Business of Platforms Platforms version 06132020 n A

Business of Platforms: Platforms (version 06132020) n A platform is a collection of essential components that brings together a variety of components or complementary goods and allows them to function together n n n Windows platform allows a variety of applications to function Intel microchip allows a keyboard, a OS, a video monitor to connect and function In computers, a platform opens hooks (Application Programming Interfaces, APIs) to which components or applications attach 1

Windows operating system is a multisided platform facilitating applications for the PC MS - Word Adobe Acrobat Mathematica Windows Platform OS Video player Users 2

Intel chip is a multi-sided platform for PC peripherals (complementary components) Keyboard Dynamic Memory Windows, DOS Intel 80386 chip Video monitor Hard drive 3

Facebook is a multi-sided platform bringing together various parties Users Applications Facebook Partners Advertisers 4

Railroad tracks is a multi-sided platform Passenger rail cars Railroad tracks (infrastructure Platform) Freight rail cars 5

Public roads as multi-sided platforms for cars and trucks Passenger cars Roads (public infrastructure) platform Trucks 6

Two-sided platforms n A platform defines the intermediary that connects and coordinates buyers and sellers (or in general complementary sets of actors or functions) 7

Uber as a two-sided platform Passenger Uber car Driver 8

Features of a platform vs apps or other components (peripherals) n n n Platform is essential/indispensable for services produced using complementary components Typically a platform has little or no value without the complements More variability in complements or peripherals than in platform Each component or app (module) performs many internal functions and is connected “thinly” with the platform but “thickly” within itself Modular setup of platform and peripherals 9

History: Silos vs Modules n n n Before the late 1970 s, computing services were provided by vertically integrated companies, so-called “silos, ” selling hardware & software Microsoft was the first successful company to sell software without hardware This transformed the silos to collections of vertically-related modules n Each module typically made by different companies 10

Silos v. vertically-related interoperable modules Pre-1980 IBM mainframe Post-1980 Apps Various companies’ software IBM Apps IBM OS OS: DOS, Windows Microsoftware Intel, AMD Microchip Hardware: Intel microchip, various OEMs of PCs IBM Microchip 11

Two-sided pricing: Two or more prices! Firms can make money from either side of a platform or network, or from both sides n n n from a server or a client (example: Adobe Acrobat and Adobe Reader) from a caller (typical) or a receiver (800 numbers) of a phone call or from both (cellular in U. S. ) Internet backbones collect money from both parties that send and receive traffic (when not in a peering relationship) – see Internet slides The availability of prices on both sides of the network allows for complex pricing strategies, and, depending on the dynamics and market shares on the two sides of the market, can be used strategically to enhance and leverage a firm’s strong strategic position on one side of the network 12

Are prices on both sides of a platform positive? n n Sometimes, both positive Sometimes, one positive, one zero Sometimes, one positive, one negative See examples: 13

Two-sided platform charging both sides (Xbox) Platform Xbox is paid by users R > 0, and collects royalties from game developers s>0 Game s Platform Xbox p R Users 14

Platform charging one side, other side free (net neutrality) Internet platform (AT&T) collects from users, R > 0, wants to collect from the other side, s > 0, but is forced at s = 0 because of net neutrality rules Netflix, Google s Platform AT&T p R Users 15

Platform Google charging one side, other side free The Google platform collects from advertisers s > 0, while it allows free search, R = 0 Advertisers Advertised product s Platform: Google search p R Users 16

Uber collects from users and pays drivers Platform Uber collects from users R > 0, and pays drivers s < 0 Drivers s Platform Uber R Users 17

Windows collects from users and subsidizes apps The Windows platform charges users R > 0, but subsidizes applications by s < 0 (and not only for MSFTmade apps) s Application s Platform Windows p R Users 18

Amex collects from merchants and subsidizes cardholders Amex charges merchants s = 3% > 0, and subsidizes cardholders through “rewards” R = -1% < 0 Merchants s Platform Amex p R Cardholders 19

Telephone platform: pricing of phone calls Regular calls: phone company collects R > 0 from originator, receiver pays s = 0. Mobile calls: both sides pay, s > 0, R > 0. Receiver s Platform AT&T R Collect calls: phone company collects s > 0 from receiver, originator pays R=0 Originator 20

The i. Phone apps store platform (similarly, Google Play) i. Phone charges apps 1/3 of revenue, s = p/3, while also selling the phone and other services to users R>0 Apps s = p/3 Platform i. Phone p R Users 21

Examples of platforms Platform Uber Airbnb MSFT OS Apple i. OS Google M-Pesa Sony PS 3 Internet You. Tube Facebook Side 1 Driver Apartment MS-Word Phone apps Advertiser Money sender Game Google Search Netflix Kindle books Video creators User Side 2 Rider User Money receiver User Video user Kindle app Video users User Service(s) Transport Accommodation Writing Various Ads/Search Money transfer Game playing Search Video e. Book Video Discussion, live audio, video 22

Who gets charged n n In summary, some platforms collect from both sides, some from one side only and the other side pays nothing, and some collect from one side and subsidize the other Prices are determined from the two markets’ characteristics 23

Who makes most of the money in the ecosystem? n The platform makes much more money than the apps or peripherals n Constant complaint against platforms Microsoft, Intel, Apple by apps 24

