What do Amazon, Uber, Google, Facebook, Microsoft and many of the world's most successful companies have in common? Platform power. They're all platform companies driving staggering levels of business growth which has big implications for every aspect of what any organization does.
Understanding the value of platforms and how to take advantage of them is essential for anyone looking to compete and win in the age of digital transformation.So says Marshall Van Alstyne , a globally-recognized expert on network business models.
Alstyne co-authored the international bestseller "Platform Revolution: How Networked Markets are Transforming the Economy and How to Make Them Work for You".As co-developer of the concept of "two-sided networks" he has been a major contributor to the theory of network effects, Heis also a tenured professor at Boston University with research that has appeared in top journals such as Science, Nature, and Harvard Business Review. His expert commentary has also appeared inBloomberg, The New York Times, The Wall Street Journal and National Public Radio.
In this thought-provoking interview, Alstyne breaks down the power of platform economics,whyvalue creation is moving from inside the organization to outside the organization, and why this important shift has profound implications for companies everywhere.
Enjoy the conversation.
Appian:Your book, "Platform Revolution", has been called provocative, cutting edge, a manual for disruption. One reviewer said that you should read it, or keep it out of the hands of your competitors.What motivated you to write the book and what are the biggest takeaways?
MVA: The book grew out of a sense that information is becoming increasingly important. IT covers the information asset and how it drives productivity and innovation. How it changes over time. The network effect derives from information. And corporate valuations stem from information.
"Why is this worth noting? Well, thirty years ago, the market capitalization of firms tended to be about 85% tangible assets and 15% intangible assets. But that has completely flipped. It's now about 86% intangible assets and 14% tangible assets."
Velocity of Information Speeds Business Transformation
Appian:By 2023, more than half of all GDP worldwide will be driven by products and services from digitally transformed enterprises, according to recent research from IDC.What do you make of this trend and how do you take advantage of it?
MVA: Those are some very deep questions. And we think that there are some profound changes in the economy, driven by the velocity of information.Let's start with why the platform trend is such a big deal. And then we can go into specifics.But to answer your question, the firm is inverting. That is, value creation is moving from inside the organization to outside the organization. And it's a profound shift in the nature of organizations.
This has specific implications for IT. But it also has big implications for every aspect of what a business does. If you want a summary of the takeaway, it is that firms are inverting the value creation process. So, why is this happening? We believe it's all driven by network effects users creating value for users. And this cannot be scaled inside the firm as easily as outside the firm.If you look at the giant firms today, all of them are driven by network effects.
Mega Platforms Generate Staggering Levels of Growth
Google has 87% market share in mobile, 90% in mobile search, and dominates in maps. If you look at Amazon in retail. Or at Facebook, with 2 billion users. And Uber they came from nowhere to completely dominate the transportation marketplace.If you look in China, Alibaba is 80% of eCommerce. And Tencent has almost a billion users in a country with a total population of about 1.3 billion people to begin with.
"This is a staggering level of concentration and growth. Seven of the top 10 firms in the world today are platform companies. All of them are driven by network effects. And all of them are based on value created by communities, and not just the firms themselves."
https://youtu.be/PhBVrc5eQ5M
Appian: So, with this inversion of value creation, how can traditional companies fight back, what must they do to compete and win?
MVA: So, the choice is to become a platform company. Or, partner with a platform. Otherwise you're going to have shrinking sales.It's just inevitable. Some businesses won't have to deal with this as much as others. But any business that's using APIs is certainly within that marketplace.Which goes back to your original question about why I'm interested in this trend. The proportion of value driven by information is a predictor of transformation.
On the flip side, the proportion of value in heavy or hard assets indicates a market that's more resistant to transformation. Construction and mining are good examples of this.Let me give you a test for when you can expect companies to transform to platform business models:
4 Signs Your Business Is Platform-Ready
- The first indicator is the proportion of value derived from information. The reason is, it's easier to create network effects from information. And you can spread the value from user to user.
- How easy is it for third parties to provide the asset and review the quality of it? This is a great way for third parties to sell products on Amazon, or eBay or Alibaba. So the retail industry is predicted to transform in that way. And this is consistent with the notion of inversion.
