Print Money Like Mark Zuckerberg: Understanding Platform Economics

Print Money Like Mark Zuckerberg:
Understanding Platform Economics
Innospective Innovation Briefing
September 2018
www.innospective.net

Digital platforms dominate the modern economy
• The 5 most valuable companies in the
world are all platform companies:
Apple, Amazon, Alphabet/Google,
Microsoft, Facebook
• Many industries are getting disrupted by
new players who use platform economics
against incumbents (e.g. Uber, Spotify,
Netflix)
2Source: Kleiner Perkins

Why care about platforms?
• They are everywhere: Almost every company and consumer interacts with and
sometimes depends on digital platforms daily, often without even knowing it.
• Your smartphone, your PC or Mac
• Your email/social media/office software/messaging/web search/music or video
streaming service
• Travel booking sites and new transportation services
• It’s one of the most attractive business models in existence: Some of the most
successful and profitable businesses in the world are platforms. Many
startups and existing businesses want to be platforms.
• Platforms have more power than ever – understanding them is crucial: Fake
news scandals, privacy concerns, platform dominance in search, social media,
mobile etc. have stirred the attention of regulators and the general public.
© 2018 Innospective and Andreas Göldi. All rights reserved. 3

What is a platform?
• Platform (in the economic/technical sense) =
a foundation that connects individuals and organizations so they
can innovate, transact and/or interact in ways not otherwise
possible or economically efficient.
• Digital industry platform = an online environment that provides
access to goods or services with near-zero costs of access,
reproduction and distribution.
• This presentation is focusing on the last type and will use the term
“platform” in that sense.
Source: Cusumano et al., Brynjolfsson et al. 4

Three types of platforms
There are three general types of platforms, but many providers incorporate two
or three of these aspects into their overall hybrid platform strategy.
Communication platforms
Enable information
exchange between
participants
Examples: Instagram, Slack,
WhatsApp, GitHub
Market platforms
Enable buying and selling of
goods and services
Examples: eBay, Airnbnb,
Amazon Marketplace,
Spotify
Development platforms
Enable creation of new
functionality
Examples: Microsoft
Windows, Android,
Amazon AWS
Hybrid platforms
Examples: Facebook, iOS/AppStore, Salesforce AppExchange, Valve Steam

The five pillars of platform
economics

Pillars of digital platform economics
Note: Several of these pillars are closely related or depend on each other. For example, a winner-takes-all dynamic couldn’t exist without near-zero marginal
costs and network effects. But it still makes sense in practice to think about these dimensions separately when designing a platform strategy, be it as a platform
owner or complementor.
Sources: Cusumano et al., Brynjolfsson et al, Innospective analysis 7
Platform
Network
effects
Enabling base technologies
e.g. mobile devices, cloud infrastructure, AI, networks
Multi-sided
markets
Near-zero
marginal
costs
Winner-
takes-all
dynamics
Asset-light
business
model
Modern digital platforms rest on five economic pillars that enable their growth and profitability.

Multi-sided markets
• Platforms typically bring together
two or more different types of users.
• One-sided platforms exist, but they
often have more characteristics of a
product than a real platform.
• Advantages:
1. Fill a clear need for participants
because they often can’t reach the
other side easily without the platform
2. Value is added from multiple sides
3. Opportunity to create multiple
revenue streams
PlatformConsumers
Vendors, e.g.
app makers
Complementors,
e.g. publishers
Advertisers
Example for a (complex) four-sided market.
Facebook is an example for such a platform.

