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Ignition book mobpay

  1. 1. Launching New Payments Businesses:The Role of Critical Mass and Ignition Strategies David S. Evans
  2. 2. 1 Why Every Payments Product Needs Chapter One an Ignition Strategy   Hard data are not available but, based on my experience, billions of dollars each year go poof in the payments industry from investments in products that crash and burn soon after launch. These products didn’t have a sound ignition strategy, which should be the foundation of all payments innovation. This book describes what an ignition plan is, why every entrepreneur inside and outside of major corporations should have one, and why investors and directors should insist on seeing one. Failure itself is hardly surprising. Most new businesses die young and few products become hits. Unless someone really does invent a working crystal ball, that’s the way it will always be. But a lot of money gets wasted in payments because of the failure to deal with a difficult coordination problem. Many payments products provide value only if they are adopted by both buyers (such as consumers) and sellers (such as merchants). They have to achieve a critical mass of these buyers and sellers to provide a valuable product. If they don’t, they will crash and burn, after early adopters lose interest. If they do, they may ignite as an increasing number of buyers attract sellers and an increasing number of sellers attract buyers. Discover ignited. So did PayPal. Pay by Touch crashed and burned. Hundreds more just didn’t get off the ground. The problem of getting both buyers and sellers on board is sometimes called the chicken-and-egg problem in payments. That analogy to the childhood riddle of which came first isn’t helpful to understand either the problem or the solution. In payments, it isn’t a question of who comes first: the chicken and the egg better show up at the same time and that makes it silly to talk about chickens and eggs in the first place. As I’ve described in “More Than More Money” (Chapter 3 of the 3rd edition of Paying with Plastic) when Diners Club ignited the first general purpose payments card system, it got restaurants and cardholders on board before it even opened its doors. Cardholders had restaurants they could go to, and restaurants had people who wanted to use their cards. Payments is like dating. There’s no product unless both sides of the market show up at the same time. Payments isn’t the only industry that faces this sort of ignition problem. In fact there is a whole category of businesses that create value only when they can connect two or more different groups of customers, who benefit from each other, on the same platform. (See my
  3. 3. 2   2   book with Dick Schmalensee, Catalyst Code, for more details.) For these businesses to get off the ground they have to figure out how to get a critical mass of both sides on board quickly enough. In “How Catalysts Ignite” I describe the challenges that platform businesses have in igniting and the proven strategies that have worked for many. One of the things we learn from examining the economic theory and experience of platform industries is that, just like a rocket has a limited amount of time to achieve enough momentum to launch into outer space, platform businesses have a limited amount of time to achieve a critical mass of both customer groups to have the prospect of viable growth. Despite 60 years of experience, payments entrepreneurs and investors often either don’t really understand the ignition problem or vastly underestimate the challenge in solving it. Irrational exuberance over some nifty new technology or the naïve belief that demand by one side can pull the other along leads to For background on platform disappointment. It isn’t just young overly businesses—also known as “two enthusiastic entrepreneurs or inexperienced sided markets”—see my Essays investors who fall into this trap. In the United States on the Economics of Two-Sided the introduction of contactless cards by the card Markets. networks and large issuers lacked a sensible ignition   strategy and has just sputtered along, fueled too often by hype, although even that has tailed off. An ignition plan won’t guarantee success. But it does force entrepreneurs and investors to think carefully about how they are going to get both buyers and sellers on board, in sufficient numbers, and quickly enough, to ignite. In doing so they may realize that ignition is too difficult and they may choose to save their money. A well-done ignition strategy, however, can also increase the odds of success. My vision is that every VC deck, every board presentation, every proposal for investing in a payments innovation that requires adoption by multiple stakeholders, should have a detailed ignition plan. An ignition plan is different from a typical marketing plan, which seldom deals with the problem of coordinating the multiple sides of the platform. An ignition plan describes the strategies and tactics for getting both sides on board and reaching critical mass in a timely fashion. It should be an integral part of the business plan—but seldom is. This book will explain the ignition problem in more detail, describe some successes and failures, and conclude with a template for an ignition plan. It is written mainly with payments entrepreneurs in mind but anyone who is thinking about starting or investing in a new platform business should benefit from following the lessons described here.