- Fault tolerance, and how much it's regulated, is the third criterion of platform transformation you do not open APIs on pacemakers and nuclear power plants. A related indicator is how much experimentation is allowed. Again, if you want third parties to develop new activities and insights for you, the question is, how much can you open the process, so third parties can deliver that value?
- The fourth criterion is spare capacity. Is there spare capacity in the marketplace? If so, then it's easier to share that market and time-slice the extra capacity. Simple examples of this are Uber, Airbnb and MRI machines.
With multi-million-dollar assets like MRI machines and other equipment, you can time-slice spare capacity to increase efficiency and utilization of that asset.
Appian: So, If I'm a traditional company in a market that's primed to transform, what are my options?
MVA:If this sounds like the market you're in, then your first option should be to try to become the lead platform in that market. But this is tricky, because these tend to be winner take all markets.So, if you're a late comer, your next option is to try and be a good partner with specialized assets on top of a platform. If you're later than a latecomer, you're going to have a rough time.
Biggest Barrier to Change: Management Mindset
Appian:What are the biggest barriers to adopting a platform approach? And what are some of the common roadblocks you've seen in your research?
MVA: Probably the single biggest barrier we come across is management mindset. When you invert the firm, every single management function changes from human resource to marketing to operations to finance, whatever. Everything changes.You're shifting value creation from inside the firm to outside the firm. And it's a completely different way of thinking.
Let's take IT. We've gone from back office to front office to ERP and CRM systems to what I call out-of-office social media systems. You're doing Search Engine Optimization and sentiment analysis. You're doing customer self-service through firms outside the organization.
"Take operations management. It used to be that you managed your own inventory for the production of a good. And the ideal was some version of Just-in-Time inventory to minimize your overhead costs. But platforms don't work that way."
Killer Brands Create Value From the Outside In
Instead, you're often orchestrating value created by others. And, in so doing, you shift to zero marginal cost production. Platform companies like Uber, Airbnb, Amazon, Facebook and Alibaba don't even incur marginal costs for delivery of a service or a product. The costs are borne by third parties, which explains why platform companies can scale so much.
My point is that no matter what your managerial function is, you have to take a new perspective, which is how can I orchestrate value outside the firm instead of inside the firm. And to answer your question about what's the biggest barrier to this, it's usually mental models.Business leaders that are used to operating under a product model have a hard time transitioning to a platform model, because they are used to orchestrating value created inside the firm, as opposed to value created by others.
https://twitter.com/InfoEcon/status/951168017928515586
From Software to Platforms Eating the World
Appian: In "The Platform Revolution", you said that we need to update the old-school notion of internet-enabled disruption and the notion of software eating the world. And that we need to think about the notion of platforms eating the world. What did you mean by that?
MVA: The original article by Marc Andreessen is a wonderful article, the notion of software eating the world. And the notion of software taking pictures with your phone, or algorithms replacing human judgement in any number of opportunities. But the next step is to orchestrate network effects.
"How do you design a system in such a way that users create value for other users? That's a network effect. How does your Google search make my Google search better? Or your movie-watching behavior make my movie-watching behavior better?"
How can the consumption patterns for one set of users on Amazon be used to improve product recommendations for other users?And how can product recommendations for users be inverted to design whole new products? That's taking information from users and about users and leveraging it to make the experience of other users better.
That's a network effect. If you stop at software, you're substituting a highly scalable low cost good which is software, for a non-scalable, high-cost good which is hardware or a product.But if the next step is to orchestrate the spillover of value from one to another, this is the nature of a platform business as opposed to just substituting one kind of product for another.
Intelligent Automation: Creating Feedback That Allows Users to Create Value for Other Users
Appian:How does artificial intelligence and machine learning fit into the platform narrative?
MVA: Machine learning and artificial intelligence will drive network effects. There's the wonderful notion of "data-driven network effects, and data-driven design." You observe how folks are using a product. Your machine learning algorithm learns from how people use a product to help you make it better. Which drives sales. Which gives you more data to make your product or service even better still.
It's creating another kind of feedback system like what we described earlier, of users creating value for other users. Only it's indirect, via machine learning algorithms, as opposed to having users create that value themselves.
