Platform Revolution

In the world of platforms, the nature of competition is being transformed. Companies find themselves struggling to make sense of new competitive threats posed by unexpected, often counterintuitive rivals.¹ The educational book publisher Houghton Mifflin Harcourt doesn’t fear McGraw-Hill as much as it fears Amazon. Broadcaster NBC worries less about ABC than about Netflix. Legal information purveyor Lexis feels less threatened by Westlaw than by Google and by the online legal services purveyor LegalZoom. Appliance maker Whirlpool fears GE and Siemens less than it fears Nest, the maker of smart home monitoring and control devices that is rapidly becoming a key element in the emerging “Internet of things.” And the social network Facebook was less worried about a rebooted Myspace than about Instagram and WhatsApp—which is why it bought them.

What has changed is not simply the types of competitors but the very nature of the competitive battle. The result is a series of seismic upheavals that are making one business landscape after another almost unrecognizable. We’re not speaking only of the dramatic disruptions produced by the advent of platform businesses in traditional marketplaces (as described in chapter 4 and elsewhere in this book). We’re also referring to the dramatic competitive battles being waged within the world of platforms, between platform companies—with results that are often startling, even shocking.²

It’s probably safe to say that the $25 billion initial public offering of shares in Alibaba Group in September 2014—the largest IPO in history—was one of the most unexpected business stories of the year. Many Westerners who had not obsessively followed the world of e-commerce had never heard of the company. Those who had were mainly familiar with it through its connection with the floundering Yahoo, which owned a significant stake in Alibaba. Much U.S. coverage of the Alibaba story was vaguely dismissive, treating the company’s amazing growth and impressive size as fluky results of the sheer vastness and parochialism of the Chinese market and the impact of government protectionism.

A 2010 story in the New York Times was typical. Reporter David Barboza acknowledged Alibaba as one of several “fast-growing local firms that are making huge profits” through online sales. But in the future, Barboza wrote, “China’s Internet market could increasingly resemble a lucrative, walled-off bazaar, experts say. Those homegrown successes … could have trouble becoming global brands.” Barboza quotes one analyst as predicting, “When the Chinese companies go outside of China, they will find that they fail to understand their competitors as well as they did when they were competing in China.”³

By the summer of 2014, with Alibaba’s U.S. stock debut just weeks away, U.S. business analysts were singing a different tune. In Businessweek, Brad Stone warned of “the Alibaba invasion” and explained how the Chinese giant was suddenly posing the first ever significant threat to U.S. domination of the Internet. Stone recounted how Alibaba had outcompeted eBay in China, had become a huge source of Chinese goods for businesses around the world, had successfully opened the Chinese consumer market for global companies such as Nike and Apple, and was quickly building the infrastructure to challenge Amazon and eBay in their own home market—the U.S. Stone concluded, “China’s Web entrepreneurs are positioning themselves to compete in—and win—the race to build the first truly global online marketplace.”⁴

In most traditional industries, such a rapid emergence from relative obscurity to global leadership would be virtually impossible. Glancing back at business history, we see that it took American businesses in industries like steel and heavy machinery decades to overtake once-dominant rivals in Britain and Germany. After World War Two, Japanese upstarts required three decades to seize leadership roles in auto making and electronics from industry leaders in the U.S. But Alibaba today has the potential to outstrip companies like eBay and Amazon a decade or so after entering the battle for platform marketplace dominance.

As with most big business stories, there are many contributing elements in the Alibaba saga, including the strategic insights of CEO Jack Ma, the explosive growth of China’s middle class, and, yes, government-imposed restrictions on foreign companies operating in China, which gave Alibaba a bit of space to grow without being crushed by American competitors. But the swiftness of Alibaba’s ascent is largely a function of the new realities of platform competition.⁵

Explosive network effects and strong economies of scale enabled this relatively new company to expand so rapidly on the stage of international commerce. Alibaba.com, one of five major businesses operating under the corporate umbrella, allows companies around the world to source goods, products, and parts from Chinese manufacturers. One California cosmetics maker marvels that, through Alibaba.com, “I have access to hundreds of suppliers at my fingertips.” Conversely, Tmall, another Alibaba subsidiary, sells foreign goods to millions of Chinese consumers, bypassing the country’s traditional broker system, which slowed imports and added layers of paperwork and cost. One U.S. shoe retailer says Alibaba “has compressed the whole middle layer of retail.” The result is near-frictionless cross-border trading that connects thousands of merchants with millions of customers—a phenomenon scarcely imaginable before the advent of the platform.