  4. 4. 1   3   What The Little Engine That Could and Chapter  Owo   T ne   Chapter Two Nuclear Physics Have To Do with Ignition Strategies Remember the kids’ story “The Little Engine That Could”? That well describes what goes on with many startups in two-sided markets. The train is trying to get up the mountain. But it needs to accelerate to offset the force of gravity that’s pushing it down. If it picks up enough momentum it can make it. But if not, it stalls, and worse, slides back down the mountain. Unfortunately, saying “I think I can, I think I can” won’t get a two-sided business off the ground. The basic problem for a two-sided business is that it needs “critical mass” to get ignited. That’s a concept from nuclear physics and a pretty good analogy to what goes on with two- sided platforms. To get an atomic reaction going there needs to be enough fissionable material, enough neutrons banging around, to set off a chain reaction. Too few and nothing happens. Platforms create value by helping two kinds of customers who need each other get together. It takes two to tango in these businesses. When the right customers get together they can benefit each other. eBay, for example, creates value early on because it helps people who want to buy things find people who want to sell things. Early on, it created tremendous value in part because it initially specialized in fairly obscure items for which it was hard for buyers and sellers to find each other. This is a numbers game. One of the reasons platforms create value in the first place is that they make it easier for those who come to a platform to find someone with whom they can engage in a mutually advantageous trade. That’s easier for members of each customer group if there are more members of the other customer group. If eHarmony had only one man and one woman it is very unlikely they would be attracted to each other. Dating platforms have to have a lot of prospects to have any possibility of finding people who would want to see each other. Critical mass is known as liquidity in financial markets. There have to be enough participants who want to buy or sell for the market to discover a price efficiently. Most of the B2B exchanges learned about this concept the hard way. They couldn’t attract enough participants, particularly sellers who didn’t look forward to having their prices beaten down, to make the market liquid. Markets that are too “thin” perform poorly or collapse. Here’s how critical mass and ignition usually works. As with any new product there are early adopters who, for whatever reason, like trying new things or get an exceptional amount of value by participating. Some of them may give the platform a try expecting that it will get bigger and become more valuable to them. With any new product there’s attrition as people
  5. 5. 2   4   learn about it and decide it doesn’t have enough value. But with platforms, participants attract more participants. If the rate at which new participants join exceeds the rate at which early adopters leave by enough then the platform can grow. The goal is to get to a tipping point when there are enough participants that this growth is explosive. This is just like a chain reaction in nuclear physics. Once there are enough participants they release so much value that even more participants join leading to explosive growth. (For a formal economic model of this, see “Failure to Launch.”) Timing is everything here. So just like The Little Engine That Could, there’s a race up the mountain. If the platform can get enough participants to join at a rapid enough pace, then the forces pulling it up will offset the forces pulling it down. Just as The Little Engine That Can gets to the top has an easy ride down, the platform that gets to critical mass accelerates rapidly. If the platform cannot get enough participants to join at a rapid enough pace, then it stalls or loses customers. Just like The Little Engine That Can’t gets stuck on the side of the mountain or falls back down, the platform stops growing and more likely implodes. When we talk about critical mass for platforms it is important to distinguish between the two sides. To ignite, platforms need enough of both sides and in the right proportions. This is easiest to see with exchanges. A platform that had a lot of sellers but few buyers wouldn’t be very interesting to the sellers. There need to be enough participants on both sides to make it likely that there will be profitable match-ups. (That doesn’t mean that platforms need equal numbers of both sides since one side might be more valuable: the obvious example is any dating venue.) Critical mass is different from the so-called chicken-and-egg issue that both sides need to be on board to create any value at all. Instead, critical mass refers to the phenomenon that a platform has to reach a critical size in order to grow explosively, and that if it doesn’t reach this critical size it will probably implode. For payment cards, critical mass requires having “enough” merchants who want to take cards and “enough” people who want to use cards to make it valuable for more merchants and people to join and thereby rev up the network effects. It is hard enough to get both sides on board a new payment system. It is even harder to get critical mass. Most payments startups don’t get to critical mass. They implode. A few do get critical mass: they ignite following the same principles as a chain reaction.      
  6. 6. 1   5   Chapter  TThree Chapter hree   Blast Off! How Two-Sided Platforms Ignited Facebook wunderkind Mark Zuckerberg and his partners made it look easy. The social networking platform ignited almost immediately after it was introduced at Harvard College. It didn’t take many friends seeking friends and guys seeking girls and vice versa to create enough “fissionable material” as discussed above. Within a week, more than half of the undergrads had signed on. Facebook then repeated this over the next few years at colleges across the country by introducing the network when this startup was sure there was critical mass at the school. Over time these individual networks were knitted together and today, six years after its start, Facebook has more than 500 million users globally, accounts for more time on site than any other web property including Google, and is growing quickly. Its large user base attracted advertisers and attracted application developers. Igniting a platform is hardly ever this easy, although looking backwards it may seem that way. I’ve told the story about the start of Diners Club in “More Than More Money.” It started with a handful of restaurants that took the card and a few hundred people who carried the card. We know results were spectacular—it ignited within a year. But think about how hard it must have been for Frank McNamara and his colleagues to persuade consumers to carry a card they could only use at a few merchants. To get an idea of what these payments pioneers were going through that first year, listen to one of the YouTube founders describe how they ignited that video sharing platform. It required a lot of trial and error to get people to upload videos and for people to watch them. And it took months to reach the critical mass necessary for blast off. That brings me to an important point on starting new platforms. It is helpful to distinguish between two obviously related aspects of reaching ignition. • The design of the platform to provide value to its users by getting both sides on board and interacting with each other. • The strategies for getting enough people to use the platform to release the values from these interactions. A great design can help ignition, but it seldom guarantees it. Suppose you design a platform that would provide great value to users if it got enough users on board. You still need to figure out how to go from no users   to critical mass. A startup with a better