"It's also interesting that every one of these giant platform companies have invested heavily in large A.I. programs Facebook, Google, Alibaba, Tencent all have deep programs in A.I. and using machine learning algorithms to improve their offerings."
Let me give you another example. Alibaba uses its machine learning algorithm to track where you've been, what products you've been buying. So, when you visit one of their stores, they're able to completely customize the store to you. There are a million different variations of the store that will be presented. And it will be adapted to each individual user, based on what they've done.That's how machine learning algorithms are being used to customize the customer experience for each individual user.
https://twitter.com/McKinsey_MGI/status/959217636977598464
$10 Trillion in Value at Stake
Appian: The World Economic Forum's Digital Transformation Initiative estimates that platforms could generate $10 trillion in value through 2025. From a value creation standpoint, the implication is that platform companies may dominate the digital economy.
MVA: One of our findings is that a weak platform will beat a strong product every time. The litany of examples is all over the place. Take Steve Jobs' original Macintosh. It was a better product, but Microsoft had a better ecosystem.
"Take all of the original handset manufacturers. In 2007 before the iPhone was introduced, just seven firms controlled 90 percent of the industries profits. But Apple built a better ecosystem. And by 2015, Apple alone controlled about 90% of mobile phone profits."
Appian: That's an amazing stat. On the flip side, I've read that nearly half the companies on the Fortune 500 in 2000 have disappeared. And some experts are predicting that over 40% of the firms on the Fortune 500 today will not be there over the next 10 years.
MVA: I think those stats confirm that we're going through a deep and profound change in the economy. We argue that the changes in the internet era are every bit as profound as the changes in the industrial era. That was a shift from agricultural practices to industrial practices driven by supply-side economies of scale.
And now we've got a new business model driven by demand-side economies of scale. Demand-side economies of scale is just another name for network effects. So, we should expect huge transformation as the economy goes through this shift from traditional business models to new ways of doing business.
Digital Giants Feast on Disruption
You mentioned how many firms have disappeared. It's also worth reflecting on what is likely to be the case. I'm quite willing to bet that Google and Amazon and Alibaba will be here 10 or 20 years from now. These firms won't disappear, because they are becoming even more colossal. But the opposite is true of individual competitors.
Think of Apple and Google together. The mobile ecosystem erased sales on GPS systems, on cameras, on Filofax day planners, on voice recorders, on calculators. You wouldn't expect these things to be natural competitors.
"But what happened is that ecosystems supplanted individual products. And the ecosystem is far more powerful and far more efficient than an individual company. So, the disruption you're seeing, and the pruning of individual product firms is coming down to the benefit of these huge platforms."
The smaller firms that are selling products are going to get gutted. While these huge platforms are going to be with us for another generation at least.
Reinvention: Critical Success Factor for Traditional Firms
Appian: Last question...what are your expectations for the platform revolution and the growth of digital transformation?
MVA: I think huge changes are afoot with digital transformation.Many traditional firms will have more trouble than they realize. As an example, giant firms like Toyota and GM are going to have great difficulty as the car transforms to a platform.Automobiles touch many different areas of our economy such as steel, glass, banking and insurance. And this entire chain of industries is going to be transformed.
We're going to see transformation of energy markets, as we move to smart grids. And even your thermostat will be able to buy energy and manage the operation of your household over time.Education is going to be transformed, as schools get competition from these massive online programs available across the globe. So, expect to see lots of transformation in industries that have yet to be affected. Healthcare is another one where we should expect to see immense transformation, as different firms start taking the lead in platforms.
In banking, the European Union's PSD2 (Revised Payment Service Directive) legislation will open up traditional bank accounts, so that third-party providers can create services on top. So you should expect to see significant transformation in banking services in Europe, and then spilling over into the U.S.This is going to lead into lots more transformation of traditional businesses into platforms. Beyond that, we're also going to have to address the anti-trust issues. Because these firms are getting so large, we're going to face many of the same antitrust issues we confronted a century ago, during the industrial revolution in steel, autos, oil and railroads.
The big question is this: Can we adapt our antitrust laws to deal with the challenges of demand-side economies of scale to create fairness and prevent exploitation of labor?
(This updated post was previously published in 2019.)
