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Platform Revolution - Ch 02 Network Effects: Power of the Platform

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Contents: (1) Two sided market definitions (2) How demand- and supply-side economies of scale differ (3) Free goods: when and why to subsidize one side or the other (4) How switching and homing costs affect winner take all outcomes.

These slides provide course materials that complement the second chapter of Platform Revolution: How Networked Markets are Transforming the Economy and How to Make Them Work for You. The final slides provide additional reading suggestions for industry and academia.

Published in: Business

Platform Revolution - Ch 02 Network Effects: Power of the Platform

  1. 1. Geoffrey Parker Dartmouth College @g2parker Marshall Van Alstyne Boston University @InfoEcon Chapter 2 Network Effects: The Power of the Platform Platform Revolution: Making Networked Markets Work for You Questrom School of Business 2016 Parker & Van Alstyne with Choudary – licensed under Creative Commons Attribution- ShareAlike 4.0 Int’l (CC BY-SA 4.0). with Sangeet Choudary Platform Thinking Labs @sanguit
  2. 2. Platform Revolution: Chapter 2 – Network Effects 1. Introduction: Welcome to Platform World 2. Network Effects: The Power of the Platform 3. Architecture: Basic Principles for Designing Successful Platforms 4. Disruption: How Platforms Conquer &Transform Traditional Industries 5. Launch: Chicken or Egg? 8 Ways To Launch Successful Platforms 6. Monetization: Capturing the Value Created by Network Effects 7. Openness: Defining What Platform Users/Partners Can &Cannot Do 8. Governance: Policies That Increase Value and Enhance Growth 9. Metrics: How Platform Managers Can Measure What Really Matters 10. Strategy: How Platforms Change Competition 11. Policy: How Platforms Should (and Should Not) Be Regulated 12. Future: Industries Facing Imminent Change 2016 Parker & Van Alstyne, with Choudary – licensed under Creative Commons Attribution-ShareAlike 4.0 International (CC BY-SA 4.0). (click to order on Amazon) Click on left hand icons to access content (downloaded slides).
  3. 3. CONSUMERSPRODUCER Elements of value exchange PLATFORM A PLATFORM: • Is a nexus of rules and architecture • Is open, allowing regulated participation • Actively promotes (positive) interactions among different partners in a multi-sided market • Scales much faster than a pipeline business because it does not necessarily bear the costs of external production. Source: Platform Revolution2016 Parker & Van Alstyne, with Choudary – licensed under Creative Commons Attribution-ShareAlike 4.0 International (CC BY-SA 4.0).
  4. 4. PLATFORMS LEVERAGE NETWORK EFFECTS More users = more value = more users … 1 interaction 2 phones 10 interactions 5 phones 66 interactions 12 phones Source: Wikipedia.org2016 Parker & Van Alstyne, with Choudary – licensed under Creative Commons Attribution-ShareAlike 4.0 International (CC BY-SA 4.0).
  5. 5. IT HELPS TO BREAK EACH INTERACTION INTO 2 SIDES Phone Callers Uber Drivers eBay Sellers Xbox Developers Amex Merchants Aga Khan Doctors YouTube Videographers AirBnb Rooms Tesla Charge Stations Mechanical Turk Laborers LinkedIn Employers Upwork Projects Android Developers Phone Callees Uber Riders eBay Buyers Xbox Gamers Amex CardHolders Aga Khan Patients YouTube Viewers AirBnb Renters Tesla Car Drivers Mechanical Turk Jobs LinkedIn Employees Upwork Freelancers Android Users This helps explain how attraction and feedback happen 2016 Parker & Van Alstyne, with Choudary – licensed under Creative Commons Attribution-ShareAlike 4.0 International (CC BY-SA 4.0).