  7. 7. 2   6   set of ignition strategies can beat a startup with a better design. In practice, platforms reach ignition when they have provided interdependent users more value than they can get with other alternatives and when they have a sound ignition strategy for reaching critical mass. Mobile payments platforms illustrate this point. A lot of mobile payments platforms have had trouble getting off the ground. That’s especially true in developed countries. In Kenya, though, M-PESA reached critical mass quite quickly and has grown rapidly. Ignacio Mas and Dan Radcliffe have explained how this 2007 startup managed to get more than half of Kenyan adults using this mobile payments method that allows P2P and P2B payments and transfers. They attribute a good part of the success to the fact that M-PESA was solving a very real problem. People didn’t have convenient ways to transfer money to each other, which was critically important when families were separated between cities and rural areas. There were relatively few banks and money was transferred unreliably by bus and other transport methods. M-PESA developed a killer mobile phone–based app to “send money home” and built on this basic payment product. M-PESA still had to solve the coordination problem faced by all two-sided businesses. They needed a network of retail stores to redeem payments and to help outfit mobile phone users and they needed enough consumers to want to use this method to make this attractive to the stores. As it turned out, M-PESA was able to reach critical mass more easily than other payment startups because it started with a base of mobile phone users (from Safaricom, which is the dominant carrier in Kenya) and a network of stores that already sold prepaid phone cards. Like Discover, which started with the Sears cardholder base and Sears stores, M-PESA started with access to many of the components necessary for critical mass. M-PESA ignited because it offered a service of great value to senders and receivers of money and because it had the wherewithal to get enough senders, receivers, retails stores, and other platform participants on board quickly enough. Other mobile payments platforms may have just as compelling ignition strategies but fail because they ultimately don’t provide enough value while others may provide value but haven’t figured out how to reach critical mass. Payments entrepreneurs and investors can learn a lot from looking at the multi-sided platforms that ignited in various industries and understanding the strategies that helped them reach critical mass. Imitation is, after all, the sincerest form of flattery. And we can all learn a lot from looking at the many more platforms that crashed and burned.
  8. 8. 1   7   Chapter Four Why Even Great Payments Ideas Crash and Burn The movie promo for The Social Network screams “You Don’t Get to 500 Million Friends without Making a Few Enemies.” I haven’t seen it yet but I’ve heard that the film suggests that Mark Zuckerberg stole the idea for Facebook. That’s hardly a novel charge against innovators. The tech press couldn’t get over Bill Gates’ success either. He was regularly portrayed as just making money off of other people’s ideas. This brings me to a stark point: there are many great ideas out there, but precious few entrepreneurs who can turn great ideas into successful businesses. If we lined up all the people that tried to start social networks, Zuckerberg would be standing well around the block. We know there were several reasonably successful sites before Facebook—Six Degrees of Separation, Friendster, and MySpace are the best known. But we also know from experience that there were probably hundreds more that tried but simply vanished leaving no trace for history. I guess, however, “You Don’t Get to 500 Million Friends without a Killer Ignition Strategy” wouldn’t get me a job as a Hollywood screenwriter. Much the same story is true for Bill Gates. There were surely hundreds of people writing operating systems and starting computer companies in the late 1970s and early 1980s but again their names are lost to history. What Gates figured out was the secret to igniting the personal computer revolution—which involved (in part) promoting inexpensive computer hardware and many applications that ran on that hardware. Zuckerberg and Gates were masters at executing ignition. They are fabulously wealthy because of that rarest of rare skills. Entrepreneurs with “great ideas” for multi-sided platforms routinely fail because they haven’t figured out how to reach critical mass. The contactless card was a great idea. Waving instead of swiping saves time. It made a lot of sense for transit properties seeking to provide a payment instrument that helped maximize the through-put of passengers especially during rush hours. But contactless has been a debacle in the United States and the reasons are instructive. MasterCard and Visa made significant investments to encourage the growth of contactless in the United States, persuaded several of their issuers to follow along and issue millions of contactless cards, and talked a few large merchants into taking contactless cards. This was a really botched ignition strategy. Many of us wish we could see the internal decks and management consulting tomes that suggested this could work since it would help diagnose the sources of the “wet match” problem with ignition strategies. Consumers didn’t
  9. 9. 2   care much about using the card since it didn’t save them much time at most merchants; that was especially true if they weren’t buying something cheap because they still needed to sign. Merchants weren’t interested in spending money on upgrading their equipment because consumers didn’t care enough to get them extra sales. With so few merchants taking contactless, consumers never got into the habit of wanting to use them much further, adding to the malaise. All the hype that was poured onto contactless by the networks and assorted research and consulting firms couldn’t get around the fundamental problem that there was wasn’t enough extra value being created for the participants in the platform to ignite it. That doesn’t mean that contactless was destined to fail. But igniting this technology would have required either developing killer applications that consumers and merchants could only use with contactless or a lot of applications that collectively brought value. The failure of contactless in the United States was no more inevitable than the failure of Microsoft’s Windows operating system for mobile after a decade of effort and billions of dollars. Apple figured out a way to get a lot of users and then used that base of users to get lots of applications. And remarkably Google’s Android followed with an approach that—oh no, theft of an idea, time for a movie!—basically copied Gates’ approach to dominating the PC operating system business (that is, an operating system that worked with many different types of hardware in addition to being open to app developers). The B2B exchanges that sprouted up by the hundreds in the late 1990s and underwent mass extinction in the early 2000s are the other interesting example of failed ignition strategies. The B2B proposition sounded like a great idea: provide buyers and sellers a convenient Internet-based place to find each other and transact. The entrepreneurs behind these exchanges almost all failed to work through a sensible ignition strategy for reaching critical mass. An exchange can attract sellers only if there are enough buyers to do business with and can attract buyers only there are enough sellers to do business with. Critical mass refers to having enough buyers and sellers to satisfy each other’s needs. Otherwise the market is “too thin” and not enough value is generated. This sounds simple but in fact in practice it is hard to get sellers to sign on to an exchange: these exchanges emphasized the use of auction methods to get the best price for buyers but for sellers that meant getting their prices competed down. The few surviving B2B transaction networks eventually discovered that they had to bring suppliers on for free at least initially. Most learned that lesson way too late. The failures had adopted the wet match approach to ignition: open the platform and assume that people will come. The payments landscape is littered with businesses that had “great ideas” but couldn’t reach critical mass. That begins with the hundreds of payment brands that started in the 1950s but quickly went under. Looking forward I suspect that a number of the mobile payments startups in the United States will fall victim to the wet match problem: sort of great idea, no   ignition plan.