Asset-light business models
• Most quickly growing digital platforms don’t own the most expensive assets (or incur
the majority of the necessary costs) to provide their services.
• Examples:
• Uber doesn’t own cars
• Airbnb doesn’t own hotels or apartments
• Apple doesn’t employ the developers necessary to create millions of apps in its iOS App Store
• There are exceptions to the rule and some hybrid models.
Source: Yahoo Finance, company financial reports 9
4%
26%
Walmart Alphabet/Google
Operating income as % of
revenue
$500 B
$22 B
$111 B
$29 B
Revenue Operating Income
Revenue and Operating
Income
Walmart
Alphabet/Google $205 B
$115 B
$197 B
$42 B
Total Assets Property Plant and
Equipment
Assets
Walmart Alphabet/Google
A comparison between Walmart and
Alphabet/Google shows the effects of a
(relatively) asset-light model: While Walmart
has almost 5x the revenue of Google, the latter
produces significantly more income.
Both companies have a similar amount of total
assets, but Alphabet’s is mostly cash. It only
needs about 1/3 the tangible assets (here
represented by the “Property, Plant and
Equipment” number) to generate higher
profits. And that’s despite Google’s giant global
network of expensive datacenters it needs to
run its business.
All numbers 2017 fiscal years

Near-zero marginal costs
• Digital platforms can typically add new users at a minimal
cost once the necessary infrastructure is in place.
• These are the same dynamics that can be observed in
other industries:
• Pharmaceuticals: It costs a lot to develop a new drug, but
making another dose is typically cheap.
• Installed software: Developing a new operating system costs
billions, but installing it on another device is nearly free.
• Depending on the nature of the business the costs to build
and operate the underlying platform can be high. Average
costs per user can still be substantial and rise over time as
a platform expands its functionality, but low marginal costs
mean that profitability often increases with growth (see
Facebook example on the right).
Source: Facebook financial reports, Innospective analysis 10
Facebook’s average revenue per user rose from $3.25 in 2010
to $19.09 in 2017, a 488% increase. Its average costs to serve
these users increased as well, but somewhat more slowly,
leading to a significant growth in profitability per user.
0
500
1000
1500
2000
2500
$-
$5.00
$10.00
$15.00
$20.00
$25.00
2010 2011 2012 2013 2014 2015 2016 2017
Users(MM)
Avg.revenue/costperuser
Facebook User Profitability
Monthly active users at EOY Avg. Revenue per user
Avg. Operating costs per user

Network effects
• Successful platforms exhibit positive self-
reinforcing feedback loops, called network
effects.
• The value of the network for a user increases
as more other users join the same network.
• Results:
• Very fast growth is possible because a more
useful network attracts ever more users.
• Hard for competitors to displace once a network
has reached critical mass.
Facebook’s user growth over the past decade
from 100M to over 2.2B users
(Source: Statista)

The principle behind network effects:
Metcalfe’s Law
• The value of a network grows by the square of
its number of users (not linearly) as new
users join. A network with n participants has a
value of n2
• Main reason: The number of unique possible
connections in a network with n participants =
n(n-1)/2
• Named after Bob Metcalfe, the inventor of the
Ethernet networking standard
• This explains the quick continuing growth of
successful networks because the value
increases much faster than the number of
participants.
Source: https://commons.wikimedia.org/wiki/File:Metcalfe-Network-Effect.svg 12
Two telephones can make only one
connection, five can make 10 connections,
and twelve can make 66 connections.

Winner-takes-all dynamics
• Platform-driven markets typically show a
strong winner-takes-all or winner-takes-most
effect, with one or few players taking almost
all market share.
• This is driven by near-zero marginal costs and
strong network effects.
• If a new user joins dominant platform A, the costs
are low but the generated benefit is higher than
joining smaller platform B.
• However, markets that exhibit low barriers to
entry (e.g. low capital needs) or are subject to
disruptive technological innovation can see
even once dominant platforms lose their
importance rapidly.
Source: Statista, Innospective analysis 13
Winner
takes all
Near-zero
marginal costs
Network effects
Low barriers to
entry
Disruptive
innovation
A typical example for a winner-takes-most market: Android has 88% of the
mobile operating system market, followed by iOS’s 12%. Nobody else matters.
 
 

How to create and grow
platforms

Pick the participants types of your platform
• (Almost) all platforms connect two or multiple types of participants.
• Google Play Store or iTunes: Content/app vendors and consumers
• Spotify: Record labels and music consumers
• Facebook: 4 sides – consumers, app developers, complementors such as
news publishers, and advertisers
• Some rules:
1. Start simple. More sides is not better.
2. At least one side should be clearly underserved by current solutions.
3. At least one side needs to have a substantial willingness to pay.