Best platform wins over best product n n n Apple’s Mac was considered a better product than DOS or early Windows PCs But, Windows had wide adoption and a huge number of apps in comparison Result: the Windows platform has 95% market share vs Mac’s 5% over the last 30 years 25

Platforms are taking over … 26

Why are platforms taking over? Reason 1: network effects n n Network effect: a user will pay more to connect to a larger network Larger scale increases profits exponentially 27

Special features of markets with network effects n n Increasing returns to scale in consumption (network effects) A market exhibits network effects when the value of a transaction (or subscription) is higher when more units change hands, everything else being equal 28

Same-side (direct) network effects: a customer benefits from other customers on the same side of the platform Platform (Telephone Company, Instant Messenger) Customer 1 Customer 2 Customer 3 29

Special features of markets with network effects: complementarities n In a traditional network, network effects arise because a typical subscriber can reach more subscribers in a larger network 30

Special features of markets with network effects: complementarities n n n Network effects arise because of complementarities When customer A makes a phone call to customer B, he uses both AS and BS Although goods “access to the switch” AS, BS, …, GS have the same industrial classification and traditional economics would classify them as substitutes, they are used as complements 31

Cross-side (indirect) network effects: a customer benefits from more participation on the other side of the platform Drivers Platform Uber Users 32

The more Uber cabs in a city, the more riders they will attract and vice versa n Uber reaps network effects by increasing scale 33

Virtual network or platform; components Di complementary with components Sj; also has network effects n n In a virtual network, externalities arise because larger sales of components of type D induce larger availability of complementary components S 1, . . . , Sn, thereby increasing the value of components of type D Examples: n n CPUs & monitors Users and advertisers in Yellow Pages or Internet search engines Razors and blades Cameras and film 34

What happens when there are two competing platforms? n n Examples of competing platforms: MS-DOS v. DR-DOS (OSs for PCs) Windows v. IBM’s OS/2 (OSs GUIs for PCs) Intel v. AMD microchips for PCs In most cases, there is a clear winner: MS-DOS, Windows, Intel n Why? 35

“Winner-takes-most” world n n n Network effects transform size into “quality” Result: high inequality among companies in sales and profits Larger scale increases profits exponentially Resulting in very concentrated markets Top company has much higher sales and profits than the second one; second one much larger than third, etc. Often the fourth or fifth largest company are too small to make any difference in the market structuref 36

Winner-takes-most markets n n Successes: Windows, Google, i. Phone, Facebook, Adobe, Linked. In, Visa, Master. Card, Amex, Alibaba, We. Chat (Tencent) Failures: Betamax, IBM OS/2, Blackberry, Discover Card 37

Second reason for success of platforms: they usually have fewer employees and much less fixed investment than traditional companies 38

High platform profits because they have much less fixed investment and fewer employees n n Uber, the largest taxi company, owns no taxicabs Airbnb, the largest accommodation provider, owns no real estate Alibaba, the most valuable retailer, has no inventory Facebook, the most popular media company, creates no content 39

Traditionally, the focus of the company was internal n n Tweaking the value chain to make perfect products In contrast, for platforms the focus is external n n A platform tries to bring together as many as possible from both (or all) sides, match them and create transactions Need to minimize the conflicts among them 40

More efficient platforms disrupt traditional business n n n Amazon displaced bookstores for hard copy books and is now displacing retailers of many types of products Netflix, Hulu, Amazon displace subscription cable TV Google, Bing displaced the “yellow pages” 41

Not easy to do platforms correctly n n Microsoft almost killed the Mac in the 80 s by attracting more developers to write applications for Windows Microsoft killed IBM’s OS/2 Recently, Android and Apple killed Microsoft’s cellphones Android (Google) is taking over from i. Phone as dominant phone platform 42

Micro consequences of the prominence of platforms n n Data becomes even more important Companies collect all data “just in case” Data analysis without a prior economic/econometric model has become the norm Robustness of these analyses is doubtful 43

Macro long term effects of platforms taking over Because of the intense use of computing technology and artificial intelligence, platforms need less labor that traditional industries This leads to: n High profits n Lower labor share of national income n Higher income inequality because shareholders tend to be wealthier n Both the macro and micro consequences of platforms will intensify over the next decade n 44

Summary (1) n Platforms have high profits because they n n n Take advantage of network effects Have low fixed investment and low labor use Platforms can use a zero price or subsidies on one side of the market or positive prices to both sides Platforms result in a “winner-takes-most” market with big inequalities in market shares, prices, and profits Low use of labor results in higher income inequality 45

Review Questions (1) n n n What are multi-sided platforms? Two-sided platforms? Who are the players in some of the platforms that you know? Give an example of a two-sided platform where pricing is positive for both sides? Free for one side and positive price for the other? Positive for one and negative for the other? What are the two types of potential network effects on a platform? Give some examples of competing platforms, some successes, some failures Describe “winner-take-most” markets. Give two real world examples. 46

Review Questions (2) n n n True or False: Platforms usually require a large labor force but low fixed investment in order to maintain their networks, however big they are, resulting in low profit margins Why have some traditional businesses failed to compete successfully against various rising business platforms? Describe the difference between silos and vertically-related modules 47