What exactly is a platform? And how to react to it?

By Prof. Dr. Werner Reinartz | Dr. Nico Wiegand | Julian R. K. Wichmann

Platform businesses have become the poster child of the digital transformation. In the past two decades, no other business model has seen faster growth and disrupted more industries. Today, companies from many different industries, as well as manufacturers, retailers, and suppliers to consumers and businesses, are acknowledging the need to grapple with digital platforms in one way or another - by pushing initiatives to create platforms on their own or using third-party offerings as retail channels. However, in many companies, understanding of platform markets is still limited and reactions to the platformization threat are unsystematic and hasty. In response to this situation, this white paper of our retailing center (IFH) aims to address two questions:

How exactly do (retail) platforms differ from traditional “pipeline” models of retailing?

How can firms survive and thrive in an increasingly platformized market environment?

 The public debate on digital platforms has, at least in part, moved away from market realities. This is not least owing to an over- and misuse of the term “platform,” creating substantial confusion about what characterizes a platform-based business model and which companies actually (and purely) operate one. As a result, two challenges have emerged. First, it is important to understand exactly what a platform is, what distinguishes platform-based business models from traditional pipeline models, and where their particular strengths and weaknesses lie. Second, companies must learn how to deal with plat-form competition not only to survive, but also to continue to grow. Using a mixture of conceptual synthesis, empirical evidence from market observations, expert opinions, and a consumer survey, we examine these challenges and make concrete recommendations for action. We find that while consumers and companies increasingly use platforms because they often generate more value than pipeline business models, not every self-proclaimed platform in fact operates a fully-fledged platform business. At the same time, our analysis suggests that not every traditional company can or should initiate the transformation into a platform business. Given the high concentration on these markets, only a few players can establish themselves permanently in any industry. Therefore, firms need to seek ways to coexist with and benefit from platform-based competitors. We depict different options to do so and discuss crucial points to consider when selecting a strategy

So what are the characteristics of true (and successful) platforms?

FOCUS ON MEDIATION

In their purest form, platforms provide an open and participatory infrastructure to find the best match between sellers (supply side) and buyers (demand side). They act as intermediaries in the exchange process between two or more parties. This characterization as “matchmaker” stands at the core of every platform business and has far-reaching operational and economic consequences for the platform owner. In particular, platform revenues are not equal to the platform owner’s revenues, as exchanges occur between independent third parties. Therefore, frequent forms of revenue generation for platform owners are commissions on goods sold, fees per offering, or regular subscription payments to maintain access to the platform’s infrastructure. Fees for the mobility service provider Uber vary depending on supply and demand at the time of service request. Job search engines like Indeed or Monster charge companies for top listings on their results pages, and the dating platform Parship relies on monthly payments in exchange for premium functions. In addition, many platforms without a clear transaction focus, such as social networks and dating apps, earn revenue through ad placements.

AUTONOMY OF PARTICIPANTS

Platforms aim to facilitate exchange, not actively engage in it. Depending on the governance structure, participants thus act largely autonomously with respect to the depth and width of their product offerings, fulfillment of transactions, and often even pricing decisions. This autonomy is one of the main distinctions from traditional retailers. While retailers arguably also act as matchmakers to bring together the market’s supply side (brand manufacturers) and demand side (customers), they exert a high degree of control over the branded assortment and the way it is offered. By contrast, platforms provide a level playing field and set certain rules. However, the restrictions usually do not reach the point where the platform dictates when, in which quantities, and at what price suppliers offer their goods and services. Naturally, autonomy varies between platforms. They range from entirely open architectures, where virtually anyone can join and participate without restrictions (e.g., eBay and YouTube), to heavily regulated markets with thorough vetting processes and partial control of offerings by the platform owner (e.g., Uber). For example, especially in standardized service industries like transportation, pricing decisions are made by the platform, and suppliers of products or services need to comply if they want to continue their engagement.