Find the right differentiation
• Most new platforms are not created in an untouched market, but
have to compete with existing platforms.
• Finding the right differentiation to get network effects going is
therefore essential.
• Examples:
• Apple iPhone: Superior user experience, synergy with iTunes
• Google Android: Almost as good as an iPhone but cheaper and with more
choice of hardware
• Facebook: Initially concentrating on a clean, organized social networking
experience for college students, leveraging exclusivity
• Spotify: All-you-can-listen-to access to streaming music instead of
downloads

Solve the chicken-and-egg problem
• For two- (or multi-) sided markets, one side typically already has to exist in order to attract the
other side.
• But since the two sides depend on each other, how can you attract enough users when
starting from scratch?
• Possible strategies:
1. Subsidize one size first
• Google Android: To encourage adoption, gives away the mobile OS with liberty to make modifications to
smartphone makers to encourage adoption. Later Google introduced new rules for smartphone vendors to
make sure it was able to capture value from mobile search and the Play store.
2. Rapid iterations: Grow both sides in quick turns
• Airbnb: Started with copied listings from Craigslist, then growing step by step, expanding into new markets
3. Build a useful product for one side, then open the platform for another side
• Salesforce.com: First built SaaS CRM, then added developer platform AppExchange
4. Subsidize multiple sides (particularly risky)
• Uber/Lyft: still making massive losses because rides are cheaper than they should be and drivers aren’t
getting charged much

Figure out monetization
Four basic models:
1. Direct: Charge one or multiple sides directly
• Salesforce AppExchange: Only paying Salesforce CRM users can access additional 3rd party
apps. App developers have to pay fees as well.
• YouTube: Free for users, but advertisers are paying for visibility in an auction model that puts a
premium on desirable audiences.
2. Freemium: Give free access to basics, charge more advanced users
• LinkedIn: Charges for a premium level with special features
• YouTube: Free with ads, monthly subscription fee to get rid of ads
3. Commission: Take a share of one side’s revenues
• App sales in Apple App Store/Google Play (30% commission)
• YouTube: Takes a 45% commission of video creators’ ad revenues
4. Indirect: Make money through complementary services
• Google: Gives away Android but makes money from mobile search

Reduce multi-homing behavior
• Multi-homing = users participating in multiple competing networks
• Example:
• Using both Instagram and Snapchat
• Using both Uber and Lyft
• Unattractive for platform owners
• Reduces revenue potential
• Reduces user lock-in and therefore value of the network
• Possible solutions:
• Build features that are hard/impossible to migrate (e.g. Apple iMessage)
• Offer attractive bundles with strong synergies between the bundled elements (e.g. Microsoft Office, Adobe
Creative Cloud, Google’s various services)
• Use aggressive pricing that immediately emulates competition and rewards loyalty (e.g. Amazon’s cloud
services)
• Build out number of integrated of 3rd party services aggressively to deepen lock-in (e.g. Slack’s many API
partners)
• Establish exclusivity clauses for complementors so that some services are only available on one platform
(problematic from an anti-trust and ecosystem health perspective)

Define and enforce ecosystem standards
• Platforms can only thrive if they can provide a reasonably good
experience to all users.
• Platform owners therefore have to define and enforce standards for
their platform ecosystem to prevent abuse.
• Examples:
• Apple App Store: detailed review before apps are accepted
• Facebook and Twitter: Fighting against “fake news” and hate speech
• Google: Provides many APIs, but all with precise terms of service that guide
data usage and allowed use cases.
• Some platforms establish certification programs or other quality
labels to make adherence to their rules transparent.
• Examples: Facebook Marketing Partners, Google Premier Partners

Deal with ecosystem conflicts
• “Every new iOS release kills about two dozen startups.”
• Platform owners often get into competing situations with their ecosystem
partners as they expand the features of their own platforms.
• Microsoft Office killing Lotus 123, Harvard Graphics and others.
• Amazon selling its own store-brand products.
• Occasionally, platform owners feel they have to reign in an aspect of their
ecosystem, often to the dismay of their partners.
• Twitter basically killing 3rd party Twitter clients that originally provided much of the
innovation in the ecosystem.
• Facebook strongly restricting data access for app makers after Cambridge Analytica
scandal.
• No easy solutions. Platforms should provide as much predictability and
transparency as possible, but that’s often not in their own best short-term
interests.