  10. 10. 3   9   Perseverance pays off, of course, in many parts of life. Unfortunately, it usually doesn’t with multi-sided platforms. A clock starts ticking when a new platform opens its doors, as I will explain in the next chapter. Just like a rocket has to build up enough momentum to escape gravity within a defined period of time so a platform has to reach critical mass quickly enough. That’s all the more reason every multi-sided platform business—and certainly every payments business—should start life with an ignition plan. Catalyst Code
  11. 11. 1   10   Chapter Five Tick, Tock. How Long Does the Ignition Clock Tick? Not long is the short answer. A completely unscientific but reasonably educated guess is a couple of years. Here I explain why. To some degree all new firms face a countdown to mission aborted or launch. Most firms fail and do so, mercifully, quickly. That happens because the firms aren’t nearly as good as they thought they were. Their products can’t attract customers or the firms can’t make those products efficiently. They lose to the competition as a result. Only a handful of the automobile companies that were around at the turn of the 20th century ultimately survived. Many died young. Maybe entrepreneurs have a new great idea but the market doesn’t agree. For every Pet Rock that’s a success there are thousand more Bob’s (Microsoft failed user interface for Windows 3.1) that are duds. Competition is the survival of the fittest and that show doesn’t last long. New platform businesses face all those problems too. But there’s something else going on that should scare the living daylights out of entrepreneurs as they hear the tick, tock counting out in the background. Remember the secret of platform businesses: they need to reach critical mass to grow explosively. A two-sided platform has to get to the point where it has so many mutually attractive customers that more of each type of customers wants to join. Positive feedback effects then drive it forward. That’s what we saw M-PESA and Discover do. And it is what PayPal did with eBay by getting enough merchants and shoppers on board. You might think that platforms could just keep slogging along, adding members of each of the critical type of customers, year in and year out, until it launches. That might work if customers tried the platform and stayed. Here’s the problem: members of one type of customer try the platform. If some of those members don’t find that they are meeting enough of the other type of customers they won’t come back. Maybe they will give it a try for a while. But if the platform doesn’t grow quickly enough eventually more customers will decide that they aren’t getting enough value than new customers that decide to give it a shot. Once that happens the platform goes into a death spiral. If fewer customers of one type patronize the platform, then fewer customers of the other type will, and so forth. Consider starting a nightclub. It has a good opening night with lots of men and women having a pretty good time. Many of them will come back and tell their friends.
  12. 12. 2   11   But if it doesn’t get enough momentum men will come one night and wonder why there aren’t enough women, or vice versa, and then both groups will stop coming. When customers need to make an investment to join a platform, securing momentum is even more important. One type of customer won’t be willing to make investments unless she is confident that the other type of customer will show up. Microsoft ran into this problem in launching its XBox game console (as Schmalensee and I described in Catalyst Code). Game makers wouldn’t produce games until they were confident Microsoft would have console users. Microsoft had to produce its own games in part to seed the other side of the market. The expectation issue was one of the reasons contactless cards fizzled in the U.S. Merchants didn’t have enough confidence that contactless would succeed to invest in new terminals and the card networks and issuers were unable to convince them. As the clock counts down, the typical race for new catalysts—new multi-sided platforms—often involves increasing the numbers of both types of customers quickly. That’s what YouTube did and one reason it did so much better than Google (and everyone else) that Google ended up closing down its own video site and buying YouTube. It managed to get enough people downloading videos that it was able to get enough people watching videos to encourage people to keep downloading videos and so forth. Getting momentum behind this is absolutely critical. Once that momentum stops, like the train that can’t quite get enough steam going up the mountain, the platform stalls and eventually spirals down. In my experience platform entrepreneurs have about 18-24 months to make this happen—but that’s totally subjective and I’d love to hear counterexamples. The fact that new platforms have a deadline—with the constant beat of the tick, tock in the background counting down the time to success or failure—means that it is essential to have an ignition plan and to execute successfully against that plan. Plans can be revised on the fly. But every new platform needs to give serious thought—as do their investors—into how that platform is going to win the race to reach critical mass.