  6. 6. • Businesses can be very complex • Rapid growth may preclude trial-and-error • Network effects = winner often takes most/all • Successes: Windows, Adobe, iPod/iPhone, Alibaba, LinkedIn, Facebook, etc. • Failures: Betamax, IBM OS/2, Amazon auctions, eBay Japan, MusicNet, N- Gage, Blackberry, etc. Distinctive Challenges 2016 Parker & Van Alstyne, with Choudary – licensed under Creative Commons Attribution-ShareAlike 4.0 International (CC BY-SA 4.0).
  7. 7. • Network effects are demand-side scale economies. Rising network effects increase existing and prospective users’ willingness-to-pay (willingness-to-participate) • Supply-side scale economies are realized when firms reduce unit costs by leveraging fixed costs or experience effects. With high fixed costs and low unit costs, average costs decline with volume. • Many businesses that exhibit network effects also enjoy strong supply-side scale economies • However, demand-side and supply-side economies are conceptually distinct: unit cost reductions that result from network growth should not be labeled network effects Demand vs Supply-Side Scale Economies 2016 Parker & Van Alstyne, with Choudary – licensed under Creative Commons Attribution-ShareAlike 4.0 International (CC BY-SA 4.0).
  8. 8. Price Quantity Supply Demand • Rising average costs • Competitive supply • Soda, Eggs, Bread STANDARD GOODS 2016 Parker & Van Alstyne, with Choudary – licensed under Creative Commons Attribution-ShareAlike 4.0 International (CC BY-SA 4.0).
  9. 9. • Falling average costs • Monopolistic supply • Utilities, SemiconductorsSupply Price Quantity Demand SUPPLY ECONOMY OF SCALE 2016 Parker & Van Alstyne, with Choudary – licensed under Creative Commons Attribution-ShareAlike 4.0 International (CC BY-SA 4.0).
  10. 10. GIANTS OF SUPPLY SIDE ECONOMIES OF SCALE Electric Dynamo 1893 Ford Model T 1908 Acklam Ironworks 1924 Standard Oil 1909 Vanderbilt Colossus of (Rail) Roads 2016 Parker & Van Alstyne, with Choudary – licensed under Creative Commons Attribution-ShareAlike 4.0 International (CC BY-SA 4.0).
  11. 11. • Value grows with volume • Monopolistic Demand • Often falling average cost • Operating Systems, Instant Messaging, Social Networks SUPPLY ECONOMY OF SCALE Price Quantity Demand Supply 2016 Parker & Van Alstyne, with Choudary – licensed under Creative Commons Attribution-ShareAlike 4.0 International (CC BY-SA 4.0).
  12. 12. GIANTS OF DEMAND SIDE ECONOMIES OF SCALE Social Networks Windows OS Mobile Merchant Mkts 2016 Parker & Van Alstyne, with Choudary – licensed under Creative Commons Attribution-ShareAlike 4.0 International (CC BY-SA 4.0).
  13. 13. TRADITIONAL LINEAR VALUE CHAIN Stage 1 Stage 2 Stage 3 $ $ $ Value accumulates from stage to stage Minimal Network Effects 2016 Parker & Van Alstyne, with Choudary – licensed under Creative Commons Attribution-ShareAlike 4.0 International (CC BY-SA 4.0).
  14. 14. APPLE iPOD PRE-PLATFORM Apple iPod Retailer Music ProducerListener $ $ $ (1) Product First Thinking (2) Standard linear value chain (3) User bought music retail (or P2P) (4) Minimal network effects 2016 Parker & Van Alstyne, with Choudary – licensed under Creative Commons Attribution-ShareAlike 4.0 International (CC BY-SA 4.0).
  15. 15. Apple iPod Retailer Music ProducerListener $ $ $ APPLE iPOD COMBINED WITH iTUNES (AND APPLE MUSIC!) 2016 Parker & Van Alstyne, with Choudary – licensed under Creative Commons Attribution-ShareAlike 4.0 International (CC BY-SA 4.0).