Furthermore, Alibaba is shrewdly leveraging another enormous competitive strength of platforms—the ability to seamlessly incorporate the resources and connections of outside partners into the activities and capabilities of the platform. For example, to expand its ability to offer U.S. goods to Chinese consumers, Alibaba has now forged a partnership with ShopRunner, a U.S.-based logistics company in which Alibaba owns a stake. ShopRunner already has arrangements with U.S. brands including Neiman Marcus and Toys“R”Us that enable Alibaba to ship American products to customers in China in two days.⁶

Back in the nineteenth and early twentieth centuries, it took decades and vast investments in retailing, warehousing, product testing, management, printing, shipping, service, and fulfillment systems for Sears, Roebuck to make itself into America’s merchant. Today, a platform business like Alibaba can assemble the capabilities of dozens of preexisting entities and swiftly become a contender for the title of merchant to the world. And, of course, Alibaba’s chief rivals for the crown are other platform companies such as Amazon and eBay. Such is the world of competition that the rise of platforms has brought.

But to fully understand how the rise of the platform is transforming the nature of competition, we need to reexamine the traditional concepts of competition that have dominated business thinking for decades—and that many businesspeople still take for granted.

For three decades, the five forces model of competition outlined by Michael Porter of Harvard Business School has dominated the world of strategic thinking.⁷ As one measure of Porter’s influence, his writings have received more than a quarter million citations, exceeding those of any Nobel Prize-winning economist.

Porter’s model identifies five forces that affect the strategic position of a particular business: the threat of new entrants to the market, the threat of substitute products or services, the bargaining power of customers, the bargaining power of suppliers, and the intensity of competitive rivalry in the industry. The goal of strategy is to control these five forces in such a way as to build a moat around the business and thereby render it unassailable.

Thus, when a firm can erect barriers to entry, it can keep competitors out, and entrants with substitute products cannot storm the castle. When a firm can subjugate suppliers, competition among them weakens their bargaining power so the firm can keep its costs low. When a firm can subjugate buyers by keeping them relatively small, disunited, and powerless, the firm can keep its prices high.

In this model, the firm maximizes profits by avoiding ruinous competition for itself but encouraging it for everyone else in the value chain. Advantage is found in industry structures that create a protective moat—one that enables the firm to segment markets, differentiate products, control resources, avoid price wars, and defend its profit margins.

For decades, companies have studied the five forces model and used it to guide their decisions about which markets to enter and exit, what mergers or acquisitions to consider, what sorts of product innovation to pursue, and what supply chain strategies to employ. Approaches like horizontal integration (in which a firm controls most or all of a specific product or service marketplace) and vertical integration (in which a firm controls an entire value chain, from raw materials to manufacturing to marketing) have been analyzed and implemented based on the strategic implications of the five forces model. Under this model, Houghton Mifflin Harcourt competes with McGraw-Hill by striving to control the best authors and content and by using copyright to construct a moat around its fortress of value. Whirlpool competes with GE by engineering differentiated products, squeezing the supply chain, and continually improving its manufacturing efficiencies, thereby constructing a moat that makes it hard for GE to poach Whirlpool’s customers.

Later thinkers have added nuance and fresh insights to Porter’s approach. In 1984, MIT’s Birger Wernerfelt first described in detail what he called the resource-based view of the firm, a variation on strategic thinking with roots in the work of several earlier scholars.⁸ The resource-based view highlights the fact that a particularly effective barrier to entry is control of an indispensable and inimitable resource. A firm with such a resource is safe from new entrants who lack and cannot acquire means to produce it. A simple example is De Beers, whose control of a worldwide diamond marketing cartel enabled it to maintain a near-monopoly over the diamond industry for the entire twentieth century. The De Beers cartel broke down after 2000 when some diamond producers decided to market their product outside the De Beers-controlled system, reducing the cartel’s share of the market from 90 percent in the 1980s to about 33 percent in 2013.⁹ Until then, however, De Beers’s control of an irreplaceable resource gave it a sustainable advantage that yielded a hundred years’ worth of profits.

In the twenty-first century, a number of strategy scholars have challenged the resource-based view, pointing out that nimble firms are using new technologies to ford the moats established by control of scarce resources. In separate works, Richard D’Aveni and Rita Gunther McGrath have argued that, in an age of “hypercompetition” (D’Aveni’s term), sustainable advantage is illusory. Technological advances drive shorter and shorter cycle times on everything from “microchips to corn chips, software to soft drinks, and packaged goods to package delivery services.”¹⁰ Connecting across the Internet also allows firms to redraw industrial and geographic boundaries so that stable, slow-moving oligopolies fall to nimbler competitors attacking with new tools and technologies.