  13. 13. 1   12   Chapter Six Ignition Strategies: How to Ignite a Two-Sided Platform Getting a new product off the ground is one of the great challenges in business. That’s well documented for entrepreneurs. VCs don’t get any return from more than 40 percent of their first-round investments and get back less than they put in for two-thirds of those investments that do post returns. I haven’t come across any stats for major companies that launch new products but my experienced guess is that a lot of really new products go bust too. Google Video, Microsoft Kin, and the Apple Lisa are just a few that come to mind. The start-up problem is especially hard for firms that are based on multi-sided platforms. Besides the usual problems faced by new firms, they often must contend with a difficult coordination issue, the so-called the chicken-and-egg problem. This section describes some high level strategies on how to ignite a multi-sided platform business. You won’t learn the real tricks of the trade here. For that I have been known to succumb to monetary inducements, water torture, and being tickled. A. Catalyst Framework Let’s start with some basics. A business is an “economic catalyst” if it creates value by bringing two or more groups of customers together and getting them to interact. Catalysts create value by reducing transaction costs faced by multiple distinct economic agents that would benefit from coming together. Catalysts reduce search efforts, facilitate matching, and make it easier for the two groups of economic agents to exchange value between each other. The economic value created by the catalytic reaction is essential for understanding the feasible set of business strategies that a multi-sided platform can use. The value must be big enough to warrant the cost and risk of investment in developing the platform. The value also provides the “pie” that can be split among the distinct groups of economic agents to provide incentives for them to join and interact on the platform with a portion of the pie going to the platform for performing its role. Some of the pie can be used to subsidize certain groups of economic agents, or members of those groups, to join the platform. In “chemical catalysis” it is necessary to get the catalytic agent and the chemical agents in the right proportions to ignite and accelerate a reaction. The same is true for economic catalysis. Both economic agents have to be present on the platform in the right parts and levels to create any value at all and to accelerate value creation. This conundrum is often referred to as the chicken-and-egg problem. The problem that
  14. 14. 2   13   platforms face is sometimes sequential as the children’s riddle suggests—does the platform need to get economic agents A on board the platform before economic agents B; or B before A? Other times, though, it is simultaneous—how does the platform secure the participation of economic agents A and B so that both will be present on the platform when members from each group show up? That typically involves solving a very difficult coordination problem between the platform and these two groups of economic agents. The problem, however, is not just getting members of the two groups of economic agents to show up at the same time to create value. There have to be enough members of group A to make it valuable to members of group B to incur the costs of participating in the platform and to return it in subsequent periods; and vice versa. Strength in numbers arises primarily because economic agents in one group are searching for appropriate value-creating matches among members of the other group. There have to be enough members to make it likely that economic agents will find valuable matches. B. Catalytic Ignition and Critical Mass Figure 1 shows the basic concept of critical mass and catalytic ignition. (For those of you who like differential equations and lots of Greek notation the technical details are in Failure to Launch.) There is a range of minimal numbers of XX customers in each group that, if achieved, provides a  “thick enough market” or a sufficiently “liquid” market to permit sustainable growth. When the mass of customers on either side is insufficient a catalyst fizzles rather than ignites. Once a catalyst achieves critical mass on C’-C”, for example, it can grow to its profit- maximizing potential of D*; if it does not achieve critical mass on the segment C’-C’’ it contracts and fails. The growth paths to critical mass depend on many factors including pricing. But the point here is that achieving critical mass is essential. Google Video, for example, failed to achieve critical mass because it did not generate enough content to attract viewers and did not attract enough viewers to attract paid or user-generated content. The optimal growth path to critical mass and to long-run equilibrium is well away from the horizontal and vertical axes in most plausible cases. New multi-sided platforms generally need to have balanced growth. Having too many of one side and too few of another side will lead to quick failure. (This is reflected in Figure 1 in that the equilibrium growth path to critical mass must occur within the triangle 0-C’-C”.) The challenge that catalyst entrepreneurs face is how to achieve the critical mass that is necessary for ignition. That means getting to critical mass over some reasonable space of time. One can think of this phase as the ignition phase of the product launch process, in which customers are trying the platform and assessing its value; these early adopters will stop coming
  15. 15. 43   14   back, and stop recommending it to their friends, if the platform does not grow quickly enough. The entrepreneur must increase the number of customers on each side to a point where there are enough to reach critical mass. That involves horizontal and vertical movements within the cone- shaped area in the Figure. A transaction platform, for example, needs to take actions that increase buyers and sellers. The entrepreneur must also maintain the right proportions of customers on each side so that there are enough participants on each side to interest the participants on the other side. That involves diagonal movements to the northeast in Figure 1. An exchange platform needs to make sure there are enough buyers to interest sellers and vice versa. Figure 1. Catalytic Ignition and Critical Mass C. The Basics of New Product Introduction There is extensive literature on launching new products. Key tactics involve logistics; advertising, sales, and marketing; and pricing. Companies should make sure they have a production and distribution system for getting products and services to consumers. They need to sell consumers on the merits of trying a product through the dissemination of information as well as persuasion. Finally, they need to set prices recognizing both the competition and the fact that consumers may need an incentive to try a new and unproven product. These traditional strategies facilitate obtaining consumers on both sides of a two-sided platform, that is, in making horizontal and vertical movements. The original models of product diffusion distinguished between two types of consumers: innovators who would try a product as a result of direct communication with them, and
