This document summarizes how companies can build competitive advantage through downstream activities focused on customers rather than upstream production activities. It discusses how companies can influence customer purchase criteria, accumulate advantage through customer data and network effects, and provide value through solving customer problems rather than just product innovation. It provides examples like Coca-Cola building advantage through brand associations rather than physical assets, and Orica gaining advantage over competitors by gathering blast data to reduce customer risks and costs.
2. He is the author of Tilt:
Shifting Your Strategy from
Products to Customers
(Harvard Business Review
Press, 2013).
When
Marketing
Is
Strategy
Why you must shift your strategy downstream,
from products to customers by Niraj Dawar
consumer, finding herself in a park on a hot summer
day, gladly pays two dollars for a chilled can of Coke
sold at the point-of-thirst through a vending machine.
That 700% price premium is attributable not to a bet-
ter or different product but to a more convenient
means of obtaining it. What the customer values is
this: not having to remember to buy the 24-pack in
advance, break out one can and find a place to store
the rest, lug the can around all day, and figure out
how to keep it chilled until she’s thirsty.
i
t’s no secret that in many industries today, up-
stream activities—such as sourcing, production,
and logistics—are being commoditized or out-
sourced, while downstream activities aimed at
reducing customers’ costs and risks are emerg-
ing as the drivers of value creation and sources of
competitive advantage. Consider a consumer’s pur-
chase of a can of Coca-Cola. In a supermarket or ware-
3. house club the consumer buys the drink as part of a
24-pack. The price is about 25 cents a can. The same
HBR.ORg
December 2013 Harvard Business Review 101
Downstream activities—such as delivering a
product for specific consumption circumstances—
are increasingly the reason customers choose one
brand over another and provide the basis for cus-
tomer loyalty. They also now account for a large
share of companies’ costs. To put it simply, the center
of gravity for most companies has tilted downstream.
Yet business strategy continues to be driven by
the ghost of the Industrial Revolution, long after
the factories that used to be the primary sources of
competitive advantage have been shuttered and off-
shored. Companies are still organized around their
production and their products, success is measured
in terms of units moved, and organizational hopes
are pinned on product pipelines. Production-related
activities are honed to maximize throughput, and
managers who worship efficiency are promoted.
Businesses know what it takes to make and move
stuff. The problem is, so does everybody else.
The strategic question that drives business today
is not “What else can we make?” but “What else can
we do for our customers?” Customers and the mar-
ket—not the factory or the product—now stand at
the core of the business. This new center of gravity
4. demands a rethink of some long-standing pillars of
strategy: First, the sources and locus of competitive
advantage now lie outside the firm, and advantage
is accumulative—rather than eroding over time as
competitors catch up, it grows with experience and
knowledge. Second, the way you compete changes
over time. Downstream, it’s no longer about having
the better product: Your focus is on the needs of cus-
tomers and your position relative to their purchase
criteria. You have a say in how the market perceives
your offering and whom you compete with. Third,
the pace and evolution of markets are now driven by
customers’ shifting purchase criteria rather than by
improvements in products or technology.
Let’s consider more closely how companies can
use downstream activities to upend traditional
strategy.
Must Competitive Advantage
Be Internal to the Firm?
In their quest for upstream competitive advan-
tage, companies scramble to build unique assets
or capabilities and then construct a wall to prevent
them from leaking out to competitors. You can tell
which of its activities a firm considers to be a source
of competitive advantage by how well protected
they are: If the company believes its edge lies in its
production processes, then plant visits are strictly
controlled. If it believes that R&D sets it apart, secu-
rity around its research labs is airtight and armies of
lawyers protect its patents. And if it prizes its talent,
you’ll find hip work spaces for employees, gourmet
lunches, yoga studios, nap nooks, sabbaticals, and
flexible work hours.
5. Downstream competitive advantage, in contrast,
resides outside the company—in the external link-
ages with customers, channel partners , and comple-
mentors. It is most often embedded in the processes
for interacting with customers, in marketplace infor-
mation, and in customer behavior.
