions)
- Scalability is a key characteristic of platforms, allowing them to grow rapidly and efficiently by leveraging network effects and technology (Facebook's ability to onboard billions of users)
Network Effects and Platform Growth
- Network effects occur when the value of a platform increases as more users join, creating a self-reinforcing growth cycle (more users on a social media platform make it more valuable for everyone)
- Direct network effects happen when the value of a platform increases with the number of users in the same user group (more phone users make the phone network more valuable for all users)
- Indirect network effects occur when the value of a platform for one user group increases with the number of users in a different user group (more Uber riders make the platform more attractive for drivers, and vice versa)
- Cross-side network effects refer to the mutual benefits that different user groups provide to each other on a platform (game developers and gamers on a gaming console)
- Same-side network effects describe the benefits that users within the same group provide to each other (professional connections on LinkedIn)
Platform Architecture
Key Components of Platform Architecture
- Platform architecture refers to the design and organization of the platform's components, including hardware, software, and data, to enable interactions and transactions between users
- User interface is the part of the platform that users interact with directly, designed to be user-friendly and facilitate seamless interactions (mobile app, website)
- is a set of protocols, routines, and tools that specify how software components should interact, allowing third-party developers to build applications on top of the platform (Twitter's API for third-party apps)
- Data management and analytics are crucial components of platform architecture, enabling the platform to collect, store, and analyze data to improve user experience and inform business decisions (Netflix's recommendation engine)
Modular and Layered Architecture
- Modular architecture allows platforms to be divided into smaller, interchangeable components that can be developed and maintained independently (WordPress plugins)
- Layered architecture organizes the platform into distinct layers, each with a specific function, such as data storage, business logic, and user interface (e-commerce platform with separate layers for product catalog, shopping cart, and payment processing)
- and layered architecture enable platforms to be more flexible, scalable, and adaptable to changing user needs and technological advancements (adding new features or integrating with other platforms)
Platform Strategies
Network Orchestration and Governance
- Network orchestration refers to the strategies and actions taken by the platform owner to manage and coordinate the interactions between different user groups (setting rules, standards, and incentives)
- involves establishing policies, rules, and mechanisms to maintain the quality, trust, and sustainability of the platform ecosystem (Apple's App Store review guidelines)
- Curation and quality control are essential aspects of network orchestration, ensuring that the platform offers high-quality content, products, or services to its users (Airbnb's host verification and property quality standards)
- Incentive design is a critical component of network orchestration, involving the creation of rewards, subsidies, or penalties to encourage desired behaviors and discourage undesired ones (Uber's surge pricing to incentivize drivers during high-demand periods)
Disintermediation and Platform Envelopment
- occurs when a platform bypasses traditional intermediaries and directly connects producers and consumers, often resulting in lower costs and improved efficiency (Amazon connecting buyers and sellers directly)
- is a strategy where a platform leverages its existing user base and infrastructure to enter and dominate adjacent markets or industries (Amazon expanding from e-commerce to cloud computing with Amazon Web Services)
- Bundling and cross-subsidization are common tactics in platform envelopment, offering multiple products or services together at a lower combined price or subsidizing one side of the market with revenues from the other (Microsoft bundling Office applications with Windows)
- Data-driven strategies, such as personalization and targeted advertising, can help platforms create a competitive advantage and maintain user loyalty (Facebook's targeted advertising based on user data)
Key Terms to Review (18)
Antitrust issues: Antitrust issues refer to legal and regulatory challenges that arise when companies engage in anti-competitive practices, such as monopolization, collusion, or unfair trade practices. These issues are crucial in ensuring fair competition in the market, particularly for platform business models that connect multiple parties. Understanding antitrust issues helps address concerns related to market power and consumer welfare, especially in an increasingly digital and globalized economy.
API (Application Programming Interface): An API, or Application Programming Interface, is a set of rules and protocols that allows different software applications to communicate with each other. It acts as an intermediary that enables developers to access the functionalities of an application or service without needing to understand its internal workings. APIs play a crucial role in platform business models by enabling seamless integration and interaction between various services and applications, fostering innovation and collaboration within ecosystems.
Churn Rate: Churn rate is the percentage of customers or subscribers who stop using a service or product within a specific time frame. This metric is crucial for businesses, especially in the IT industry, as it helps them understand customer retention and satisfaction, which are vital for sustainable growth and profitability.
Customer acquisition cost: Customer acquisition cost (CAC) refers to the total expense incurred by a business to acquire a new customer. This metric is crucial for understanding the effectiveness of marketing strategies and sales efforts, as it helps determine how much a company is willing to spend to gain new customers while ensuring profitability. High CAC can impact scalability, especially in the fast-evolving IT sector, and is also vital for evaluating platform business models and their ability to create value sustainably.