  16. 16. 5   15   imitators who would try a product as a result of communication with someone else who had tried the product. The innovator might learn about the product through advertisements in the mass media. The imitator might learn about the product either from the innovator or from other people who learned about it directly or indirectly from the innovator. The word- of-mouth aspect to this model gives rise to the well-known S-curve of product diffusion where there is a convex rise in adoption, an inflection point, and a concave rise that levels off at some saturation point. The population of economic agents is sometimes broken down into innovators, early adopters, early majority, late majority, and laggards. Figure 2 shows the standard framework. The literature on social networks provides insights into the process of word-of-mouth communication. The social graph describes the relationships among members of a network. It consists of nodes which reflect the agents and lines that show the connection between the agents. The connections can be uni-directional (x communicates with y) or bi-directional (x and y communicate with each other). The nature of the relationships among members of the network can provide insights into the organic workings of the network. There are three key ramifications for product diffusion. Word of mouth will spread more quickly: (1) the more connections innovators have; (2) the more connections friends of the innovators have; and (3) the denser the network is in the sense that there are fewer degrees of separation among members of the network. Two types of agents facilitate the diffusion information within the network. “Influencers”—or gregarious members—account for a disproportionate share of communications. They send a lot of messages out to a broad range of connections. “Centers” have connections with many people who are not connected to other agents. They are important because they are the only way to reach isolated agents within the network. Product diffusion may provide double duty for two-sided businesses in which economic agents have shifting roles in the platform. Individuals who upload photos on the photo-sharing network Flickr may view photos from their friends. People who use eBay’s auto exchange may use it for both buying and selling, though some users may specialize in selling, and some may never sell. Consumers may value a product more if similar consumers use that product as well. This
  17. 17. 6   16   is known as a positive direct network effect. It can arise because it is easier to connect to people using the product or because there are knowledge spillovers among them. Consumers may also value a product less if similar consumers use that product. This is known as a negative direct network effect. That might happen because of congestion or because people want to be different. For simplicity, we will assume that direct network effects are positive unless noted otherwise. Direct network effects act as an accelerant to a catalytic reaction. Diffusion happens more quickly. The value of the network is higher to each additional member who is contacted. All else equal direct network effects increase the likelihood that each subsequent agent that is contacted by an earlier adopter will adopt the product also. Figure 3 shows how direct network effects modify the S-curve of diffusion. Social networking theory provides some guidance on how to use direct network effects strategically. I would conjecture that economic agents that are more densely connected in a network have stronger direct network effects among them. Thus using influencers to connect to more densely connected portions of networks will tend to have higher payoffs. One type of economic agent may value a product more if more of another group of economic agents uses that product as well. This is known as a positive indirect network effect. It can arise because one type of economic agent (e.g., a buyer, a man, a cardholder) wants to search for and transact with another type of economic agent (e.g., a seller, a woman, a merchant) and vice versa. It can also arise because one type of economic agent (e.g., a computer user, a video game user) wants to be able to find complementary products for the platform he or she uses (e.g., applications, video games) and the maker of those products want to focus its efforts on platforms that have users who will demand its products. There are also negative indirect network effects: one type of economic agent on the network harms another type of agent. The leading case of this for platform businesses is advertising-supported media. Consumers may dislike the advertisements. The platform solves the externality problem between advertisers and consumers by using content to bribe people into viewing ads. Indirect network effects are the key aspect of multi-sided platforms. They are the source of the
  18. 18. 7   17   catalytic reaction—and much of the value—created  by the platform. A key practical aspect of these indirect network effects is that they require that the platform “balance” the two sides to maximize the value of the platform to either side. The platform has zero value to either side if the other side is not on board. For many platforms the optimal balance is likely well into the interior and away from the axes, as was shown in Figure 1. The analysis above has already pointed to the fact that not all customers are created equal for multi-sided platforms. It is useful to pull these concepts together here and summarize their implications for platform ignition. There are three major kinds of heterogeneity. • First, some customers value a product or service more than other customers. All else equal those are the ones to go after initially to grow a business because they involve the lowest cost of sales and marketing. They can then kick off product diffusion. Two-sided platforms sometimes need to recruit these customers on both sides. • Second, some customers on one side are valued more by customers on the other side. The two-sided literature calls these “marquee” customers while the social networking literature calls them “prestige” nodes—i.e., nodes that many people want to connect to and therefore receive many messages. All else equal marquee customers are the most important ones to attract early on. They not only increase the value of the platform but also bring in more customers on the other side who help stimulate product diffusion on that side. Marquee customers may appear on one or both sides. • Third, some customers are more gregarious than others in the sense that they are more likely to influence other customers to join the platform. These “influencers” are important to attract early on because they will accelerate the vertical or horizontal growth of the platform. To ignite, platforms want to identify and recruit heavy influencers on both sides. Prestige and influencer customers both generate significant direct or indirect externalities. It therefore often pays to subsidize their joining the platform. D. Five Strategies for Igniting Catalytic Reactions Here are five proven strategies for reaching critical mass. 1. The basic zig-zag A basic strategy for reaching critical mass is to build participation on the two sides incrementally. The platform starts with a small number of economic agents on both sides. It