  16. 16. CONSUMER PRODUCER APPLE (1)Triangular platform supply network (2) Apple owns financial chokepoint (3) Apple helps users find content (4) Stronger network effects 2016 Parker & Van Alstyne, with Choudary – licensed under Creative Commons Attribution-ShareAlike 4.0 International (CC BY-SA 4.0).
  17. 17. A TWO-SIDED NETWORK HAS FOUR NETWORK EFFECTS Side 2 Side 1 PLATFORM • A same-side effect for each side, i.e., preference regarding number of other users on own side • A cross-side effect in each direction, i.e., preference regarding number of users on other side Source: Eisenmann, Parker, Van Alstyne, 2006. “Strategies for Two Sided Markets.” Harvard Business Review.2016 Parker & Van Alstyne, with Choudary – licensed under Creative Commons Attribution-ShareAlike 4.0 International (CC BY-SA 4.0).
  18. 18. A TWO-SIDED NETWORK HAS FOUR NETWORK EFFECTS. THESE CAN BE POSITIVE OR NEGATIVE. Side 2 Side 1 PLATFORM + same-side : Player-to-player contact in Xbox MMOG, end-user PDF sharing. + cross-side : merchants & consumers for Visa, developers & end-users for Windows - same-side : competing suppliers in Covisint auction, competing dates on Match.com - cross-side : Digital Rights Management costs to consumers. Advertising clutter to viewers. You must manage all such interactions 2016 Parker & Van Alstyne, with Choudary – licensed under Creative Commons Attribution-ShareAlike 4.0 International (CC BY-SA 4.0). Source: Eisenmann, Parker, Van Alstyne, 2006. “Strategies for Two Sided Markets.” Harvard Business Review.
  19. 19. DAVID SACK’S (COO PAYPAL, CEO YAMMER) SKETCH SHOWS HOW POSITIVE FEEDBACK DROVE UBER GROWTH Less driver downtime Lower prices MORE DEMAND MORE DRIVERSFaster pickups MORE Geographic coverage, Saturation Source: David Sacks2016 Parker & Van Alstyne, with Choudary – licensed under Creative Commons Attribution-ShareAlike 4.0 International (CC BY-SA 4.0).
  20. 20. ALL POSITIVE FEEDBACK LOOPS MEET NEGATIVE FEEDBACK LOOPS (ELSE THEY EXPLODE). MAKE SURE YOU FIND THEM AND MITIGATE THEM. Less driver downtime Lower prices MORE DEMAND MORE DRIVERSFaster pickups MORE Geographic coverage, Saturation Source: Adapted from David Sacks 2016 Parker & Van Alstyne, with Choudary – licensed under Creative Commons Attribution-ShareAlike 4.0 International (CC BY-SA 4.0).
  21. 21. HOMING AND SWITCHING COSTS Mono-homing Switching Multi-homing Mobile Handsets Xbox Xbox- PS4 Credit Card Netflix/Hulu 1 SETUP + 1ONGOING 2 SETUPS + 1 TERMINATION + 1 ONGOING 2 SETUPS + 2 ONGOING Source: Eisenmann, Parker, Van Alstyne, 2006. “Strategies for Two Sided Markets.” Harvard Business Review.2016 Parker & Van Alstyne, with Choudary – licensed under Creative Commons Attribution-ShareAlike 4.0 International (CC BY-SA 4.0).
  22. 22. 1. Large Supply/Demand Effects (Utilities & Facebook vs Consulting). Costs fall or value rises with volume. 2. Large Multi-Homing Costs (OS vs credit cards). Consumers tend to choose just one 3. Niche specialization is low (geographically unrestricted courses vs geographically restricted courses). Differentiation creates protected markets not swamped by scale economies. WHEN DO WINNER-TAKE-ALL MARKETS EMERGE? More Likely Less Likely Source: Eisenmann, Parker, Van Alstyne, 2006. “Strategies for Two Sided Markets.” Harvard Business Review.
