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The rise of platform industries

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Image: The rise of platform industriesPlatform industries, which are gaining considerable attention, are information technology industries with components and rules that facilitate interactions among a network of users. Examples are Microsoft Windows and Facebook.

Such platform industries are important in their own right, but also because many other industries increasingly use platforms. For example, many companies use core information technologies such as Oracle databases or SAP enterprise resource planning (ERP) software to run their entire operations. They may use platforms such as LinkedIn or Alibaba to connect with others for marketing or R&D activities. Consequently, what platform companies do has important implications both inside and outside platform industries.

Platform businesses comprise a large and rapidly growing share of the world economy. Examples are as diverse as barcodes, credit cards, container shipping, DVDs, HMOs, instant messaging, package delivery, real estate brokerage, shopping malls, video games, and web search. Sixty of the world's 100 largest companies earn most of their revenue from such networks, including American Express, Cisco, Citigroup, Time Warner, UPS, and Vodafone.

There are four fundamental drivers of the rise of platform businesses:

  1. Modularity – Whether it is the standard shipping container, which allows Maersk to ship the same container as YK Pao's fleet, or it is standard HTML, which allows people from all over the world to exchange files, modular design has helped to create the basis for platform businesses.

  2. Increased interconnectivity – The internet, physical logistics networks, and phone systems, among many examples, are more inter-connected now than ever before and becoming more so.
  3. Self-organization – For traditional networks (one-to-one), the value scales with the square of the number of users, which says that a network of n users has a value proportional to n 2, i.e. a network that is twice as large is worth four times as much. For group forming networks (many-to-many), where consumers organize themselves around their desires, as groups do in, for example, Facebook or LinkedIn, the value scales exponentially, proportional to 2n.
  4. Low marginal cost of production, which makes the advent of two-sided markets more prevalent – A two-sided market, or two-sided network, is one in which one group of market participants creates value for another group in the market, possibly even subsidizing the other group. Google is now a huge threat to Garmin, because given Google's advertising market and their very low marginal cost to serve customers, they may be able to create another two-sided market in which they give away the access to maps in the car. This would be devastating to Garmin, but good for Google.

So we see that the platform businesses are more important than ever, and becoming more so. Also, the four drivers mentioned above are enabling platform businesses to have more and more market success. In fact, some platform industries are “winner-take-all”, i.e. the platform leader has a large market share, with few, if any, serious contenders

Platform envelopment

Although there are many strategies that are potentially relevant for platform leaders, many employ “platform envelopment.” Platform envelopment is defined as “entry by one platform provider into another's market, combining its own functionality with the target's in a multi-platform bundle that leverages common components and/or shared user relationships”.

As platform envelopment occurs, previously separate products evolve and integrate into ever-larger platforms. For example, personal digital assistants (PDAs), cellular phones and personal computers are rapidly evolving into smartphones (e.g. iPhone and BlackBerry). Traditional enterprise resource planning (ERP) software packages (e.g. SAP and Oracle) – themselves an evolution of software for accounting, HR and production management – are integration customer relationship management (CRM) software (e.g. Oracle ERP integrating Siebel CRM). CRM software, in turn, is the result of an integration of various previously separate software products for the management of sales, service and marketing.

Analysis of what platform envelopers do reveals two key patterns:

  1. follower advantage; and
  2. staircase strategies.

Follower advantage

First-mover, or first-to-market, advantage has been a pervasive part of the body of thought on business strategy. However, first-mover advantage may have been over-emphasized because empirical research in to first-mover advantage has suffered from survivor bias, whereby a firm that has survived was incorrectly identified as the pioneering company. For instance, Amazon and AOL (America Online) are often referenced as first movers but were, in fact, followers. The true first movers in these product categories, Bookstacks and The Source, respectively, are forgotten first-movers. While first movers may still reap financial gains (e.g. from selling the business to followers), long-term advantage and the ability to set industry standards appears more pronounced for followers.

“…as a product staircase grows, to emphasize backward compatibility, new applications should readily interface with pre-existing functionality.”