  19. 19. 8   18   then persuades agents on either side to join. It also relies on the natural processes of product diffusion. Because of indirect network effects, the platform is more valuable to each successive group of prospective customers. Figure 4 shows that basic zig-zag approach to growth. eBillme provides an example of this strategy. Consumers who click on the eBillme sign at the checkout for an e-tailer can pay with their online banking account. They then send an e-mail which contains details for paying from their online banking account. After they enter the information into their online banking account they receive a receipt and the product is shipped. This payment alternative is attractive to people who are either concerned about the security of paying with cards online or who do not happen to have a card conveniently available. A small but significant fraction of consumers, as it turns out, like paying this way. To get started, eBillme persuaded ToolKing to offer eBillme at checkout. A small percentage of customers used this payment alternative. eBillme then went to other online retailers. Each led to eBillme having more people who were accustomed to using its service. For each subsequent merchant it went to it offered an increasingly valuable offer since it had more users who were predisposed to use this payment alternative. At the same time it let its users know that they could pay at more places thereby increasing the value to the merchants. eBillme grew from one merchant and hundreds of users during its first year of entry in 2005 to hundreds of online stores taking 2percent to 10percent of the merchant’s transaction volume by 2008. 2. Pre-commitment to both sides Some platforms such as eBillme are able to start with one member on one side that it uses to attract members on the other side. More commonly platforms need to have multiple members of both sides to begin the zig-zag process above. They therefore need to persuade a minimum number of early adopters on both sides to show up at the start of the platform to make it credible. That requires getting both sides to believe that when the platform opens for business
  20. 20. 9   19   there will be members of the other side present. Diners Club is the classic example of this strategy. Although the precise sequence is lost to history it persuaded 14 restaurants in Manhattan to accept Diners Club cards for payment. At the same time it persuaded several hundred people in Manhattan to take the Diners Club Card. Those commitments were enough to start the platform. Over the next year Diners Club zig- zagged its way to 330 restaurants and 42,000 cardholders. Customers may require more assurance that the other side will in fact show up especially if they have to invest resources to join. Contingent contracts can be entered into for this purpose. Customers agree to commit to join the platform conditional on other customers on the same and other side also joining. Once these contracts have been entered into, the catalyst only needs to persuade one customer to sign on because that will have a domino effect on all the other customers. MobiTV serves as an example where contingent contracts play an important role for “catalyzing” the platform. Started in 1999, MobiTV planned to offer TV service to customers on their mobile phones for a subscription fee. It needed to persuade TV content providers and mobile operators to join its platform. Neither of the two wanted to embark on the new project unless they were assured that the other side would also join. MobiTV used contingent contracts to ignite the platform. It signed an agreement with Sprint that if television channels joined, Sprint would offer service, and it signed agreements with MSNBC and other TV channels that if Sprint joined, they would broadcast. It was enough for MobiTV to get Sprint to agree and everyone else followed. The video-console example considered by Hagiu is an extreme example of this phenomenon. Video games and other software applications are platforms that connect application developers and video game players. The game player will not purchase a video console without enough applications and games, and the former will not put the time to develop such if they are not sure that people will buy their applications. Because game developing is a long process, the vendors have to secure sellers a long time before the new game is launched in order to make sure that developers will provide the applications. 3. Single- and double-marquee strategies The marquee strategy discussed above is another way to obtain enough members on both sides to begin the zigzag to critical mass. In a single-sided marquee strategy the platform acquires an “influential” or “prestige” member of one side. Announcement of that may attract enough members of the other side at the beginning. The shopping mall strategy is the classic: the mall gets an anchor tenant which many shoppers want to connect to. In a two-sided marquee strategy the platform acquires “influential” or “prestige” members on both sides. They provide value to each other as well as attract other members. Nightclubs are common users of this strategy. They try to get popular men and women to come on opening night. Popular men and
  21. 21. 0   20   women want to connect to each other and less popular men and women want to connect with them. 4. The two step The two-step strategy involves getting enough members of one side on board first and then getting members of the other side on board. As mentioned earlier this works when the first side does not value access to the second side which is often the case for advertising-supported media. Search engines followed this strategy. They attracted users who did searches of the World Wide Web. The search results were displayed on a series of pages. Once they obtained enough page views they sold access to those pages to advertisers. Google, for example, operated its search engine for 23 months (including a beta version) before it opened its search results pages to advertisers. At that time it had more than a billion pages indexed and 18 million user queries per day. 5. Zig-zag with self-supply Catalysts may be able to jumpstart their platforms by providing one of the sides themselves at least initially. Consider YouTube which is a three-sided platform: user-generated content attracts viewers, viewers attract content providers who want an audience, and access to the viewers can then be sold to advertisers. YouTube started by focusing on users and viewers. Its founders seeded the site with content they generated themselves and started the process of diffusion by suggesting that members of their personal social networks check out the content. They also used various marketing strategies to attract viewers: they posted an ad on craigslist to compensate attractive women to post on the site and promised to give an iPod to a random user every day till the end of the year. E. Going from Strategies to Tactics These strategies are only examples of what catalysts can do in practice to ignite their platforms. Every ignition strategy needs to be implemented through a series of tactics. As we saw earlier those tactics are time-sensitive. Catalysts in practice often have a limited amount of time to succeed. They are just like rockets. If they don’t get enough momentum to escape the earth’s atmosphere they will crash and burn. Having a great strategy for blasting off into outer space doesn’t do much good if by the time you implement it your rocket ship is on the bottom of the Atlantic Ocean. Having an ignition strategy is no guarantee of success, of course. Some new platform businesses just don’t create enough value to create critical mass. The failure to have a well- thought out launch plan that can quickly get a platform to critical mass is almost a sure guarantee of failure even for the best platform ideas. That’s why every investor, board, and company exec should insist on seeing an ignition plan.
