Source: https://hbr.org/2016/04/pipelines-platforms-and-the-new-rules-of-strategy
Summary
Executives must learn the new rules of platform businesses or plan their exit. A platform doesn't create a moat. Porter’s five forces are still relevant but the factors are different. Instead of creating a moat and keeping out external forces, a platform focuses on network effects. Producers and consumers must be close and incentivized to use the platform. Execs must understand the core value interaction and measure that. It's not about revenue or sales --that's the old pipeline way.
Notes
A platform orchestrates resources whereas a pipeline controls resources
Quotes
As Apple demonstrates, firms needn’t be only a pipeline or a platform; they can be both. ==While plenty of pure pipeline businesses are still highly competitive, when platforms enter the same marketplace, the platforms virtually always win. That’s why pipeline giants such as Walmart, Nike, John Deere, and GE are all scrambling to incorporate platforms into their models.
The move from pipeline to platform involves three key shifts:
1 From resource control to resource orchestration.
The resource-based view of competition holds that firms gain advantage by controlling scarce and valuable—ideally, inimitable—assets. In a pipeline world, those include tangible assets such as mines and real estate and intangible assets like intellectual property. ==With platforms, the assets that are hard to copy are the community and the resources its members own and contribute, be they rooms or cars or ideas and information. In other words, the network of producers and consumers is the chief asset.
2 From internal optimization to external interaction
Pipeline firms organize their internal labor and resources to create value by optimizing an entire chain of product activities, from materials sourcing to sales and service. ==Platforms create value by facilitating interactions between external producers and consumers. Because of this external orientation, they often shed even variable costs of production. The emphasis shifts from dictating processes to persuading participants, and ecosystem governance becomes an essential skill.
3. From a focus on customer value to a focus on ecosystem value
Pipelines seek to maximize the lifetime value of individual customers of products and services, who, in effect, sit at the end of a linear process. ==By contrast, platforms seek to maximize the total value of an expanding ecosystem in a circular, iterative, feedback-driven process. Sometimes that requires subsidizing one type of consumer in order to attract another type.
==These three shifts make clear that competition is more complicated and dynamic in a platform world. The competitive forces described by Michael Porter (the threat of new entrants and substitute products or services, the bargaining power of customers and suppliers, and the intensity of competitive rivalry) still apply. But on platforms these forces behave differently, and new factors come into play. To manage them, executives must pay close attention to the interactions on the platform, participants’ access, and new performance metrics.
The Power of Network Effects
The engine of the industrial economy was, and remains, supply-side economies of scale. Massive fixed costs and low marginal costs mean that firms achieving higher sales volume than their competitors have a lower average cost of doing business. That allows them to reduce prices, which increases volume further, which permits more price cuts—a virtuous feedback loop that produces monopolies. Supply economics gave us Carnegie Steel, Edison Electric (which became GE), Rockefeller’s Standard Oil, and many other industrial era giants.
==In supply-side economies, firms achieve market power by controlling resources, ruthlessly increasing efficiency, and fending off challenges from any of the five forces. The goal of strategy in this world is to build a moat around the business that protects it from competition and channels competition toward other firms.
==The driving force behind the internet economy, conversely, is demand-side economies of scale, also known as network effects.
==These are enhanced by technologies that create efficiencies in social networking, demand aggregation, app development, and other phenomena that help networks expand.
In the internet economy, firms that achieve higher “volume” than competitors (that is, attract more platform participants) offer a higher average value per transaction. ==That’s because the larger the network, the better the matches between supply and demand and the richer the data that can be used to find matches.
Greater scale generates more value, which attracts more participants, which creates more value—another virtuous feedback loop that produces monopolies. Network effects gave us Alibaba, which accounts for over 75% of Chinese e-commerce transactions; Google, which accounts for 82% of mobile operating systems and 94% of mobile search; and Facebook, the world’s dominant social platform
==The five forces model doesn’t factor in network effects and the value they create. It regards external forces as “depletive,” or extracting value from a firm, and so argues for building barriers against them.
==In demand-side economies, however, external forces can be “accretive”—adding value to the platform business. Thus the power of suppliers and customers, which is threatening in a supply-side world, may be viewed as an asset on platforms. Understanding when external forces may either add or extract value in an ecosystem is central to platform strategy.
Forces within the ecosystem.
==Platform participants—consumers, producers, and providers—typically create value for a business. But they may defect if they believe their needs can be met better elsewhere.