Followers have several advantages: They can focus merely on explaining why their products are better, while early entrants must first explain what their new product is and does. Importantly, fast-followers enter the market closer to the inflection point in the S-curve where market growth increases rapidly. For example, started selling books online three years after Book Stacks Unlimited, when the market was poised for rapid growth, enabled by the World Wide Web. Later followers enveloped platforms that had already grown large; for example, AOL's online platform integrated Netscape browsers.

For followers, free-ridership is important to imitate or improve an existing product. For example, Microsoft copied the look and feel of the graphical user interface and incorporated it into ever-extending architectures of products such as Windows and Office. Free-ridership can also refer to when a company does something different after seeing an existing product. For example, Pierre Omidyar, the founder of eBay, was familiar with other online B2C auction sites, but wanted to be different. He built eBay as a C2C site.

Staircase strategies

To manage integration of product architectures, platform envelopers employ “staircase strategies” that treat product extensions as part of a strategically crafted portfolio of customer experiences that expand the company's original products. Each step up the staircase is part of a long-term vision of how relationships among past, present, and future products create a highly sustainable advantage. Staircase strategies unlock growth pathways for platform envelopers by opening attractive upgrade paths as new products increasingly reinforce each other. Staircase strategies treat product extension as part of an expanding suite of functionalities linked to the company's original source of market entry.

Platform envelopers draw on a variety of design tactics and market strategies to construct a cascading series of customer experiences built on compatibility with past products, thereby creating customer lock-in. Primary among these is the role of two kinds of connectivity:

  1. cross-platform: the ease with which customers can move data from one application or device to the other; and

  2. backward compatibility: the ease with which customers can continue to use older applications and database protocols as newer versions appear.

Emphasizing the ease with which customers can move data from one application to another was behind the strategy of Microsoft to use the same graphical user interface (GUI) for old and new products. The GUI was also used to bring customers from the initially separate Win95 and WinNT markets together by preparing both sets of customers for a common user environment, which, over time, extended advantage, strengthened customer lock-in, and displaced incumbents. More generally, research suggests that a common user interface that is attractive, predictable and scalable plays a central role in creating the cyberspace equivalent of brand loyalty.
Thus, as a product staircase grows, to emphasize backward compatibility, new applications should readily interface with pre-existing functionality. In notable contrast to this approach, early upgrades to the Apple operating system were hampered by a tendency to abandon functionality of earlier applications (such as printer drivers). Also, the Onstar telematics system is constrained by a design architecture that limits upgrades without replacing hardware. Done right, by minimizing the customer's adoption costs of new applications and by designing for easy upgrades, platform envelopers lay the foundation for additional steps up the staircase. The key to staircase strategies is to preserve the original base of products while linking new products that benefit from increased connectivity. Unlike in traditional markets, therefore, new products do not make old products obsolete but build on them, creating an ever-expanding suite of interconnected capabilities.

Platform industries versus traditional industries

There are important differences between traditional industries and platform industries. For example, late followers in platform industries tend to win more often than late followers in traditional industries such as consumer products. Perhaps the requirements of continuing compatibility with its own existing platform as well as compatibility with the platforms to-be-enveloped make innovations in these industries less radical or “disruptive”. After all, the performance of the next generation of products is arguably higher than of the previous generation, as the existing features should still work while new ones are added. As a result, platform envelopment may be more incremental and sustaining innovations.

Another difference between traditional and platform industries is the prevalence of network externalities. Network externalities occur when the value of a product or connecting to a network to one user depends on the number of other users. Network externalities have also been called “positive network externalities to adoption,” “demand-side externalities,” or simply “network effects.” Network effects are of particular relevance in platform industries. The value of a platform to an individual user increases with each additional user. Network effects can lead to market “tippiness” when competition among two or more firms becomes “winner takes all.” In a tippy market, there are two cycles:

  1. the virtuous cycle is where the product with many users becomes more and more valuable to each subsequent user and attracts ever more users;

  2. the vicious cycle involves a death spiral when the second product loses value as it is abandoned by users.

September 2011.

This is a shortened version of “How platform leaders win”, which originally appeared in Journal of Business Strategy, Volume 32 Number 2, 2011.

The authors are Gezinus J. Hidding, Jeff Williams and John J. Sviokla.