McGrath describes how the Internet era has created radically new tools and techniques with which to attack incumbent firms. Imagine a company that wanted to compete with the Union Pacific Railroad in 1915—a firm with a five-decade head start thanks to its authorization by Congress in 1862. The would-be competitor would have needed to make investments in locomotives, rolling stock, depots, terminals, warehouses, and the legal right-of-way required to build a nationwide rail network. The massive investment in these and other fixed costs already spent by Union Pacific provided a mile-wide moat that made the railroad incumbent virtually impregnable.¹¹

By contrast, imagine a firm that wants to compete with any of the Global 500 companies in 2015. Depending on the specific industry, such an upstart could buy production resources from manufacturing firms around the world, cloud and computing services from a range of suppliers, marketing and distribution services from various intermediary companies, and professional services from many online networks of freelancers—all at near marginal cost. In today’s hypercompetitive environment enabled by technology, ownership of infrastructure no longer provides a defensible advantage. Instead, flexibility provides the crucial competitive edge, competition is perpetual motion, and advantage is evanescent.

Other analysts have offered additional insights into the evolving nature of competition. Author Steve Denning has highlighted the weakness of Porter’s assumption that the purpose of strategy is to avoid competition. Denning pointed instead to management guru Peter Drucker’s dictum that the purpose of business is “to create a customer.” According to Denning, in a world where sustainable advantage is an illusion, a company’s relationships with customers are its only lasting source of value.¹²

It would be an exaggeration to say that events of the last decade have demolished the five forces model—but they suggest that the nature of competition has become more complicated and dynamic than Porter’s model might imply.

THREE-DIMENSIONAL CHESS:
THE NEW COMPLEXITIES OF COMPETITION
IN THE WORLD OF PLATFORMS

Enter platforms. Many of the insights embodied in the five forces, resource-based, and hypercompetition models remain valid, but two new realities are now shaking up the world of strategy.

First, firms that understand how platforms work can now intentionally manipulate network effects to remake markets, not just respond to them. The implicit assumption in traditional business strategy that competition is a zero-sum game is far less applicable in the world of platforms. Rather than re-dividing a pie of more-or-less static size, platform businesses often grow the pie (as, for example, Amazon has done by innovating new models, such as self-publishing and publishing on demand, within the traditional book industry) or create an alternative pie that taps new markets and sources of supply (as Airbnb and Uber have done alongside the traditional hotel and taxi industries). Actively managing network effects changes the shape of markets rather than taking them as fixed.

Second, platforms turn businesses inside out, moving managerial influence from inside to outside the firm’s boundaries. Thus, a firm no longer needs to seize every new opportunity on its own; instead, it can pursue only the best opportunities while helping ecosystem partners seize the others, with all partners sharing the value they jointly create.¹³

These two new realities add a dramatic layer of complexity to business competition. Platform strategy resembles traditional strategy much the way three-dimensional chess resembles the traditional game.¹⁴ Within the ecosystem, the lead firm negotiates dynamic tradeoffs involving competition at three levels: platform against platform, platform against partner, and partner against partner.

At the first level, one platform competes with another, as in the video game console battles among Sony (PlayStation), Microsoft (Xbox), and Nintendo (Wii). Strategic advantage is based not on the attractiveness of particular products or services but rather on the power of entire ecosystems. The Sony PlayStation Portable was a stronger gaming device than the iPhone, which lacked specialized left and right controls. When Sony released the PSP-2000 in fall of 2007, after Apple’s summer release of the iPhone, Sony’s stock rose about 10 percent. But before long, the iPhone ecosystem vastly outstripped that of the PSP. As we’ve already noted, Apple has subsequently enjoyed far great financial success than Sony, thanks in large part to the size and value of its ecosystem.

At the second level, a platform competes with its partners—for example, when Microsoft appropriates such partner innovations as browsers, multithreading, streaming media, and instant messaging and incorporates them into its operating system, or when Amazon operates as a platform for independent merchants while also selling some of the same goods on the same platform in competition with those merchants. This is a delicate and dangerous move. It can strengthen the platform, but at the expense of weakening partners—a short-term gain that can lead to painful long-term consequences.

At the third level, two unrelated platform partners compete for positions within the platform ecosystem, as when two game app developers strive to attract the same consumers on the same console.¹⁵

Let’s consider some of the specific impacts that these platform-driven changes have on traditional views of strategy.

As we’ve seen, platforms expand the boundaries of the firm. The shifting horizons of managerial influence now make competition less significant for strategists than collaboration and co-creation—or, as scholars Barry J. Nalebuff, Adam M. Brandenburger, and Agus Maulana call it, “co-opetition.”¹⁶ The shift from protecting value inside the firm to creating value outside the firm means that the crucial factor is no longer ownership but opportunity, while the chief tool is no longer dictation but persuasion.

The five forces model depends on the distinct boundaries that characterize traditional product markets. Each of the five forces—customer power, supplier power, and so on—is a separate entity that must be managed independently. By contrast, in platform markets, a winning strategy blurs the boundaries among market participants, thereby increasing valuable interactions on the platform. A Skillshare student today can become a teacher tomorrow; an Etsy customer one day can begin selling her own crafts on the site the next. Platform competition requires treating buyers and suppliers not as separate threats to be subjugated but as value-creating partners to be wooed, celebrated, and encouraged to play multiple roles.