NETWORK EFFECTS

As matchmakers, platforms are interested in providing value for all participating market sides. The more accurate the match between what customers are looking for and what is offered, the more value the platform delivers. Therefore, the platform owner has two main objectives: (1) creating a large pool of participants on all market sides and (2) reducing search costs to find suitable matches. The main mechanism of platform businesses to achieve a large participant pool are network effects, more specifically indirect network effects. Essentially, network effects arise whenever attracting additional participants to a network—be they consumers, users, or businesses—increases the attractiveness of the network to all other participants. In the case of retail platforms, the more consumers join a platform to purchase goods, the more attractive the platform becomes to complementary goods providers, which offer more and better products. The larger supply in turn increases the platform’s value to consumers because they are more likely to find what they are looking for, causing more consumers to join in. A positive feedback loop emerges and leads to growth on both sides of the market. Retail platforms’ susceptibility to network effects is by no means unique to the digital age—traditional marketplaces or retail malls function according to the same principles. As more merchants offer products, more consumers are attracted and additional merchants join in to serve them. However, naturally occurring physical boundaries prevent rapid growth and the extension of such traditional platforms beyond a certain point, as only so many merchants can fit in a marketplace or brand shops in a mall. Only today’s digital infrastructure has made the effective use and amplification of network effects possible. By dissolving physical and geographic boundaries, digitization has become the fuel that boosts the platform model to growth rates far beyond what was previously conceivable.

Network effects are not new, but in the digital environment, they boost platform growth substantially.

 DIGITAL INFRASTRUCTURE

Digitization has created a new playground for platform businesses without physical boundaries and resulted in a rapid decrease in transaction costs, which provides the digital platform model’s foundation for success. Digitization’s emergence and diffusion is not a result of idiosyncratic developments, but is a wholly natural evolution of business—platforms had to happen, because when transaction costs decrease, market consolidation is inevitable. This response holds especially in markets where exchange is time-critical, such as for perishable products and virtually all services. Airplanes take off regardless of whether all seats are sold. Taxi drivers forgo revenues while waiting for the next passenger, and festival tickets lose their value after the last concert has concluded. Although digital platforms have advanced into durables and non-perishable commodities, time-critical goods lend themselves naturally to the platform business model because it rids the market of inefficiencies and generates new sources of value creation for both suppliers and consumers. Accordingly, in recent years, the number of platforms focusing on services has increased sharply (e.g., Airbnb, Uber, and MyHammer).

For the platform itself, the benefits of digitization are generally two-fold. On the supply side, digitization allows for rapid growth by adding suppliers at virtually zero marginal cost because platforms rarely accumulate much inventory. Instead, they focus on managing the infrastructure to facilitate exchanges while vendors manage their own inventory. The world’s biggest accommodation chain owns not a single bedroom (Airbnb), the largest mobility provider owns no cars (Uber), and the largest food delivery service does not own a single restaurant (Doordash). To serve more guests by increasing its number of rooms, Hilton would incur substantial monetary and time resources to build an additional hotel. Airbnb can, and does, add many beds almost instantly at a fraction of Hilton’s costs.

On the demand side, digital platforms’ offerings have a globally installed base of potential customers to jumpstart network effects. Without technology, however, this advantage would quickly turn into a disadvantage because as demand and supply grow, the ability to provide good matches at reasonable search costs diminishes. At the extreme, users on the demand side might not be able to find suitable offers because of the vast catalog of alternatives. In traditional marketplaces, additional participants would reduce the attractiveness of existing participants (negative network effects). However, with filtering and recommendation technologies, platforms can narrow down the catalog of available goods and serve each user almost individually, allowing platform expansion in the digital space to continue without negative consequences for the matchmaking process. Every minute, 300 hours of video content are uploaded to the YouTube platform by its 1.3 billion users and every year over one million new sellers are listed on Amazon’s Marketplace. Despite the virtually endless assortment, consumers can find exactly the right offer with the help of intelligent filters and search and recommendation algorithms.

What this all now means in terms of strategic options to pursue you will find in our white paper which can be downloaded here: https://www.marketing.uni-koeln.de/sites/marketingarea/Document/Research/2019_IFH_Whitepaper_ENG_Reinartz_Wiegand_Wichmann.pdf

 Source: Reinartz, Werner, Nico Wiegand, und Julian Wichmann (2019), “THE RISE OF DIGITAL (RETAIL) PLATFORMS”. White Paper, Institut für Handelsforschung e.V. (IFH).