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Grahamites
Grahamites
Articles (314) 

Why They Dominate - Part II

A discussion on platform companies

This is the second part of my summary notes of Alex Moazed and Nicholas Johnson’s wonderful book, "Modern Monopolies – What It Takes to Dominate the 21st Century Economy." My notes in my last article were about the big picture ideas. Today’s notes are about how different platform types need different disigns and why it's important to get the design right from the start.

Matching intention

A key concept in understanding platform companies is the matching intention - the maximum number of unis an item can exchange at a given time. For exchange platforms, usually the matching intention is 1:1. For instance, on eBay (NASDAQ:EBAY), a seller can only sell each unit of inventory to only one buyer. For Uber drivers, when they give non-Uber-Pool rides, each driver can only give ride to one rider. In both instances, the matching intention is one. However, for marker platforms such as Youtube, the matching intention is at least 1:Many because many viewers can view the same Youtube video.

Platform types

Although we’ve broken down platforms companies into two major categories – exchange platforms and maker platforms we can further break them down into nine distinct types snince each type has a core transaction built around a particular type of value being exchanged. Platforms within each type often operate very similarly. Here are the nine sub-categories.

Exchange Platforms

  1. Services marketplace: a service such as Uber and Airbnb.
  2. Product marketplace: a physical product such as eBay and amazon (NASDAQ:AMZN).
  3. Payments platform: monetary payment such as PayPal (NASDAQ:PYPL) and Apple Pay.
  4. Investment platform: an investment such as Lending Club (NYSE:LC) and AngelList.
  5. Social networking platform: a double-opt-in mode of social interaction such as Facebook (NASDAQ:FB) and Twitter (NYSE:TWTR).
  6. Communication platforms: 1:1 direct social communication such as WhatsApp and Skype.
  7. Social gaming platform: a gaming interaction involving multiple users, either competing or cooperating such as PokerStars and DraftKings.

Maker platforms

  1. Content platform: a piece of content such as Youtube and Amazon Kindle.
  2. Development platform: a software program such as Fitbit (NYSE:FIT) and Android.

The important thing to note is that each platform type exists along a commoditization spectrum that defines how it should be built and designed. The level of commoditization is a reflection of the amount of complexity inherent in the core transaction. Commoditization can be thought of as a reflection of the transaction costs incurred by consumers and producers to complete a transaction. More commoditized platforms operate in industries with naturally lower transaction costs.

For example, within services marketplaces, platforms vary depending on how commoditized the service offering is. A service is "commoditized" if the service has only a limited number of relevant characteristics that consumers care about. For instance, a job like fixing a toilet or delivering a meal. In both cases, the consumer simply wants the job done well and in a timely manner. As long as the platform can guarantee a certain level of quality at the right price, all that matters to the consumer is that there is someone available to fulfill a request.

As a result, platforms that offer these commoditized services should focus on matching consumers with available producers as seamlessly as possible. And the best ones do exactly that. For example, Uber's automatic matching and even its controversial surge pricing are all about facilitating the most transactions. Compare Uber's commoditized services to a non-commoditized service, such as renting an apartment on Airbnb. On Airbnb, many additional characteristics matter to consumers such as the location and size of the property, the amenities, whether the host will be there or not. Automatic matching will not work well. That’s why Airbnb focuses on facilitating easy search and discovery for its users rather than automatic matching. For non-commoditized services platforms, that’s the right way to go.

Matching a platform's design to its type is essential to its success. Platforms that don't get this right tend to get left behind by the competition. Within services marketplaces, TaskRabbit is a good example of not getting it right. TaskRabbit allows you to hire a tasker" to do odd jobs such as cleaning or home repair. However, TaskRabbit acts like a non-commoditized services platform in a commoditized industry. It initially built itself around an auction model, in which users would post tasks to the platform and contractors would seek out and bid on tasks they wanted to complete – an onerous process. The company eventually realized it had gotten the core transaction wrong, and in July 2014, it replaced its auction model with more simple and transparent pricing. In the new model, a consumer is offered a choice of three different producers with a listing of their hourly prices and experience levels and is able to order services on demand, rather than having to wait for bids to come in. This change was a step in the right direction for TaskRabbit. But the update didn't get everything right, as it still lacked control over pricing.