A classic thought experiment in the world of
branding is to ask what would happen to Coca-
Cola’s ability to raise financing and launch opera-
tions anew if all its physical assets around the world
were to mysteriously go up in flames one night. The
answer, most reasonable businesspeople conclude,
is that the setback would cost the company time,
effort, and money—but Coca-Cola would have little
difficulty raising the funds to get back on its feet.
The brand would easily attract investors looking for
future returns.
On a hot day, consumers
gladly pay a 700% price
premium for the convenience
of buying a cold can of soda
from a vending machine.
102 Harvard Business Review December 2013
When MArketIng Is StrAtegy
The second part of the experiment is to ask what
might happen if, instead, 7 billion consumers around
the world were to wake up one morning with partial
amnesia, such that they could not remember the
brand name Coca-Cola or any of its associations.
Long-standing habits would be broken, and custom-
6. ers would no longer reach for a Coke when thirsty. In
this scenario, most businesspeople agree that even
though Coca-Cola’s physical assets remained in-
tact, the company would find it difficult to scare up
the funds to restart operations. It turns out that the
loss of downstream competitive advantage—that is,
consumers’ connection with the brand—would be a
more severe blow than the loss of all upstream assets.
Establishing and nurturing linkages in the mar-
ketplace creates stickiness—that is, customers’ (or
complementors’) unwillingness or inability to switch
to a competitor when it offers equivalent or better
value. Millions or billions of individual choices to
remain loyal to a brand or a company add up to real
competitive advantage.
Must You Listen to Your Customers?
A company is market-oriented, according to the
technical definition, if it has mastered the art of lis-
tening to customers, understanding their needs, and
developing products and services that meet those
needs. Believing that this process yields competitive
advantage, companies spend billions of dollars on
focus groups, surveys, and social media. The “voice
of the customer” reigns supreme, driving decisions
related to products, prices, packaging, store place-
ment, promotions, and positioning.
But the reality is that companies are increasingly
finding success not by being responsive to custom-
ers’ stated preferences but by defining what custom-
ers are looking for and shaping their “criteria of pur-
chase.” When asked about the market research that
went into the development of the iPad, Steve Jobs
famously replied, “None. It’s not the consumers’ job
7. to know what they want.” And even when consum-
ers do know what they want, asking them may not
be the best way to find out. Zara, the fast-fashion
Idea in Brief
The OppOrTuniTy
Companies’ upstream activi-
ties—such as sourcing, produc-
tion, and logistics—are being
commoditized or outsourced,
while downstream activities
aimed at shaping customers’
perception and reducing their
costs and risks are emerging as
the main sources of competi-
tive advantage.
The STraTegy
To compete effectively, compa-
nies must shift their focus from
upstream to downstream ac-
tivities, emphasizing how they
define their competitive set,
influence customers’ purchase
criteria, innovate to solve
customer problems, and build
advantage by accumulating
customer data and harnessing
network effect.
The LeSSOn
The downstream tilt is most
relevant to three types of com-
panies: those in product-based
industries such as pharma,
those in maturing industries,
8. and those seeking to move
up the value chain. Master-
ing downstream activities can
allow these firms to build new
forms of customer value and
lasting differentiation.
FIxed Costs, CustoMer VaLue, and CoMpetItIVe adVantage are
MoVIng downstreaM
The Shifting Source of Competitive Advantage
sourcing production Logistics Innovation shaping
Customer
perception
Innovation Building
accumulative
advantage
Contract with
lowest-cost
suppliers
Reduce costs/
maximize scale
and throughput
Optimize
supply-chain
and distribution
efficiency
Build better
products
9. Define
competitive set
Change
purchase
criteria
Build trust
Tailor offering
to consumption
circumstances
Reduce
customer costs
and risks
Harness
network effects
Accrue and
deploy
customer data
downstreaM aCtIVItIesupstreaM aCtIVItIes
what eLse Can we Make and seLL? what eLse Can we do For
our CustoMers?
hbr.org
december 2013 harvard business review 103
retailer, places only a small number of products on
10. the shelf for relatively short periods of time—hun-
dreds of units per month compared with a typical
retailer’s thousands per season. The company is set
up to respond to actual customer purchase behavior,
rapidly making thousands more of the products that
fly off the shelf and culling those that don’t.