Defend against new entrants
• History shows: Even the strongest platform position is not unassailable.
New market entrants with a different approach and unique economics
can unseat incumbents within just a few years.
• Even very dominant platforms have to remain vigilant and defend
against new entrants, possibly through early acquisitions.
• Facebook buying Instagram, WhatsApp, Oculus, then trying to buy Snapchat and
just copying it when that failed.
Sources: Statista, StatCounter, Asymco 22
Mobile Operating Systems: Global Market Share Web Browser Market Share Microcomputer Market Share
Nokia
Google
Microsoft Google

Strategies for platform
complementors

Platform complementors
• The dream of many entrepreneurs is to build a dominant platform,
but the reality is that very, very few will succeed.
• 99.9%+ of businesses will need to exist as platform participants, or
if they get involved more deeply, as platform complementors.
• Platform complementor = a business that systematically
participates in and adds value to another company’s platform
• App vendors in iOS, Android
• Publishers who put their articles and videos on Facebook
• Record labels on iTunes or Spotify
• Google partners who provide services or additional software capabilities

Platform complementors in context
Horizontal Platforms
e.g. iOS, Android, Windows, Google, Facebook, Amazon Cloud
End Users
Platform Complementors
Apps, Service Providers, Content
Providers, Industry Solutions
Market Platforms
e.g. Uber, Netflix, Airbnb
Base Technologies
e.g. Mobile Devices, AI, Chips, Network Hardware

There’s money to be made as a platform
complementor – but levels differ
• Platform owners like to point out how much money their respective complementors/ecosystem partners
make.
• Apples-to-apples comparisons are hard, but there is often a clear difference in how much of the total
ecosystem value the platform owners capture vs. leave for partners.
• The following comparison of the platform owner’s relevant revenue (blue) vs. ecosystem revenue (red)
shows that depending on the market, platform take rates can be very different. More complex platforms
(such as Microsoft Windows, which opens many revenue opportunities for partners in software products,
training, integration etc.) tend to have a larger ecosystem than simpler platforms.
Sources: IDC, company financial reports, Midia Research, Innospective analysis 26
62.5
580
Microsoft corporate revenue Microsoft ecosystem revenue
Microsoft-related revenue (2010, $B)
29.9
26.5
Apple services revenue iOS developer revenue
iOS-related revenue (2017, $B)
4.1
7.4
Spotify revenue Total streaming music revenue
for record labels
Streaming music revenue (2017, $B)

Platform complementor strategies
1. Cover a type of value proposition that the platform owner is not interested in
• Services, such as consulting or system integration, are difficult to scale and therefore often not attractive
to platforms, but interesting for 3rd parties. Platforms often provide rich support to 3rd party service
partners.
• Hardware for software platforms
2. Provide a complementary niche product that covers a particular market that might be too specific
for the platform owner
• Industry-specific solutions building on a platform can have high margins and customer loyalty
3. Provide a cross-platform product that lets users do easy multi-homing and therefore is impossible
for individual platforms to provide
• Oracle database: Runs on pretty much any server operating system. Enabled IT departments to use the
same database on all servers.
• Google Chrome and Gsuite apps: Provides functionality that performs identically on any host operating
system.
4. Warning: Filling functionality holes in a platform is rarely a viable strategy
• 3rd party Twitter clients were much better than Twitter’s own UI, but Twitter improved and at some point
largely shut down the necessary APIs