The new roles that players assume can be either accretive or depletive. For example, consumers and producers can swap roles in ways that generate value for the platform. Users can ride with Uber today and drive for it tomorrow; travelers can stay with Airbnb one night and serve as hosts for other customers the next. In contrast, providers on a platform may become depletive, especially if they decide to compete with the owner. ==Netflix, a provider on the platforms of telecommunication firms, has control of consumers’ interactions with the content it offers, so it can extract value from the platform owners while continuing to rely on their infrastructure.
==Finance, which historically has recorded its activities on private internal accounts, now records some transactions externally on public, or “distributed,” ledgers. Organizations such as IBM, Intel, and JPMorgan are adopting blockchain technology that allows ledgers to be securely shared and vetted by anyone with permission. Participants can inspect everything from aggregated accounts to individual transactions. This allows firms to, for example, crowdsource compliance with accounting principles or seek input on their financial management from a broad network outside the company. Opening the books this way taps the wisdom of crowds and signals trustworthiness.
==Competitive threats tend to follow one of three patterns. First, they may come from an established platform with superior network effects that uses its relationships with customers to enter your industry. Products have features; platforms have communities, and those communities can be leveraged. Given Google’s relationship with consumers, the value its network provides them, and its interest in the internet of things, Siemens might have predicted the tech giant’s entry into the home-automation market (though not necessarily into thermostats).
Focus
==Managers of pipeline businesses focus on growing sales. For them, goods and services delivered (and the revenues and profits from them) are the units of analysis. For platforms, the focus shifts to interactions—exchanges of value between producers and consumers on the platform. The unit of exchange (say, a view of a video or a thumbs-up on a post) can be so small that little or no money changes hands. Nevertheless, the number of interactions and the associated network effects are the ultimate source of competitive advantage.
With platforms, a critical strategic aim is strong up-front design that will attract the desired participants, enable the right interactions ==(so-called core interactions), and encourage ever-more-powerful network effects.
==In our experience, managers often fumble here by focusing too much on the wrong type of interaction. And the perhaps counterintuitive bottom line, given how much we stress the importance of network effects, is that it’s usually wise to ensure the value of interactions for participants before focusing on volume.
Access and governance
In a pipeline world, strategy revolves around erecting barriers. With platforms, while guarding against threats remains critical, the focus of strategy shifts to eliminating barriers to production and consumption in order to maximize value creation. ==To that end, platform executives must make smart choices about access (whom to let onto the platform) and governance (or “control”—what consumers, producers, providers, and even competitors are allowed to do there).
Platforms consist of rules and architecture. Their owners need to decide how open both should be. An open architecture allows players to access platform resources, such as app developer tools, and create new sources of value. Open governance allows players other than the owner to shape the rules of trade and reward sharing on the platform. ==Regardless of who sets the rules, a fair reward system is key. If managers open the architecture but do not share the rewards, potential platform participants (such as app developers) have the ability to engage but no incentives. If managers open the rules and rewards but keep the architecture relatively closed, potential participants have incentives to engage but not the ability.
==These choices aren’t fixed. Platforms often launch with a fairly closed architecture and governance and then open up as they introduce new types of interactions and sources of value. But every platform must induce producers and consumers to interact and share their ideas and resources. Effective governance will inspire outsiders to bring valuable intellectual property to the platform, as Zynga did in bringing FarmVille to Facebook. That won’t happen if prospective partners fear exploitation.
==However, unfettered access can destroy value by creating “noise”—misbehavior or excess or low-quality content that inhibits interaction.
One company that ran into this problem was Chatroulette, which paired random people from around the world for webchats. It grew exponentially until noise caused its abrupt collapse. Initially utterly open—it had no access rules at all—it soon encountered the “naked hairy man” problem, which is exactly what it sounds like. Clothed users abandoned the platform in droves. Chatroulette responded by reducing its openness with a variety of user filters.
Most successful platforms similarly manage openness to maximize positive network effects. Airbnb and Uber rate and insure hosts and drivers, Twitter and Facebook provide users with tools to prevent stalking, and Apple’s App Store and the Google Play store both filter out low-quality applications.
==Finally, platforms must understand the financial value of their communities and their network effects. Consider that in 2016, private equity markets placed the value of Uber, a demand economy firm founded in 2009, above that of GM, a supply economy firm founded in 1908. Clearly Uber’s investors were looking beyond the traditional financials and metrics when calculating the firm’s worth and potential. This is a clear indication that the rules have changed.
The failure to transition to a new approach explains the precarious situation that traditional businesses—from hotels to health care providers to taxis—find themselves in. ==For pipeline firms, the writing is on the wall: Learn the new rules of strategy for a platform world, or begin planning your exit.