The resource-based view assumes that a firm must own, or at least control, the inimitable resource. In the world of platforms, the nature of the inimitable resource shifts from physical assets to access to customer–producer networks and the interactions that result. In fact, it can be better for the firm not to own physical resources, since eschewing ownership enables it to grow more quickly. As the examples of Airbnb and Uber remind us, the resource pool that a platform company can access is capable of growing much faster than the platform company itself.

In traditional business, Porter’s five forces and the ability to control inimitable resources—as modified by the dynamic of technology-driven hypercompetition—have largely shaped business strategy. In the world of platforms, new competitive factors have moved to the fore. These new factors help determine who participates in a platform ecosystem, the value they help to create, who controls that value, and ultimately the size of the market. These new factors have become the focus of a series of new competitive strategies.

Let’s consider them one by one, beginning with the strategy of limiting platform access so as to control and capture a greater share of the value created on the platform.

As we’ve seen, the resource-based view of business value must be modified when applied to platform businesses. However, the resource-based emphasis on inimitable resources has its parallel in the world of platforms: Platforms seek exclusive access to essential assets. They do this, in part, by developing rules, practices, and protocols that discourage multihoming.

Multihoming occurs when users engage in similar types of interactions on more than one platform. A freelance professional who presents his credentials on two or more service marketing platforms, a music fan who downloads, stores, and shares tunes on more than one music site, and a driver who solicits rides through both Uber and Lyft all illustrate the phenomenon of multihoming. Platform businesses seek to discourage multihoming, since it facilitates switching—when a user abandons one platform in favor of another. Limiting multihoming is a cardinal competitive tactic for platforms.

Here’s an example of how the effort to limit multihoming plays out in the new world of strategy. Adobe Flash Player is a browser app that delivers Internet content to users, including audio/video playback and real-time game play. Flash could have been used by app developers on Apple’s iPhone operating system—but Apple prevented this by making its iOS incompatible with Flash and insisting that developers use similar tools created by Apple itself.

Developers and users responded with dismay, and some observers called the policy an anti-competitive gambit that might be subject to governmental sanction under antitrust regulations. The furor grew so heated that, in 2010, Apple’s Steve Jobs felt compelled to defend the policy in an open letter—a highly unusual step for a CEO to take. In his “Thoughts on Flash,” Jobs argued that Flash was a closed system and technically inferior to other options, consuming excessive energy and otherwise delivering poor performance on mobile devices. Keeping Flash off the iPhone, Jobs claimed, would preserve the quality of the Apple user experience.¹⁷

The real reasons were much deeper and more strategic. Adobe had designed Flash developer tools to allow content and program porting from Apple iOS to Google Android and to web pages more generally. Apps developed in Flash could multihome, reducing the iPhone’s distinctiveness. Adobe also released extensions that allowed in-app purchases. By allowing developers to take interactions off the iTunes platform, Flash would cause Apple to lose its 30 percent cut of every interaction as well as control over the associated usage data—information that provides valuable clues concerning trends in the marketplace.

If Apple had supported Flash, it would have granted users access to enormous amounts of Flash content already on the web while giving developers more ways to monetize their investments by multihoming across platforms.¹⁸ But it would have been a big loss for Apple. So they used licensing rules and technology to keep interactions from going off platform.

Another example of how the strategic battle for control of access to the customer can play out is the story of Alibaba.

Ming Zeng is chief strategy officer of Alibaba. At the MIT Platform Strategy Summit hosted by the authors in 2014, Zeng explained how denying a powerful competitor access to Alibaba helped change the shape of the market and enabled at least a portion of Alibaba’s remarkable growth.¹⁹

Early in the evolution of Alibaba, the company was scrambling for ways to attract users and generate significant network effects. The company’s “great explosion” in network effects didn’t occur until it devised a policy requiring every employee to find and list 20,000 items for sale by some person or merchant. The resulting increase in product listings generated two-sided demand. Alibaba and its companion consumer site Taobao quickly became the fastest-growing site for online purchases, attracting any Chinese consumer looking to purchase almost any imaginable product.

Prior to that great explosion, when Alibaba was struggling to attract traffic, CEO Jack Ma and his team had made a counterintuitive decision: they created technological barriers that prevented Baidu from searching their website. Baidu is China’s biggest Internet search engine—the Google of China. Blocking Baidu’s bots from searching Alibaba for products being sought by Baidu users cut off a vast supply of potential customers. Doing this at a time when Alibaba was desperate for shoppers must have seemed a bit crazy.