Indeed, market leaders today are those that
define what performance means in their respec-
tive categories: Volvo sets the bar on safety, shap-
ing customers’ expectations for features from seat
belts to airbags to side-impact protection systems
and active pedestrian detection; Febreze redefined
the way customers perceive a clean house; Nike
made customers believe in themselves. Buyers in-
creasingly use company-defined criteria not just to
choose a brand but to make sense of and connect
with the marketplace. (See the sidebar “How Cialis
Beat Viagra.”)
Those criteria are also becoming the basis on
which companies segment markets, target and po-
sition their brands, and develop strategic market
positions as sources of competitive advantage. The
strategic objective for the downstream business,
therefore, is to influence how consumers perceive
the relative importance of various purchase criteria
and to introduce new, favorable criteria.
Must Competitive Advantage
Erode over Time?
The traditional upstream view is that as rival com-
panies catch up, competitive advantage erodes. But
for companies competing downstream, advantage
grows over time or with the number of customers
served—in other words, it is accumulative.
11. For example, you won’t find Facebook’s competi-
tive advantage locked up somewhere in its sparkling
offices in Menlo Park, or even roaming free on the
premises. The employees are smart and very pro-
ductive, but they’re not the key to the company’s
success. Rather, it’s the one billion people who have
accounts on the website that represent the most
valuable downstream asset. For Facebook, it’s all
about network effects: People who want to connect
want to be where everybody else is hanging out.
Facebook does everything possible to keep its posi -
tion as the preeminent village square on the internet:
The data that users post on Facebook is not portable
to any other site; the time lines, events, games, and
apps all create stickiness. The more users stay on
Facebook, the more likely their friends are to stay.
Network effects constitute a classic downstream
competitive advantage: They reside in the market-
place, they are distributed (you can’t point to them,
paint them, or lock them up), and they are hard to
replicate. Brands, too, carry network effects. BMW
and Mercedes advertise on television and other
mass media, even though fewer than 10% of view-
ers may be in their target market, because the more
people are awed by these brands, the more those in
the target market are willing to pay for them.
Indeed, the very nature of network effects is that
they are accumulative. But other downstream ad-
vantages—particularly those related to amassing and
deploying data—are accumulative as well. Consider
Orica, an explosives company mired in a commod-
ity business in Australia. The primary concern of its
customers—quarries that blast rock for use in land-
12. scaping and construction—was to meet well-defined
specifications while minimizing costs. Because the
products on the market were virtually indistinguish-
able, the quarries saw no reason to pay a premium
for Orica’s or any other company’s explosives. At
the same time, Orica knew that blasting rock is not
as straightforward as it may appear. Many factors
affect the performance of a blast: the profile of the
rock face; the location, depth, and diameter of the
bored holes; even the weather. Mess up the complex
formula for laying the explosives often enough and
your profits crumble into dust and get blown away
by the wind.
Orica realized that customers harbored much
unspoken anxiety about handling the explosives
without accidents, not to mention transporting and
storing them safely. If it could systematically reduce
even some of those costs and risks, it would be pro-
viding significant new value for the quarries—far in
excess of any price reduction that competitors could
offer. So Orica’s engineers set to work gathering data
on hundreds of blasts across a wide range of quarries
and found surprising patterns that led them to un-
derstand the factors that determine blast outcomes.