Strategy tips for platform complementors
• Keep your friends close, but your platform provider closer.
• Develop a relationship with the platform on many levels, beyond official support channels if
possible
• Monitor very closely what the platform does and think about its incentives
• Systematically assess the risk from platform behavior and prepare in advance.
• What if the platform suddenly provides directly what I’m selling?
• What if the platform buys one of my competitors?
• What if the platform turns off a key component I need, e.g. API access?
• What if the platform starts charging for something I currently get for free?
• Try building a multi-platform business that increases robustness against the behavior
of a single platform.
• Businesses that depend on a single platform are often very vulnerable.
• Make sure to build a direct route to the customer and don’t just depend on platforms for
customer access.
• A multi-platform product can turn into a platform of its own (e.g. app development on top of
Oracle databases)

Conclusion

The challenges ahead
• As the dominance of large platforms grows and countless startups aim to build the next big
platform, all participants need to understand the mechanisms behind this phenomenon
better.
• Here are the top three challenges by participant type:
Incumbent platform owners Builders of new platforms Platform complementors Platform end users
1. Defending against new
entrants
2. Keeping profitability high
(or reaching it)
3. Dealing with external
regulation and self-
regulating the ecosystem
1. Differentiate against
incumbents
2. Solve the chicken-and-
egg problem of adoption
3. Figure out sustainable
monetization that
doesn’t run into
regulatory problems
1. Find a sustainable
strategy in an attractive
market
2. Reduce dependency on
single platforms
3. Build relationships with
platforms as they
change themselves.
1. Understand how and why
you’re using platforms
2. Understand how platforms
are extracting value and
what role you play in it
3. Make sure to verify and
optimize privacy settings
and dependencies on
platforms

Final words
• Everybody wants to build a platform – the term has become inflationary
in startup and innovation circles. That’s understandable because
successful platforms are amongst the most profitable and most rapidly
growing businesses in the world.
• However, building a successful platform is exceedingly risky and difficult.
A thorough understanding of platform economics is key (that’s one of
the things Mark Zuckerberg excels at, BTW).
• The platform business is also rapidly changing with new regulatory
initiatives and emerging technologies (such as blockchain) that can
potentially endanger incumbent platforms.
• Most of all, we are all users of these platforms, as individuals and
businesses. Recent scandals have shown that blindly trusting a
dominant platform is rarely a good idea.

Appendix

Further reading
• Cusumano, Yoffie: Strategy Rules: Five Timeless Lessons from Bill Gates, Andy Grove,
and Steve Jobs; Harper Business, 2015
• Cusumano, Gawer: Platform Leadership: How Intel, Microsoft, and Cisco Drive
Industry Innovation; Harvard Business Review Press, 2002
• Cusumano, Gawer, Yoffie: The Business of Platforms; Harper Business, forthcoming in
2019
• Brynjolfsson, McAffee: Machine, Platform, Crowd: Harnessing Our Digital Future; W.W.
Norton, 2017
• Evans, Hagiu, Schmalensee: Invisible Engines: How Software Platforms Drive
Innovation and Transform Industries; MIT Press, 2008
• Blogs and newsletters:
• www.stratechery.com
• www.ben-evans.com
• www.asymco.com

About the author
Andreas Göldi (sometimes spelled Goeldi) is an experienced Internet technologist and
serial entrepreneur with a passion for media, film and video. He co-founded and helped
build several successful startups in e-business consulting, social media analytics, video
advertising and online content. His past job roles include programmer, chief technology
officer, head of consulting, board member and CEO. He holds masters degrees in
technology management from MIT and the University of St.Gallen, Switzerland. Andreas is
currently taking a sabbatical, but he will consider speaking engagements, one-off
innovation sessions and startup investment opportunities.
Innospective is (for now) Andreas’ blog about innovation, technology strategy and
startups, plus anything else that seems related and sufficiently interesting.
Innospective Innovation Briefings is a series of presentations about key topics in
technology innovation, of which this is the first one. More to come.
To contact Andreas (comments, questions and suggestions are very welcome) please
email agoeldi (at) innospective.net or tweet at @agoeldi
More content is available on www.innospective.net

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