But Alibaba’s leaders were playing a long-term strategic game. They had their eye not just on the shopping interactions that would take place on their platform but on the potential to monetize the platform by selling advertising. They were determined to retain control of the community of would-be shoppers that they were gradually building on Alibaba—so that Alibaba alone would be able to sell ads aimed at those shoppers. Barring Baidu’s bots from Alibaba’s listings was a way of preventing Baidu from hosting the consumer-oriented ads that companies would ultimately want to direct to the growing numbers of Chinese online shoppers—and making sure that those ads would appear on Alibaba’s platform instead.

The strategy worked. As Alibaba’s user base expanded, it gradually displaced Baidu as the most valuable online advertising platform in China. It’s as if eBay or Amazon had found a way to capture the targeted advertising revenues now enjoyed by Google. The income generated helps to explain why Alibaba earned more profits in 2014 than Amazon has earned in its entire history.

The open-ended nature of platforms creates enormous opportunities for users to create new value. Platform managers can build their businesses by, first, giving partners frictionless opportunities to innovate, then capturing some or all of the value created by acquisition or duplication. As we saw in chapter 8, SAP encourages innovation by partners on its business services platform by periodically publishing a road map of the platform real estate it plans to open to developers over the next 18–24 months. This tells developers where they can build, giving them up to two years of lead time before they face competition from SAP itself, and prevents developers from wasting time and resources developing a site for SAP users only to find its work undermined by the arrival of SAP’s own bulldozers.

Over the long haul, it is in the interest of platform managers to take control of the major sources of value created by and for users in their ecosystem. This leads to what we might call the platform-world variant of the resource-based theory of value: A platform business need not own all the inimitable resources in its ecosystem, but it should seek to own the resources whose value is greatest. This is why Alibaba (rather than Baidu) owns search on its platform, why Facebook (rather than Google) owns search on its platform, and why Microsoft (rather than some outside software developer) owns Word, PowerPoint, and Excel on its platform. These are all crucial resources that create value for the majority of the platforms’ users—that’s why it is critical for the platform owners to control them. Less valuable, or more niche, resources can be ceded to ecosystem partners without significantly weakening the competitive position of the platform itself.

This principle explains why platform managers need to keep a careful watch on new features or apps that appear on the platform. These will usually make their first appearance far down the “long tail” of adoption, with relatively few platform participants using them to co-create value. Most will stay there, but a few will show the ability to jump rank, climbing rapidly toward the head of the distribution curve. A few will even show signs of attracting their own interactive communities, which means they have the potential to become platforms themselves. Recall that social gaming company Zynga and the photo-sharing services Instagram and Snapchat all started off as mere blips on the Facebook platform. But their social sharing and network effects enabled them to grow fast.

Growth of this kind often launches a strategic tug-of-war. The platform may seek to absorb the function of the innovative partner and the value it creates by acquisition. As we’ve noted, Facebook succeeded in acquiring Instagram, purchasing the company for $1 billion in 2012; it has (so far) failed to acquire Snapchat, having made a $3 billion offer that company cofounder Evan Spiegel rejected in December 2013.

The platform may also seek to weaken the startup by promoting competitors, as Facebook has done with Zynga. As of 2011, there were more than three thousand games on Facebook, collectively weakening Zynga’s individual bargaining power.²⁰ The startup’s response may be to sell, to fight back through multihoming, or to expand into other business arenas. Zynga, for example, now multihomes on Tencent’s QQ social network and on the Apple and Google mobile platforms, as well as offering its own cloud service.

One of the clichés of the Internet economy is the saying “Data is the new oil”—and like most clichés, it contains a lot of truth. Data can be a source of enormous value to platform businesses, and well-run firms are using data to shore up their competitive positions in a wide variety of ways.

Platform businesses can use data to improve their competitive performance in two general ways—tactically and strategically. An example of tactical data use is in the performance of A/B testing, to optimize particular tools or features of the platform. If Amazon wants to determine whether placing the buy-it-now button at the top right or the bottom left on a web page will generate more sales, it can run an experiment by randomly alternating the button placement and tallying the results, possibly cross-tabulated against various customer characteristics. Tactical data analysis is quite effective—and it’s the reason why Amazon now places the buy-it-now button at the top right of a web page.

Strategic data analysis is broader in its scope. It seeks to aid ecosystem optimization by tracking who else is creating, controlling, and siphoning value both on and off the platform and studying the nature of their activities. When Facebook uses data about member activity to observe Zynga doing something unexpected or to spot Instagram diverting traffic in novel ways, that is strategic data analysis.

Some notable platform strategy battles have been won by companies that took advantage of data supremacy to outcompete their rivals.

By most measures, Monster should have won the battle for supremacy among job placement platforms. As one of the earliest entrants into the market, it had a first mover advantage, and it quickly generated strong network effects in the two-sided market of employers and employees seeking one another. However, there were built-in limitations to the data Monster gathered. Because Monster targeted only active job seekers, it captured no information concerning users’ broader social networks. And once a particular job search interaction was completed, both employer and employee would leave the platform, halting the flow of data altogether.