Commoditized services marketplaces should be responsible for setting prices to ensure its users receive the optimal price. If we look at other commoditized services platforms, such as Handy and Lyft, consistent and transparent pricing is a core part of their ability to deliver seamless matching, Because TaskRabbit did a poor job at facilitating its core transaction, the platform has been surpassed by upstart competitors, such as Handy. Not surprisingly, Handy puts much more structure around pricing and requesting services than TaskRabbit result is a better user experience and a more seamless transaction model that has helped propel the platform to its position as the leading marketplace for in-home services in the United States. The hard part is determining how commoditized or non-commoditized a platform really is.

For other platform types, commoditization level plays a similar role. For example, the level of commoditization in investment platforms also dictates whether you're able to set the price and how you handle the matchmaking experience. More commoditized investment platforms like Lending Club (NYSE:LC) are able to set prices algorithmically. In fact, Lending Club started by letting lenders set their own interest rates before moving to setting rates itself. The platform rightly saw the opportunity to remove unnecessary friction from the transaction. However, other investment platforms such as AngelList (startup investing) require a more non-commoditized approach.

The same framework also fits social networks. On more commoditized platforms, such as Tinder, users only have a simple profile with photos and a short text description. The platform also matches a user automatically with other nearby users. However, on less commoditized platforms like LinkedIn, users have much more in-depth profiles. On LinkedIn, the connection is more about search and discovery than automatic matching. Commoditization plays a similar role in content platforms. More commoditized content platforms, such as Twitter or Instagram, typically have a large overlap between their consumers and producers, as producing content is quick and easy. However, less commoditized content platforms like YouTube have strongly differentiated producer and consumer user groups. These platforms tend to follow more of a power-law dynamic, where a small percentage of their users produce the vast majority of their content, and need to be designed accordingly.

Platform Design

Although all platforms are focused on connecting consumers and produces, which category a platform falls under fundamentally alters the core value it delivers. The core transaction is just one example of why the exchange/maker distinction matters for platform design. A platform's category also influences how to design and deliver on its four core functions. For example, each core transaction paradigm requires radically different matchmaking strategies or rules and standards. Which category a platform falls under also influences the audience-building strategy.

Exchange platforms, such as Uber and Alibaba, need to focus on building liquid marketplaces that have sufficient overlap of supply and demand. Maker platforms, such as Android and YouTube, are more focused on organically building stars." Stars, because of their high matching intention, can act as powerful nodes in these networks.

Many maker platforms want existing celebrities to join and bring their fans with them; however, when the platform can create its own celebrities due to the network effects within its network, it's reached critical mass. YouTube's PewDiePie, Instagram's Dan Bilzerian, and Vine's Nash Grier are all examples of normal producers who rose to fame by building huge organic followings on their respective platforms.

Understanding whether a platform is a maker or exchange platform has a big impact on how to design its core transaction and four functions. Figuring out which platform type a business fits into should always be one of the first steps in designing a platform.

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

About the author:

Grahamites
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: 4.5/5 (8 votes)

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Comments

Thomas Macpherson
Thomas Macpherson premium member - 1 year ago

Great stuff Grahamites. I've picked up the book and started reading. Well worth the purchase. One area I haven't seen discussed is the value of combining a platform strategy integrated with essential business operations. I think this is the most powerful version of the model and creates the widest moat. In my book I mention companies like SEIC, PAYX, and others that create operating platforms that are essential to their customers' business. The successful integration of a strong platform strategy with customer business process flows is generally a fantastic business. In these instances, I have found the companies produce the highest ROC, high FCF/revenue, and have a very long runway of growth. Just a thought. Thanks for a great summary. - Tom

Grahamites
Grahamites - 1 year ago    Report SPAM

Tom - Great point. Based on my current understanding and I could be wildly wrong, just on the platform front, SEIC and PAYX kinda fall into service platform with a non-commoditized service offering. And both SEIC and PAYX seem to get the platform design right. But you are absolutely right that they also combine the platform strategy with essential business operations, which is a great observation and I haven't thought about it. Thanks for the inspiration.

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