Using empirical models and experimentation, Orica
developed strategies and procedures that greatly
reduced the uncertainty that, until then, had gone
hand in hand with blasting rock. It could now pre-
dict and control the size of the rock that would result
from a blast and could offer customers something its
competitors could not: guaranteed outcomes within
specified tolerances for blasts. Quarries soon shifted
to Orica, despite lower prices from competitors. Not
only had the company developed an edge over rivals,
13. 104 Harvard Business Review December 2013
WhEn MArkETing Is STrATEgy
How Cialis Beat Viagra
The strategy serves incumbents and
challengers alike. Consider, for example,
the $5 billion market for erectile dysfunc-
tion drugs. Pfizer launched the first such
drug, Viagra, in April 1998, with a record
600,000 prescriptions filled that month
alone. At a price of $10 per dose and a
gross margin of 90%, Pfizer could afford
to splurge on marketing and sales. It
rolled out a $100 million advertising cam-
paign, and sales reps made a whopping
700,000 physician visits that year. In the
process, Pfizer created an entirely new
market on the basis of one key criterion
of purchase: efficacy. The drug got the
job done.
By 2001 annual sales had reached
$1.5 billion, and other pharmaceutical
companies had taken note of the size,
growth, and profitability of the market.
In 2003, Bayer introduced Levitra, the
first competitor to Viagra. The drug had
a profile very similar to Viagra’s and a
slightly lower price—classic “me too”
positioning.
Soon after, Lilly Icos, a joint venture be-
14. tween Eli Lilly and the biotech firm ICOS,
entered the market with a new product—
Cialis—that was different from its com-
petitors in two ways. First, whereas Viagra
and Levitra were effective for four to five
hours, Cialis lasted up to 36 hours, making
it potentially much more convenient for
customers to use. Second, product trials
showed fewer of the vision-related side
effects associated with Viagra and Levitra.
At the time, the key criteria that physi-
cians considered in prescribing a drug
for erectile dysfunction were efficacy and
safety. Those two criteria accounted for a
relative importance of 70%. Duration had
a relative importance of less than 10%.
The strategic question for Lilly Icos was
whether it could influence how physicians
perceived the importance of the criteria.
The positioning was hotly debated prior
to launch: Should the company center its
marketing strategy on Cialis’s lack of side
effects, given that safety was already one
of the two key criteria? Or should it attempt
to establish duration as a new criterion?
The marketing team decided to empha-
size the benefits of duration—being able
to choose a time for intimacy in a 36-hour
window—in its launch campaign, and it
set the price for Cialis higher than that
for Viagra to underscore the product’s
15. superiority.
The new criterion of purchase—mar-
keted as romance and intimacy rather
than sex—caught on. A BusinessWeek
article reporting on an early positioning
study stated, “Viagra users who had been
informed of the attributes of both drugs
were given a stack of objects and asked to
sort them into two groups, one for Viagra
and the other for Cialis. Red lace teddies,
stiletto-heeled shoes, and champagne
glasses were assigned to Viagra, while
fluffy bathrobes and down pillows be-
longed to Cialis.”
In 2012 Cialis passed Viagra’s $1.9 billion
in annual sales, with duration supplanting
efficacy as the key criterion of purchase in
the erectile dysfunction market.
Redefining customers’ purchase criteria is
one of the most powerful ways companies can
wrest market leadership from competitors.
but the advantage was accumulative: As Orica
amassed more data, it further improved the accuracy
of its blast predictions and increased its advantage
relative to its competitors.
Can You Choose Your Competitors?
Conventional wisdom holds that firms are largely
stuck with the competitors they have or that emerge
independent of their efforts. But when advantage
moves downstream, three critical decisions can
determine, or at least influence, whom you play
16. against: how you position your offering in the mind
of the customer, how you place yourself vis-à-vis
your competitive set within the distribution chan-
nel, and your pricing.
If you’re in the beverage business and you’ve
developed a rehydrating drink, you have a choice of
how to position it: as a convalescence drink for di-
gestive ailments, as a half-time drink for athletes, or
as a hangover reliever, for example. In each instance,
the customer perceives the benefits differently, and
is likely to compare the product to a different set of
competing products.