By contrast, LinkedIn targeted the social networks of all professionals, not just active job seekers. This led to a higher degree of ongoing engagement and captured data from those who were happily employed but willing to consider new job opportunities—a vastly expanded user base. LinkedIn also captured data from interactions among professionals interacting with one another as well as with recruiters, providing two separate feedback loops on the same platform. Later, LinkedIn began emphasizing content creation and sharing by its users to foster additional reasons for them to spend time on the platform. LinkedIn’s big edge in the scope, depth, and volume of marketplace data has given it a huge advantage in competing against Monster.

Platform design can be optimized in various ways to generate better user data. Guided by a two-sided network analysis, the authors developed a set of recommendations for the design of data analysis tools to provide improved ecosystem leverage for SAP.

We emphasized the value of search tools that help clients find solution providers among SAP ecosystem partners. Better matches facilitated by enhanced data make both sides happier. We also noted that solution providers can find clients by identifying unsuccessful user searches, reflecting the existence of potential clients in need of business solutions. In addition, we noted the need for tools that help clients benchmark their capabilities against other, similar companies on the platform, as well as tools to help developers benchmark their capabilities against other developers on the platform. Such tools can help SAP users compete more effectively with rivals who are not on the platform.

A final set recommendation that we developed with SAP is to look for new business service capabilities that cut across industry verticals and new features that are rapidly climbing the long tail, meaning that they are growing in popularity among business users. These represent new sources of value that platforms like SAP can absorb into its platform for the benefit of ecosystem partners who have yet to discover them.

Data analytics can thus significantly augment the capabilities of both the platform company and its ecosystem partners, making the platform more successful and greatly increasing its ability to generate value for users. Analytics can guide investments in product design and in customer and partner success, reinforcing the platform’s network effects. Collectively, these new data tools create a formidable barrier to entry—a platform version of Porter’s competitive moat. If competitors don’t have the data, they can’t create the value—which means they can’t create the interactions, which further limits their access to the data.

Classic merger and acquisition (M & A) strategy suggests that business leaders should pursue targets that either add complementary products or market access or subtract supply chain costs. In a world dominated by five forces competition, the key question driving M & A evaluation is whether or not the target company has a moat protecting a sizeable fortress of value.

Platform managers need to adjust this strategy. For them, the key question is whether the target company creates value for a user base that significantly overlaps with the one they are currently serving.

If the answer is yes, then a tentative conclusion that the target may be worth acquiring can be reached. However, there are additional hurdles to be surmounted before making the commitment to buy, such as the profitability of the target company and its ability to elicit a continuing stream of repeat interactions from platform participants. Fortunately, a platform business is in an unusually privileged position when it comes to measuring the value of a potential acquisition. Unlike a traditional pipeline company, a platform owner can delay an acquisition until it has observed how a partner transacts on the platform.

This solves the traditional challenge of information asymmetry in M & A evaluation. Instead of basing a buy decision on someone else’s audited financial data, the purchaser can rely on firsthand observation of transaction data and even run real-world experiments to test various strategic scenarios. Managing a platform lets you take the partnership for a test drive before signing a purchase agreement.

Furthermore, based on the fact that platform businesses don’t need to own all the critical assets as long as they have access to them in their ecosystems, platform companies can pursue fewer M & A deals than many traditional firms feel compelled to do. In the process, they enjoy at least two significant benefits.

First, claiming a portion of the value created by a platform partner is far less risky than buying that partner. Recall that, in 2011, Farmville and Mafia Wars were the biggest hits in gaming, driving the stock market value of game developer Zynga through the roof. It’s easy to imagine that the leaders of Facebook must have been tempted to buy Zynga, which would have not only provided them with the full value of Zynga’s game portfolio but also denied access to this key asset to rival platforms like Myspace.

But Facebook resisted the temptation—and wisely so. Game development is notoriously unpredictable; even the most successful games flame out after a few years, and there’s no guarantee that another hit will follow. Rather than buying Zynga and shouldering the responsibility for creating the next big sensation, it was far better for Facebook to let hundreds of game companies compete to produce the next hit and then capture a fraction of the upside.

Second, keeping a partnership at arm’s length reduces the platform’s technological complexity. As the very term vertical integration implies, any new business a platform purchases must be integrated with the platform, which creates both technical and strategic challenges. A platform built from a dozen independently developed technologies will break sooner, cost more, and deliver a worse customer experience than one built on a lean architecture that conducts all its business activity through clean interfaces. Recall our discussion of the benefits of modular design in chapter 3: in a modular system, when a part or partner fails, a new one can be swapped in relatively easily. But when a part or partner fails in an integrated system, the whole system can grind to a halt.

For these reasons, managers of platform businesses can afford to approach the challenge of M & A strategy in a more thoughtful, deliberate fashion than leaders of traditional companies, who often feel compelled to snap up the next hot startup before someone else does.

