MIT Sloan Management Review January 2018

FRONTIERS

[STRATEGY]

Why Some Platforms Are Better Than Others Although successful digital platforms can deliver remarkable value to users and riches to entrepreneurs and investors, in some sectors it isn’t clear that anyone will turn a profit. BY JONATHAN A. KNEE

T

he dramatic influence of the internet on how businesses operate and the emergence of a handful of gigantic, digitally enabled corporations have led to breathless pronouncements regarding the importance of a new class of monopolies built on digital platforms. Such platforms, it is said, can fuel network effects that lead to winner-take-all marketplaces. This perspective is often coupled with infectious optimism and investment

euphoria regarding the extraordinary scale and strength of network-effects businesses. In theory, the key attribute of a network-effects business is its momentum-driven flywheel. Every new participant increases the value of the network to existing participants, attracts more new users, and makes the prospect of a successful competitive attack ever more remote — thereby bolstering the relative attractiveness of the business. The

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imagined innate indomitability of network effects stems at least in part from the breathtaking strength of notable platform businesses such as Facebook Inc.’s social network or Microsoft Corp.’s Windows operating system. The problem is that not all platform businesses exhibit network effects that reinforce a market’s winner-take-all tendency. For every Facebook and Microsoft, there are numerous network-effects businesses operating in crowded sectors where it is not always clear that anyone will turn a profit. Nor are digital platforms necessarily better businesses than the analog versions that they displace. Analog malls had the benefit of their shoppers being miles away from competing malls, as well as the benefit of their retail tenants being committed to long-term leases. On the internet, platform competitors are only a click away, and companies regularly and dynamically optimize their customer reach across competing platforms and directly via their own sites.

It is not that marketplace businesses built on e-commerce platforms do not have advantages or cannot thrive. Rather, it is that the mere existence of network effects tells entrepreneurs and investors relatively little about the attractiveness of a particular business. For example, Uber Technologies Inc. and Airbnb Inc., the global leaders in the ride-hailing and short-term lodging marketplaces, respectively, both benefit from network effects. However, other characteristics of those industries make it likely that Airbnb will enjoy dramatically stronger results than Uber will ever achieve.

Why Airbnb Is Better Than Uber Three key structural attributes drive the value of network effects in the digital domain. The first is the minimum market share at which the network can achieve financial breakeven. The second is the nature and durability of the customer relationships spawned by the network. And the third is the extent to which the data generated by the network facilitates product and pricing optimization. These should sound familiar. They are updated versions of the same core competitive advantages that have long underpinned the best business franchises: economies of scale, customer captivity, and learning. And they are as relevant to today’s digital platforms as they were — and continue to be — to analog ones. Comparing Uber and Airbnb along these ADAM MCCAULEY/THEISPOT.COM