  23. 23. TO PRICE A PLATFORM WITH NETWORK EFFECTS, WHO GETS THE SUBSIDY? Answer: The side that is the stronger attractant (or that creates more value) Source: Parker & Van Alstyne, 2005. “Two Sided Network Effects: A Theory of Information Product Design.” Mgmt Sci.2016 Parker & Van Alstyne, with Choudary – licensed under Creative Commons Attribution-ShareAlike 4.0 International (CC BY-SA 4.0).
  24. 24. The Story of Acrobat Reader/Writer Adobe first tried to sell PDF readers and writers but no one wanted to buy readers when there was no content to read. And, no one wanted to buy writers when no one had readers. Adobe broke the logjam by giving PDF readers away. Source: Tripsas “Adobe Systems Inc.” Harvard Business School case 801-19.2016 Parker & Van Alstyne, with Choudary – licensed under Creative Commons Attribution-ShareAlike 4.0 International (CC BY-SA 4.0).
  25. 25. Adobe Acrobat: SUBSIDIZE CONSUMERS Making PDF readers free dramatically increased the value of PDF writers, shifting producer demand out and to the right. Here, Adobe subsidized consumers. Profit lost on one side of market is more than made up by profit gain on other side of market. Source: Parker & Van Alstyne, 2000. “Information Complements, Substitutes and Strategic Product Design”2016 Parker & Van Alstyne, with Choudary – licensed under Creative Commons Attribution-ShareAlike 4.0 International (CC BY-SA 4.0).
  26. 26. Operating Systems: Subsidize Developers Making System Development Toolkits (SDKs) free dramatically increased the value of operating systems, shifting consumer demand out and to the right. Here, Microsoft subsidized producers. Profit lost on one side of market is more than made up by profit gain on other side. Source: Parker & Van Alstyne, 2000. “Information Complements, Substitutes and Strategic Product Design”2016 Parker & Van Alstyne, with Choudary – licensed under Creative Commons Attribution-ShareAlike 4.0 International (CC BY-SA 4.0).
  27. 27. WHEN DOES FREE MAKE SENSE? 1) People understand the razors & blades strategy (same as cellphones & minutes, printers & ink) Give away one thing, charge for another The SAME person gets both items 2) People often misunderstand 2-sided network pricing Subsidize one party in order to attract then charge another party Subsidy side and money side of the market are DIFFERENT parties (like women & men on ladies’ nights) 3) Monetization is trickier for 2-sided networks Charging the wrong side (or both) reduces growth and network effects PLATFORM WRITERS READERS 2016 Parker & Van Alstyne, with Choudary – licensed under Creative Commons Attribution-ShareAlike 4.0 International (CC BY-SA 4.0).
  28. 28. ISSUES Q: Why is price more important in network markets? A: The entire demand curve can change with price. Q: Why is price more strategic in 2-sided networks? A: Imagine competing on the subsidy side – you need a source of subsidy at least as great. 2016 Parker & Van Alstyne, with Choudary – licensed under Creative Commons Attribution-ShareAlike 4.0 International (CC BY-SA 4.0).
  29. 29. TAKEAWAYS FROM CHAPTER TWO Network effects are the main source of value creation and competitive advantage in a platform business—and, increasingly, in today’s economy. Whereas giant industrial-era firms were made possible by supply economies of scale, today’s giants are made possible by demand economies of scale—expressed as network effects. Network effects are not the same as price effects, brand effects, or other familiar growth- building tools. Frictionless entry and other features of scalability maximize the value-building impact of network effects. A two-sided market (with both producers and consumers) gives rise to four kinds of network effects: same-side effects (consumer-to-consumer, producer-to-producer) and cross-side effects (consumer-to-producer, producer-to-consumer). Polarity on any of these can also be positive or negative. A growing platform business must manage all four. The key to minimizing most negative network effects is quality curation and minimizing congestion, which increases the chances of a happy match between producer and consumer. Source: Platform Revolution2016 Parker & Van Alstyne, with Choudary – licensed under Creative Commons Attribution-ShareAlike 4.0 International (CC BY-SA 4.0).