  22. 22. 1   21   Chapter Seven Formulating an Ignition Plan If you want to start a platform business in payments—or in any other area that involves the coordination of multiple stakeholders—you’d better have an ignition plan. Once you start the business, you are facing a countdown for achieving critical mass and launching the business successfully. If you haven’t reached critical mass by the time the clock has counted down, your business will have imploded. You face a complex series of decisions to secure ignition. Anyone who is counting on your business to succeed should run away if you don’t have a plan. Companies shouldn’t fund initiatives that don’t have plans, boards of directors should demand to see one for any material platform investment, and CEOs and other organizational leaders should dismiss underlings that haven’t prepared one. Venture capitalists and other investors in startups should react with great suspicion to entrepreneurs that haven’t carefully planned how they are going to get a catalytic reaction. Here’s what an ignition plan needs to have: 1. A clear description of the value that the platform is creating by coordinating multiple customer groups. That value determines how much value the platform can use to subsidize one side if necessary and how much value the platform can have left over as profit. 2. An analysis of the importance of each group of customers in generating this value and the difficulty of getting each group on board that platform. This analysis will determine how much of the cost of the platform each group should bear and how much profit should be generated from each group. In many cases it will determine which is the money side and which is the subsidy side of the platform. 3. Strategies for getting members of these multiple groups of customers on board the platform in sufficient numbers, probably over an 18-24 month time period. These strategies need to solve the coordination problem which is particularly difficult when, as for most payments platforms, the two groups need to belong to the platform in sufficient numbers almost from the start. 4. Operational tactics for implementing these strategies. Given the short time period available to get to critical mass, it is essential that entrepreneurs think through the tactics they are going to use to get ignited. Who are the anchor tenants and how are they going to get many members of the different groups to appear at launch? 5. Some notion of the critical mass that would be needed to secure ignition. There are no
  23. 23. 2   22   formulas for this at the moment and the critical mass will vary depending on the platform. Although this is guesswork, the entrepreneur should think through how much will be enough. If it isn’t possible to get critical mass in the necessary time period then the entrepreneur and her investors should look into something else. Of course, as the oft-quoted poem of Robert Burns says, “The best-laid schemes of mice and men go often askew, and leave us nothing but grief and pain, for promised joy!” That’s particularly true for launching multi-sided platforms because there are so many interdependent variables that will ultimately determine whether the platform will secure ignition. Most entrepreneurs, when they start one of these businesses, are making guesses about this complex system. As they start, they get more information, and oftentimes that information will lead them to modify strategies and tactics. The successful entrepreneur must not only have a plan, she must be able to quickly modify the plan, as she learns more. There are no guarantees when it comes to new products. An ignition plan can’t guarantee takeoff. Achieving critical mass can’t even ensure profitability. What is for sure is that starting a multi-sided platform business is one of the most difficult tasks facing any entrepreneur. Understanding the obstacles to a catalytic reaction is important. Thinking through how to achieve launch before the forces of gravity bring you back to earth is essential. Many entrepreneurs are working on starting new payment systems these days especially ones based on mobile. Unfortunately, most of the ones I have encountered, whether they are startups or sponsored by incumbents, haven’t understood the seriousness of the coordination problem in payments. Hundreds and hundreds of millions of dollars, perhaps many billion, will be squandered over the rest of this decade by companies large and small who still, in the face of decades of experience to the contrary, think that if they build it customers will come, that if they offer a shiny new toy people will flock to it. The ones who succeed will be those who have identified a way to provide significant additional value to groups of customers who need each other and have devised ignition plans that enable them to quickly achieve critical mass.
  24. 24.   23     Additional  Resources   The Catalyst Code Blog The Catalyst Code Blog takes our two-sided platform concepts to heart by bringing together contributors and readers to deliver thought-provoking fodder in the payments, Web 2.0, loyalty, advertising, mobile and social networking spaces. We hope you’ll join the conversation. The Catalyst Code Book In an economy where markets, consumers, and technology are ever-changing and increasingly interdependent, economic catalysts businesses that bring together a number of groups who need each other and make it easy for them to work together are essential. Think of the credit card industry. This trillion-dollar industry brings merchants and consumers together. Google creates value for its customers, and makes billions for itself, by bringing searchers and advertisers together. Companies that do this right and transform their pricing practices, incentive plans, and organizational structures are todays power brokers. Of course, catalysts have been around as long as marketplaces. But now, more than ever, they drive the economy. Doing business in this world isn’t for the faint of heart but Catalyst Code maps it out, showing where the opportunities and pitfalls lie. Two-Sided Markets Book This volume collects a series of essays that I have written, sometimes with colleagues, over the last decade on businesses that create value by providing products that enable two or more different types of customers to get together, find each other, and exchange value. Invisible Engines Series This blog series will explain how software platforms are going to transform the payments industry and why you will be touched by this new revolution and perhaps even want to be one of the entrepreneurs or investors who pioneer this new area.