Platform managers need to continually scan the horizon, observing the activities of other platforms—particularly platforms that serve similar or overlapping user bases. We call these adjacent platforms. When a new feature appears on an adjacent platform, it may represent a competitive threat, since there’s a possibility that users of your platform may find the new feature attractive enough to begin multihoming or even to abandon your platform altogether.

To respond, the platform manager can choose either to provide a similar feature directly or to offer it indirectly via an ecosystem partner. When used most successfully, this strategy leads to the phenomenon we call platform envelopment. This occurs when one platform effectively absorbs the functions—and the user base—of an adjacent platform.

For example, back in the 1990s, RealNetworks invented streaming audio in the form of its 1995 product, Real Audio. It soon owned 100 percent of the market. But once Microsoft decided to capture this market, the enormous scope of its existing platform gave it an almost unstoppable advantage. Since MS Windows had a market share of over 90 percent in operating systems, almost everyone who was interested in media streaming already had an operating system from Microsoft. All Microsoft had to do was develop a software product similar to Real Audio and offer it as part of a bundle with its Windows operating system. The Windows streaming audio platform soon enveloped the much smaller platform created by Real Audio—despite the older software’s superior performance.

The envelopment strategy is a common one that we can see in operation in many platform arenas. Apple is now endeavoring to use its iPhone platform to envelop the markets for mobile payment systems and wearable technology. Similarly, China’s Haier Group is expanding its appliance platform in an effort to envelop the market for connected home applications.

Of course, the opportunities and threats run both ways. If Platform A is trying to envelop adjacent Platform B by developing a feature that competes with Platform B’s most attractive offering, Platform B may try to envelop Platform A by mounting the same kind of attack in reverse. In this kind of envelopment battle, the larger platform, with its more numerous initial user base and more powerful network effects, is generally triumphant. But as the story of Monster versus LinkedIn demonstrated, a platform that offers superior value to users can win a competitive battle despite an initial size disadvantage.

By comparison with traditional pipeline businesses, platform companies are able to move very rapidly to respond to competitive moves—and to mount competitive assaults of their own. The winners will usually be those platforms that are able to consistently create the greatest value for users. But in today’s business, no victory is permanent, which means that platform companies must be at least as vigilant in guarding against complacency as traditional firms.

In the world of traditional business, companies compete by attempting to create higher-quality products and services. In an analogous fashion, platforms compete by trying to improve the quality of the tools they provide to pull in users, facilitate interactions, and match producers with consumers (the basic elements of platform design we described in chapter 3).

We saw a simple example of how this works in chapter 5, when we explained how video hosting platform Vimeo managed to coexist with YouTube despite serving an overlapping market, differentiating itself through better hosting services, greater bandwidth availability, more valuable viewer feedback, no obtrusive pre-roll advertisements, and other features that attract more selective video producers despite YouTube’s much larger viewer base. Vimeo’s competitive stance in relation to YouTube resembles that of many traditional businesses that coexist with a market-dominating rival by identifying a specialized niche and creating a higher-end product designed to cater to that audience.

In some cases, superior platform design enables a platform to dramatically outcompete a preexisting rival. Airbnb initially had far fewer users than the much older Craigslist, which also provides listings of rooms and apartments for short-term rent. However, Airbnb did a much better job at the key platform functions of facilitation and matching. On Craigslist, a person seeking a room for rent had to drill down through an unmanaged list of options clustered by city and organized by time of posting. By contrast, Airbnb allowed a person to search through options organized not only according to these characteristics but also by quality, number of rooms, price, and mapped geolocation. Furthermore, users could also strike deals directly through Airbnb, whereas Craigslist users had to go off platform to make a rental agreement. This made Airbnb far easier to use and enabled the platform to rapidly outgrow the erstwhile category leader.

In business, no victory is permanent—but on occasion, a particular firm is capable of enjoying a dominant position within its industry for a decade or longer. When this happens, we can say that the company has maintained a sustained advantage. This happens most often in a winner-take-all market. This is a market in which specific forces conspire to encourage users to gravitate toward one platform and to abandon others. The four forces that most often characterize winner-take-all markets are supply economies of scale, strong network effects, high multihoming or switching costs, and lack of niche specialization.

As we explained in chapter 2, supply economies of scale are an industrial-era source of market power driven by the massive fixed costs of production in such industries as railroads, oil and gas exploration, mining, pharmaceutical development, and auto and aircraft manufacture. In industries like these, volume matters, since amortizing costs over more buyers means that margins improve with scale. It might cost Intel $1 billion to develop a semiconductor fabrication plant, but once the plant is built, the incremental costs of making a million chips—or a billion—are negligible. The greater the supply economies of scale, the greater the tendency toward market concentration. In the U.S., despite competitive markets and the regulatory pressure created by antitrust legislation, a handful of firms dominate industries in which supply economies of scale play a large role—for example, the auto industry.