Data privacy: Data privacy refers to the proper handling, processing, storage, and protection of personal information, ensuring that individuals have control over how their data is collected and used. It encompasses the rights of individuals to understand, manage, and protect their personal information from unauthorized access and misuse. Understanding data privacy is crucial for businesses that operate on platform models, leverage data-driven strategies, adapt to emerging technologies, and navigate the dynamics of the global IT market.
Disintermediation: Disintermediation refers to the process of eliminating intermediaries in a supply chain or distribution channel, allowing direct transactions between producers and consumers. This concept transforms traditional business models by enabling companies to connect directly with their customers, reducing costs, and increasing efficiency. It often occurs in digital environments where technology facilitates direct engagement and transactions without the need for middlemen.
Ecosystem partnerships: Ecosystem partnerships refer to collaborative arrangements between various organizations, including companies, developers, and service providers, that work together within a platform business model to create mutual value. These partnerships leverage shared resources, knowledge, and technologies to enhance the overall ecosystem's performance and offerings, driving innovation and improving customer experiences.
Lifetime value: Lifetime value (LTV) is the total revenue a business can expect from a single customer account throughout the entire duration of their relationship. It helps businesses understand how much they can invest in acquiring new customers and retaining existing ones, and it emphasizes the importance of maintaining customer relationships in maximizing profits.
Marketplace platforms: Marketplace platforms are digital environments that facilitate transactions between buyers and sellers, providing a space for them to interact and exchange goods or services. These platforms often leverage technology to streamline processes, enhance user experiences, and create value through network effects, where the value increases as more users join the platform.
Marshall Van Alstyne: Marshall Van Alstyne is a prominent scholar in the field of information technology and platform business models, best known for his work on network effects, digital platforms, and the dynamics of platform ecosystems. His research emphasizes how platform strategies can create value by facilitating interactions between different user groups, shaping how companies leverage technology to achieve competitive advantage.
Modularity: Modularity refers to the design principle that breaks down a system into smaller, interchangeable components or modules, each of which can function independently while contributing to the overall functionality of the system. This concept is crucial for building flexible and scalable platform business models, as it allows for easier integration, updates, and customization of services and products within the platform ecosystem.
Network Effects: Network effects occur when the value of a product or service increases as more people use it. This principle is especially important in the information technology industry, as it can lead to a dominant market position and enhance scalability, sustainability, and competitive advantage.
Platform envelopment: Platform envelopment is a strategic phenomenon where one platform expands its reach and offerings by integrating the services or products of another platform, often leading to competitive advantage. This approach can create a more comprehensive service for users, making it difficult for standalone platforms to compete effectively. It reflects a shift in how platforms view their ecosystems, as they leverage partnerships or acquisitions to enhance their value proposition and gain market share.
Platform governance: Platform governance refers to the rules, policies, and decision-making processes that guide the operations and interactions within a platform ecosystem. This governance is crucial for ensuring fairness, trust, and efficiency among the diverse participants in a platform, including users, providers, and third parties. It plays a vital role in shaping platform dynamics, defining roles and responsibilities, and managing conflicts that may arise within multi-sided platforms.
Sangeet Paul Choudary: Sangeet Paul Choudary is a prominent thought leader and co-author of 'Platform Revolution,' which provides insights into the mechanics of platform business models. His work emphasizes the importance of platforms in the modern economy, explaining how they facilitate interactions between multiple user groups and create value through network effects. Understanding his theories can help grasp the dynamics that differentiate platform businesses from traditional linear models.
Two-sided platforms: Two-sided platforms are business models that create value by facilitating interactions between two distinct user groups, typically consumers and producers. These platforms rely on network effects, meaning that the value of the platform increases as more users join, enhancing the experience for both sides. The success of two-sided platforms hinges on their ability to attract and retain users from both sides, ultimately creating a thriving marketplace.
User onboarding: User onboarding is the process designed to help new users understand how to use a product or service effectively, making their first experiences smooth and informative. This process often involves guided tutorials, tooltips, and other interactive elements that engage users and encourage them to explore features, ultimately leading to higher retention rates and user satisfaction.
Winner-takes-all dynamics: Winner-takes-all dynamics refer to market situations where a single company or platform captures the majority of market share, often leaving little to no space for competitors. This phenomenon is often driven by network effects, where the value of a service increases as more users join, creating a feedback loop that reinforces the dominance of the leading player. In these scenarios, once a platform gains traction, it can rapidly outpace others, often leading to a monopoly or oligopoly in the market.