In choosing how to position products, managers
have tended to pay attention to the size and growth
of the market and overlook the intensity and identity
HBR.ORg
December 2013 Harvard Business Review 105
of the competition. Downstream, you can actively
place yourself within a competitive set or away from
it. Brita filters compete against other filters when
they are placed in the kitchen appliances section
at big-box stores, for instance. But Brita changes
both its comparison set and the economics of the
consumer decision when the filters are placed in
the bottled-water aisle at supermarkets. Here Brita
filters have a competitive cost advantage, delivering
several more gallons of clean water per dollar than
bottled water. Of course, not all buyers of bottled wa-
17. ter are buying solely for the criterion of cost (some
are buying for portability, for example), but for those
who are, Brita is an attractive choice.
If you would prefer not to be compared with
any other brands, then you’re better off market-
ing, distributing, and packaging your products in
ways that avoid familiar cues to customers. A trip
to the grocery store or a glance at online catalogs
shows how similar many products’ packaging is:
Most yogurts are sold in exactly the same pack size
and format, and their communications are often
so indistinguishable that consumers cannot recall
the brand after having seen an advertisement. The
lack of differentiation encourages competition,
when many of these brands would be better off
avoiding it.
Finally, pricing has a strong influence on whom
you compete with. When Infiniti launched its come-
back car, the G35, in 2002, it was hailed as a BMW-
beater. The car, loosely based on the legendary
Nissan Skyline, rivaled the BMW 5 series in terms
of interior space and engine power, but it would
have struggled to compete for a couple of reasons:
The 5 series is aimed at experienced BMW buyers—
or at least buyers who have previously owned a lux-
ury automobile. Also, the 5 series is very expensive,
and when customers are shelling out that kind of
money, they’re not looking for value—they’re look-
ing for an established brand and value proposition.
Infiniti chose to position the G35 against the BMW 3
series instead. The right pricing accomplished that
objective: Many consumers, especially car buyers,
use price as a key criterion in forming their consid-
18. eration set.
Although choosing to avoid competitors may
minimize head-on competition, there is no guaran-
tee that you won’t still have to contend with compet-
itors you didn’t want or ask for. But if you’ve done
your homework and established dominance on your
criterion of purchase, me-too competitors will be
putting themselves in an unfavorable position if they
choose to follow you.
Surprisingly, you have more say in determining
who your competitors are if you’re a later entrant in
a marketplace than if you break new ground. A later
entrant can choose to compete directly with an in-
cumbent or to differentiate, whereas an incumbent
is subject to the decisions of later entrants. But an
incumbent is not helpless: It can stay ahead of com-
petitors by continually redefining the market and
introducing new criteria of purchase.
106 Harvard Business Review December 2013
When Marketing Is Strategy
Brita changes its
competitive set when it
is placed in the bottled
water aisle at the
supermarket instead of
with kitchen appliances
at a big-box store.
Does Innovation Always Mean Better
19. Products or Technology?
Like prime real estate in a crowded city, custom-
ers’ mindspace is increasingly scarce and valuable
as brands proliferate in every category and existing
ones are sliced wafer-thin. Companies compete fero-
ciously against one another not to prove superiority
but to establish uniqueness. Volvo does not claim to
make a better car than BMW does, nor the other way
around—just a different one. In customers’ minds,
Volvo is associated with safety, while BMW empha-
sizes the joy and excitement of driving. Because the
two automakers emphasize different criteria of pur-
chase, they appeal to very different customers. In a
global study aimed at finding out what “excitement”
meant to customers, respondents were asked to “de-
scribe the most exciting day of your life.” When the
results were tallied, it turned out that BMW owners
described exciting things they had done—white-
water rafting in Colorado, attending a Rolling Stones
concert. In contrast, the most exciting day by far in
the lives of Volvo owners was the birth of their first
child. Brands compete by convincing customers of
the relative importance of their criterion of purchase.
That is not to say that the upstream activities asso-
ciated with building safer or faster cars don’t matter.
