Platform Innovation // Blog

What is a Platform?

A platform is a business model that creates value by facilitating exchanges between two or more interdependent groups, usually consumers and producers.

In order to make these exchanges happen, platforms harness and create large, scalable networks of users and resources that can be accessed on demand. Platforms create communities and markets with network effects that allow users to interact and transact.

DEFINITION: a business model that creates value by facilitating exchanges between two or more interdependent groups, usually consumers and producers.

Like Facebook, Uber, or Alibaba, these businesses don’t directly create and control inventory via a supply chain the way linear businesses do. Platforms don’t, to use a common phrase, own the means of production— instead, they create the means of connection.

Successful platforms facilitate exchanges by reducing transaction costs and/or by enabling externalized innovation. With the advent of connected technology, these ecosystems enable platforms to scale in ways that traditional businesses cannot.

What a Platform is Not

It’s important to remember that a platform is a business model, not just a piece of technology. A lot of people make the mistake of conflating a platform with a mobile app or a website, but a platform isn’t just a piece of software. It’s a holistic business model that creates value by bringing together consumers and producers.

The most common misuse of the term “platform” is when it’s used to describe an integrated suite of software products. This is especially common among SaaS companies, which love to claim they have a complete “platform” for X. In such cases, the word “platform” really is just being used as a marketing term. As with all of the preceding examples, these SaaS companies are still linear businesses.

In the twenty-first century, the supply chain is no longer the central aggregator of business value. What a company owns matters less than what it can connect.

We call these traditional, non-platform companies linear businesses, because their operations are well-described by the typical linear supply chain. In the case of SaaS companies, they’re building products, not networks. As such, they don’t have the cost structure and underlying economics that make platform business models successful.

In general, linear companies create value in the form of goods or services and then sell them to someone downstream in their supply chain.

Unlike platforms, linear businesses own their inventory and it shows up on their balance sheets, whether it’s a car manufacturer like GM or a subscription content provider like HBO, which either creates or directly licenses all of its content. It also includes resellers like Walmart, Macy’s or Target.

Linear business models, not platform business models

Examples of a few well-known linear businesses.

It also includes tech companies like Netflix, which pays for or licenses all of its content. Even though its a technology company, Netflix is still a linear business and not a platform. (For more on the difference between linear and platform businesses, go here.)

Remember: Platform design isn’t just about creating the underlying technology. It’s about understanding and creating the whole business and how it will create value for and build a network.

In the twenty-first century, the supply chain is no longer the central aggregator of business value. What a company owns matters less than the resources it can connect and connect to.

In the old model, scale was a result of investing in and growing a business’s internal resources. But in a networked world, scale comes from cultivating an external network built on top of your business. This is the essence of how platform business models work.

Platforms Dominate the Economy

Platform business models aren’t new. In fact, they’re as old as human civilization itself – going all the way back to early marketplaces, bazaars and auction houses in ancient Rome.

You can’t succeed in today’s economy without understanding how platforms work.

In the 20th century, we saw platform business models in the shopping mall and auction house. Like their predecessors, these businesses have mostly used brick-and-mortar locations to facilitate exchanges. But thanks to connected technology, platforms can now facilitate the exchange of value produced by decentralized networks of individuals. The result is that today’s platform businesses are able facilitate exchanges at an unprecedented scale.

The three most successful platforms to date are Google, Apple, and Facebook. But they are only the tip of the iceberg. The number of platforms at the top of our economy is growing fast. In 2016, four of the top five members of Forbes’s list of most valuable brands were platform companies, as were eleven of the top twenty. And as of early 2017, the top five companies by market cap are all platforms.

In fact, most of today’s biggest IPOs and acquisitions are platforms, as are almost all of the most successful startups. In addition to the three mentioned above, the list includes Amazon, eBay, Instagram, YouTube, Twitch, Snapchat, Slack, WhatsApp, Waze, Uber, Lyft, Airbnb, Pinterest, Square, Social Finance, GitHub, Kickstarter, ZocDoc and more.

Platform business model

Platform business models already dominate the economy.

The growth of platforms isn’t isolated to the United States either; platform companies such as Alibaba, Tencent, Baidu, and Rakuten have taken over China and much of Asia.

In fact, they play an even more prominent role in developing countries than they do in the United States.

The economies of many of these countries were growing rapidly at the same time that Internet access became widespread. And because these countries didn’t have the existing commercial infrastructure that developed economies did, their industries have been molded around the Internet and platforms.

Alibaba, for example, has controlled as much as 80% of the Chinese ecommerce market while Baidu has more than 70% of Chinese search. Tencent, now the most valuable company in Asia, has nearly 850 million users on its WeChat messaging platform and is by many estimates the largest gaming company in the world. And Didi Kuadi, China’s answer to Uber, dominates the taxi market.

The top five companies by market cap are all platforms.

In India, Amazon is competing with local platforms Snapdeal and and Flipkart for control of India’s rapidly growing ecommerce market. Paytm is the dominant payments platform, and Ola Cabs is vying with Uber and Didi for dominance in India’s transportation sector.

Whether you’re building a platform business or not, you can’t succeed in today’s economy without understanding how platforms work.

Investors Value Platforms More

Investors love platforms. Successful platforms have strong moats in the form of their networks and operate at a scale that positions them to dominate their industries.

Investors value platforms more than their linear business competitors.

It’s no wonder, then, that platforms are worth more than linear businesses. According to our research, investors value platforms more highly than their linear equivalents. Looking at the S& P 500, pure platform businesses or businesses for which a platform is a significant part of their business have an average revenue multiple of 8.9. In contrast, linear businesses are valued between two to four times revenue on average, depending on their business model.