  30. 30. Platform Revolution: Next Chapter 3 – Architecture 1. Introduction: Welcome to Platform World 2. Network Effects: The Power of the Platform 3. Architecture: Basic Principles for Designing Successful Platforms 4. Disruption: How Platforms Conquer &Transform Traditional Industries 5. Launch: Chicken or Egg? 8 Ways To Launch Successful Platforms 6. Monetization: Capturing the Value Created by Network Effects 7. Openness: Defining What Platform Users/Partners Can &Cannot Do 8. Governance: Policies That Increase Value and Enhance Growth 9. Metrics: How Platform Managers Can Measure What Really Matters 10. Strategy: How Platforms Change Competition 11. Policy: How Platforms Should (and Should Not) Be Regulated 12. Future: Industries Facing Imminent Change (click to order on Amazon) 2016 Parker & Van Alstyne, with Choudary – licensed under Creative Commons Attribution-ShareAlike 4.0 International (CC BY-SA 4.0). Click on left hand icons to access content (downloaded slides).
  31. 31. For More Chapter 2 Information Suggested background: MBA Readings 1. Eisenmann, Parker & Van Alstyne, 2006. “Strategies for Two Sided Markets.” Harvard Business Review, 84, no. 10: 92–101 2. Tripsas “Adobe Systems Inc.” (2001) Harvard Business School case 801-19. 3. W. Brian Arthur, “Increasing Returns and the New World of Business,” Harvard Business Review 74, no. 4 (1996): 100–9 4. Bill Gurley, “How to Miss By a Mile: An Alternative Look at Uber’s Potential Market Size,” Above the Crowd, July 11, 2014 5. Miner, R., (2007) “Android: Building a Mobile Platform to Change the Industry,” Nov. 28, -- YouTube 6. Tiwana, A. (2013) “Core Concepts & Principles” Ch 2 – Platform Ecosystems: Newnes 7. Hagiu & Altman (2013) “Intuit Quickbooks: From Product to Platform” HBS Case N9- 714-433 (click to order on Amazon) 2016 Parker & Van Alstyne, with Choudary – licensed under Creative Commons Attribution-ShareAlike 4.0 International (CC BY-SA 4.0). Click on left hand icons to access content (downloaded slides). Geoffrey Parker @g2parker Marshall Van Alstyne @InfoEcon with Sangeet Choudary @sanguit
  32. 32. For More Chapter 2 Information Suggested background: PhD Readings 1. Geoffrey Parker and Marshall Van Alstyne, 2000. “Internetwork externalities and free information goods.” Proceedings of the Second ACM conference on Electronic Commerce. Association for Computing Machinery, 107-116. 2. Jean-Charles Rochet and Jean Tirole, 2003. ``Platform Competition in Two-Sided Markets.’’ Journal of the European Economic Association. 3. Bernard Caillaud and Bruno Jullien, 2003. ``Chicken & Egg: Competing Matchmakers. Rand Journal of Economics. 4. Geoffrey Parker and Marshall Van Alstyne, 2005. ``Two-Sided Network Effects: A Theory of Information Product Design.” Management Science, 51 (10): 1494-1504. 5. Andrei Hagiu, 2006. ``Pricing and commitment by two‐sided platforms.’’ The RAND Journal of Economics. 6. Michael L. Katz and Carl Shapiro, “Network Externalities, Competition, and Compatibility,” American Economic Review 75, no. 3 (1985): 424–40 (click to order on Amazon) 2016 Parker & Van Alstyne, with Choudary – licensed under Creative Commons Attribution-ShareAlike 4.0 International (CC BY-SA 4.0). Click on left hand icons to access content (downloaded slides). Geoffrey Parker @g2parker Marshall Van Alstyne @InfoEcon with Sangeet Choudary @sanguit

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