As we also saw in chapter 2, network effects are the Internet-era source of market power. Thanks to positive network effects, the value created and the profit margins enjoyed by the company both increase as more users join the ecosystem.²¹ This is why firms with network effects can enjoy a 10x multiple in value relative to other firms that have comparable revenues but lack network effects.²² With their current product focus and business models, Houghton Mifflin Harcourt, NBC, Lexis, and Whirlpool do not have strong network effects. Amazon, Netflix, LegalZoom, and Nest do. Because positive network effects attract more users to whichever platform is larger, they are a second force that is likely to strengthen a market’s winner-take-all tendency.

A third factor driving the winner-take-all effect is high multihoming and switching costs. As we discussed earlier in this chapter, multihoming takes place when users participate on more than one platform. Of course, multihoming enables users to take advantage of the benefits provided by multiple platforms—but it always comes with a cost, monetary (such as multiple subscription fees) or otherwise (such as the inconvenience of having to upload data to more than one platform website).

Somewhat comparable to multihoming costs are switching costs—the costs associated with leaving one platform and moving to another. Again, these costs may be monetary (such as the penalty assessed when a cell phone user switches service providers in mid-contract) or non-monetary (such as the inconvenience of moving all your family photos from one web hosting service to another).

Both higher multihoming costs and higher switching costs tend to push a market toward higher concentration, dominated by fewer, larger companies. For example, because most people cannot afford to carry both an Android phone and an Apple phone, they tend to choose one of these two alternatives and stay with it for at least a few years. By contrast, lower costs encourage people to participate in two or more platforms at once. Because most credit cards carry a low annual fee or none at all, many people carry Visa, MasterCard, and American Express cards in their wallets, perhaps accompanied by a couple of department store cards, choosing among them in various circumstances based on convenience and other factors.

In markets where multihoming and switching costs are low, late entrants can gain market share more easily, leading to markets that are more open and fluid. For example, because most social networks offer free basic service, multihoming on two platforms is virtually costless—which is one reason Facebook and LinkedIn were able to compete successfully with their forerunners, Myspace and Monster. By contrast, high multihoming costs are one reason Microsoft has had such difficulty entering the mobile market behind Apple and Google, despite its advantage in desktop operating systems and the market share it gained when it acquired mobile phone maker Nokia.

The fourth and final factor affecting demand-side scale is users’ taste for niche specialization. When a particular set of users has distinctive needs or tastes, they can support a separate network, thereby weakening the winner-take-all effect. In the 1990s, when Windows enjoyed strong advantages in the world of desktop operating systems due to its strong network effects and the high multihoming costs in the market, Apple survived thanks to niche specialization—it was inordinately popular among graphic artists and musicians. Similarly, LinkedIn was able to establish a foothold among social networks against the overwhelming network effects of Facebook because it served the distinctive needs of business professionals.

A market with little or no niche specialization is particularly susceptible to the winner-take-all effect. And the greater the winner-take-all forces, the more vicious the platform competition. In the market for ride-sharing transportation services, the absence of distinct user needs and the presence of strong network effects explains the fierce rivalry between Uber and Lyft. Each side has ruthlessly poached the other’s drivers by offering referral bounties and cash incentives. Some of the alleged tactics border on the unethical. For example, Lyft has accused Uber of ordering, then cancelling, more than 5,000 rides in order to clog the Lyft service. Uber denied the specific charge. But there’s no doubt that both companies are convinced that only one is likely to survive their rivalry, and that each is determined to do whatever it takes to be the one left standing.²³

As we’ve seen, the nature of competition in the world of platforms is very different from that in the world of traditional pipeline businesses. It’s a natural next step to wonder whether and how these differences are impacting the nature of business regulation. Do definitions of fundamental concepts like monopoly, fair trade, price fixing, anticompetitive practices, and restraint of trade need to be reconsidered in their application to platform companies? Are existing rules designed to protect the interests of consumers, workers, suppliers, competitors, and entire communities effective and reasonable in the world of platforms? These are some of the questions we’ll examine in the next chapter.

TAKEAWAYS FROM CHAPTER TEN

Platform competition is like 3D chess, involving competition at three levels: platform against platform, platform against partner, and partner against partner.

In the world of platforms, competition becomes less important that cooperation and co-creation. Control of relationships becomes more important than control of resources.

Among the methods that platforms use to compete with one another are preventing multihoming by limiting platform access; fostering innovation, then capturing its value; leveraging the value of information; nurturing partnerships rather than pursuing mergers and acquisitions; platform envelopment; and enhanced platform design.

Winner-take-all markets exist in certain platform markets. They are driven by four main factors: supply economies of scale, network effects, multihoming and switching costs, and the lack of niche specialization. In winner-take-all markets, competition is apt to be particularly fierce.