In contrast, linear businesses are valued between two to four times revenue on average, depending on their business model. 9 Other research has found a similar valuation gap between platforms and linear businesses.

Platform businesses in the S& P 500 over the last forty years.

Platform businesses in the S& P 500 over the last forty years.

This gap is actually widening over time, and there’s a good reason. Platforms perform better over both the short and the long term along key financial dimensions. For example, they deliver faster growth, better return on capital, and larger profit margins. As a result, since the early 2000s, platforms have quickly overtaken other business models at the top of the economy.

Platforms will make up 5 percent of the overall S& P 500 by 2020 and will have the majority of the top valuations.

According to current trends, platforms will make up about 5 percent of the overall S& P 500 by 2020. They’re also on track to make up the majority of the top valuations in the S& P 500 within the next five to ten years.

Once you take a look at what’s happening in the startup economy, these projections make even more sense. The next wave of large public companies is made up of far more platforms than in the past.

Nearly 60% of today’s billion-dollar “unicorn” startups are platform businesses. If you look internationally, the numbers are even more surprising. In Asia, 31 of 36 unicorns are platforms, or about 86 percent. This includes China, where 81 percent of 21 unicorns are platforms, and India, where 8 of 9 are platforms.

Billion-dollar platform businesses do better than competitors

“Unicorn” company data: platform businesses vs. linear businesses.

Platforms also receive higher valuations than linear startups.

The average valuation for platform unicorns was $ 4.51 billion compared to $ 2.49 billion for linear unicorn companies. In other words, the average linear unicorn is valued at a little more than half of comparable platform companies.

Not surprisingly, platforms also have most of the funding raised by these unicorn startups. Billion-dollar platforms have received more than twice as much funding as their linear competitors, with $ 46.24 billion in funding for platform unicorns compared to $ 21.96 billion for linear companies. To top it off, platforms also got more favorable terms from investors.

The next wave of large public companies worldwide will be dominated by platforms.

Platform unicorns were valued about 12 percent higher relative to the funding they received when compared to linear platforms, indicating that investors are more confident in the upside of their platform investments.

Obviously, not all of these unicorn companies will survive. But the trends in both public and private markets show that platform businesses are quickly overtaking linear companies. In particular, the huge shift toward platforms among unicorn startups suggests that the next wave of large public companies worldwide will be mostly platforms.

The Anatomy of a Platform Business

A platform ultimately enables this value creation by facilitating transactions. While a linear business creates value by manufacturing products or services, platforms create value by building connections and “manufacturing” transactions.

Getting the core transaction right is the most important part of platform design.

The core transaction is the platform’s “factory”— the way it manufactures value for its users. It is the process that turns potential connections into transactions. Getting the core transaction right is the most important part of platform design, as the platform will need its users to repeat this process over and over to generate and exchange value.

Every platform has a core transaction, which consists of four parts: create, connect, consume, and compensate.

The four steps of the core transaction.

However, although a platform enables the core transaction, it doesn’t directly control its users’ behaviors. The challenge is a unique one: how to get potentially millions of people to behave the way you want them to.

Platform Business Model: the four functions

The four functions of the platform business model.

First you must attract users to join, then you aid them by matching them together, providing the technology to facilitate the transaction and establishing the rules that govern the network in order to build trust and maintain quality. These are the four core functions of a platform:

  • Audience building
  • Matchmaking
  • Providing core tools and services
  • Setting rules and standards
modern monopolies: the best selling book on platform business models

For more on platforms, read Modern Monopolies.

If a platform handles these four functions well enough, it will be able to facilitate its core transaction (and, hopefully, a lot of it).

For more on how platform business models work and how you can build one, check out our bestselling book, Modern Monopolies.

For now, this summary gives you a foundation for understanding how platforms build and maintain their networks and then turn those potential connections into transactions.

 

 

Types of Platforms

While all platforms share the same underlying business model, not all platforms are the same. Through our work and research, we’ve delineated the 9 different types of platform businesses, which are listed below. They are organized by the type of  value that’s exchanged in the platform’s core transaction.

applico platform

The eight different types of platforms.

The core value being exchanged is (by platform type):

  1. Services marketplace: a service
  2. Product marketplace: a physical product
  3. Payment platform: payment (P2P or B2C)
  4. Investment platform: investment (money in exchange for a financial instrument, be it equity or a loan, etc.)
  5. Social networks: a network in which the core transaction is a double opt-in (friending) model of interaction
  6. Communication platform: direct social communication (e.g., messaging)
  7. Development platforms
    Closed development platform: software built across access to data (usually via an API)
    Controlled development platform: software built in a controlled, integrated development environment
    Open development platform: open-source and free software
  8. Content platforms
    Social: a content platform in which the core transaction focuses on the discovery of and interaction with other people
    Media: a content platform in which the core transaction focuses on discovery of and interaction with media

Matching a platform’s design to its type is essential to its success. Platforms that don’t get this right tend to get left behind by the competition. Platform type affects everything from the design of the core transaction to how you handle the four functions, making it one of the most fundamental distinctions that any platform business must understand.

Figuring out which platform type a business fits into should always be one of the first steps in designing a platform.

For further information on platform types, read more here.

 

Additional platform definitions

Exchange Platforms vs. Maker Platforms: Exchange platforms faciliate direct, 1:1 connections. Maker platforms facilitate 1:many connections. For more, read here.

Product and Services
Commoditized: a platform in which the good or service being exchanged has a few relevant characteristics that determine quality for consumers
Non-commoditized: a platform in which the good or service being exchanged has a large number of relevant characteristics that determine quality for consumers

For more on this distinction, read here.

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