Research & Thought Leadership

  • Louis Strauss

The network effect of platforms

Key to your company’s digital transformation is your ability to introduce a platform strategy into your business.

In a nutshell, platforms are a conduit to connect buyers and sellers with one another (Facebook, Google and Amazon are all examples of platform companies).

Nobody wants to join a platform on which they are unable to transact, but people do want to join a platform where there are lots of other people to transact with.

So, as platforms grow, their value and their ‘pull’ increases. This is known as Metcalfe’s Law, according to which a good or service increases in value exponentially as more people use it.

Platform = profits

For your business, this can be a powerful profit generator. Right now, you are probably limited in the money you can make with the resources you own and the way you allocate them.

A platform, on the other hand, is only limited by the resources, decisions and imaginations of its contributors, which, in theory, could be endless.

Bill Gates once said, ‘A platform is when the economic value of everybody that uses it exceeds the value of the company that creates it. Then it’s a platform.’

In other words, the platform becomes more valuable than the organisation that owns it (a concept your accountant might struggle with!).

Understanding the platform network effect

When a platform hits a critical mass of users, the value offered outweighs the cost of joining, and a network effect is created.

Before this tipping point, you need to find some other incentive for parties to join your platform. Keep this in mind as you develop a business plan and start setting expectations.

The platform network effect is closely linked to the concept of demand- and supply-side economics, discussed in detail in our book, Chasing Digital.

The landline telephone is the classic one-sided network where there is only one type of user. As the number of telephone users grows, the value of the network grows, attracting more users, creating a virtuous cycle.

In contrast, a marketplace, like a shopping centre, is two-sided – there are merchants and buyers. Having more shopfronts attracts foot traffic, while more shoppers attracts merchants.

This phenomenon, in which the value for one group is defined by the size of the other group(s), is called cross-sided network effects. Again, this creates a virtuous cycle.

Platforms can have more than two user groups, and the relationships between these groups can become complicated, but the principles stay the same. Note that these user groups will have different wants and needs with respect to platform functionality and capabilities.

Why the platform alone doesn’t guarantee success

It’s important to note that simply creating the platform is no guarantee of success. Let’s look at the dominant online marketplace for short-term holiday rentals, Airbnb, and its battle with a lesser-known competitor.

Early on in Airbnb’s life, it came up against a European rival named Wimdu. At the time, Airbnb had a strong American presence but a significantly smaller footprint in Europe.

Wimdu had just raised $90 million and was primed to take the European market, which would position it well for global domination. Airbnb responded quickly and aggressively. After all, there is only one global market, and Europe is a major key to controlling that market.

Within three months, it had ‘localised’ Airbnb, making the website more accessible for European visitors by incorporating language and cultural adaptations, and opening eight offices in Europe.

By moving faster than its competitors, Airbnb was able to take hold of the European market, controlling both Europe and America, and creating a global network. Although Wimdu started with a similar capital base, it was unable to keep pace with Airbnb’s market share capture.

3 key tips to remember when designing your platform

  1. When designing your platform, don’t think about technology first. Go back to basics and think about the customer – think about the core transactions that you can or want to facilitate.

  2. Then figure out how you can enable and optimise these transactions through leveraging technology.

  3. Lastly, never forget that you must create more than you capture, for that is where the power of the platform lies.

For more information and guidance, check out our book, Chasing Digital.

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