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Why They Dominate: Part I

A discussion on platform companies

“What do Google, Facebook, Snapchat, Tinder, Alibaba and Uber have in common, besides soaring market share? They’re all platforms – a new business model that has quietly taken over our global economy. ” – Alex Moazed and Nicholas Johnson

A good friend recently gave me a wonderful book as a gift, which I have more than thoroughly enjoyed. The book, "Modern Monopolies: What It Takes to Dominate the 21st Century Economy," is by Alex Moazed and Nicholas Johnson.

Some readers may have noticed that over the past two years, I have written a good amount of articles on internet companies such as Alibaba (NYSE:BABA), Facebook (NASDAQ:FB), Alphabet's Google (NASDAQ:GOOGL), JD.com (NASDAQ:JD), Priceline (PCLN) and Tencent (TCEHY). For a while, I struggled to understand why those companies have been able to grow so fast with such great economics. While I could finally appreciate the merits of these new businesses, I still had not put together the commonalities among them in a systematic way. Moazed and Johnson’s book did just that. I think this book is a must-read for all of us. I took a lot of notes and will share with readers in the next several articles. Today’s focus will be the big picture.

The big picture

Moazed and Johnson define a platform as "a business model that facilitates the exchange of value between two or more user groups, a consumer and a producer."

Platform companies dominate the internet and our economy these days. They operate on a completely different business model than traditional businesses, which largely run on a linear model.

In linear businesses, value flows in one direction through the business’ supply chain. They create value in the form of goods or services and then sell them to the customers downstream in the supply chain. There are two types of linear businesses – product companies like Nike (NYSE:NKE) and service companies like Jiffy Lube.

Linear businesses dominated the 20th century because they were very efficient through the supply chain, which is also linear. The supply chain was one of the major competitive advantages for businesses before the internet came along. Linear businesses focus on creating value internally and selling that value downstream to customers. Value flows from manufacturers or service providers to the customers. In this model, the resources a business owns and controls internally are its most valuable assets.

Platform businesses work very differently – value exchange in a network is multidirectional. In the new world, networks are the new aggregator of business value. In the old model, scale was a result of investing in and growing a business’ internal resources. But in a networked world, scale comes from cultivating an external network built on top of the business.

One important point is internet companies are not necessarily platform companies. For instance, Pet.com was not a platform company while eBay (NASDAQ:EBAY) is. Technology does not equal platforms. Therefore, many software-as-a-service companies are not platforms even though they claim to be.

Platform facilitates the exchange of value and in order to make these exchanges happen, platforms harness and create large, scalable networks of users and resources that can be accessed on demand. Platforms create communities and markets that allow users to interact and transact. Ebay does not directly create and control inventory via a supply chain, but Pet.com did. Platform businesses do not own the means of production – they create the means of connection.

Linear businesses create value by manufacturing products or providing services while platform businesses create value by building connections and “manufacturing” transactions. As an example, General Motors (NYSE:GM) manufactures cars while Uber “manufactures” transactions between drivers and riders. Uber does not actually provide the ride service, but it facilitates the connection and exchange of value between drivers and passengers.

The transaction at the heart of the platform is the core transaction. The core transaction is the platform’s “factory.” It is the process that turns potential connections into transactions. Getting the core transaction right is the most important piece of platform design as it will need users to repeat this process over and over to generate exchange value.

Although a platform enables the core transaction, it does not directly control its users’ behaviors. The challenge is how to get millions of people to behave the way you want them to. The answer lies in the four core functions of a platform:

  1. Audience building.
  2. Matchmaking.
  3. Providing core tools and services.
  4. Setting rules and standards.

If a platform handles these four functions well, it will be able to facilitate its core transaction.

Some platforms are more focused on reducing transaction costs, like Alibaba, while others, like Apple (NASDAQ:AAPL), provide the underlying infrastructure that enables their users to create. In this way, platforms can be divided into exchange platforms and maker platforms. The key difference is between platforms that provide value primarily by optimizing exchanges directly between a consumer and a producer and platforms that generate value by enabling producers to create complementary products and broadcast or distribute them to a larger audience. Apple’s iOS and Google’s Android are maker platforms while Alibaba, Uber and Aribnb are all exchange platforms.

"When a linear business gains a new customer, it adds only one new relationship. But when a platform adds a new user, that person adds potential relationships with all of the platform’s users. In other words, platform companies grow exponentially rather than linearly – which is why platform businesses can expand at a pace unprecedented in human history." This is why Alibaba, Facebook and Google can still grow so fast at their current size.

It is important to get the big picture first, so I will pause here.

Disclaimer: All credit goes to Alex Moazed and Nicholas Johnson.

About the author:

A global value investor constantly seeking to acquire worldly wisdom. My investment philosophy has been inspired by Warren Buffett, Charlie Munger, Howard Marks, Chuck Akre, Li Lu, Zhang Lei and Peter Lynch.

Rating: 5.0/5 (15 votes)



Sakrezz - 1 year ago    Report SPAM

Execellent write up


Grahamites - 1 year ago    Report SPAM

Sakrezz - Thanks for the nice words. All credit goes to Alex Moazed and Nicholas Johnson.

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