The product remains an essential ingredient in dem-
onstrating the brand’s positioning on its chosen cri-
terion. The product and its features turn the abstract,
intangible promises of the brand into real benefits.
Volvo’s product innovations really do make its cars
safer, reinforcing a lasting brand association with its
customers. But the product itself does not occupy a
more privileged position in the marketing mix than,
say, the right communication or distribution.
20. Where Else Does Innovation Reside?
The persistent belief that innovation is primarily
about building better products and technologies
leads managers to an overreliance on upstream ac-
tivities and tools. But downstream reasoning sug-
gests that managers should focus on marketplace
activities and tools. Competitive battles are won by
offering innovations that reduce customers’ costs
and risks over the entire purchase, consumption,
and disposal cycle.
Consider the case of Hyundai in the depths of
the Great Recession of 2008–2009. As the economy
faltered, American job prospects looked painfully
uncertain, and consumers delayed purchases of
durable goods. Automobile sales crashed through
the floor. GM’s and Chrysler’s long-term financial
problems resurfaced with a vengeance, and both
companies sought government bailouts. Hyundai,
which primarily targeted lower-income customers,
was particularly hard hit. The company’s U.S. sales
dropped 37%.
As overall demand plunged, the immediate re-
sponse of most car companies was to slash prices
and roll out discounts in the form of cash-back of-
fers and other dealer incentives. Hyundai considered
these options, but it eventually took a different ap-
proach: It asked potential customers, “Why are you
not buying?” The resounding answer was “The risk
of buying during the financial crisis—when I could
lose my job at any time—is simply too high.”
So instead of offering a price reduction, Hyun-
dai devised a risk-reduction guarantee to target that
21. concern directly: “If you lose your job or income
within a year of buying the car, you can return it with
no penalty to your credit rating.” Called the Hyundai
Assurance, the guarantee acted like a put option, ad-
dressing the buyer’s primary reason for holding back
on the purchase of a new vehicle. The program was
launched in January 2009. Hyundai sales that month
nearly doubled, while the industry’s sales declined
37%, the biggest January drop since 1963. Hyundai
sold more vehicles that month than Chrysler, which
had four times as many dealerships. Competitors
could easily have matched Hyundai’s guarantee—
yet they didn’t. They continued to slash prices and
offer cash incentives. The Hyundai Assurance was
a downstream innovation. Hyundai didn’t innovate
to sell better cars—it innovated by selling cars better.
Reducing costs and risks for customers is central
to any downstream tilt—indeed, it is the primary
means of creating downstream value. Not surpris-
ingly, many of the cases we’ve examined illustrate
this: Facebook reduces its customers’ costs of in-
teracting with friends; Orica reduces quarries’ blast
risks; Coca-Cola reduces the customer’s costs of find-
ing a cool, refreshing drink the moment she’s thirsty.
Is the Pace of Innovation
Set in the R&D Lab?
The product innovation treadmill is an upstream im-
perative. In fact, technology innovations are some-
times thought to be the greatest threat to competi-
tive advantage. But such changes in the market are
relevant only if they upend downstream competi-
tive advantage. You don’t need to sweat every prod-
uct launch and every new feature introduction by
22. hbr.org
December 2013 harvard business review 107
a competitor—just those that attempt to wrest con-
trol of the customers’ criteria of purchase. After all, it
was not the advent of digital photography that ulti-
mately doomed Kodak—it was the company’s failure
to steer consumers’ shifting purchase criteria.
By contrast, after more than a century of shaving
technology innovation, Gillette still controls when
the market moves on to the next generation of razor
and blade. Even though for the past three decades
competitors have known that the next-generation
product from Gillette will carry one additional cut-
ting edge on the blade and some added swivel or
vibration to the razor, they’ve never preempted that
third, fourth, or fifth blade. Why? Because they have
little to gain from preemption. Gillette owns the cus-
tomers’ criterion—and trust—so the additional blade
becomes credible and viable only when Gillette
decides to introduce it with a billion-dollar launch
campaign. Four blades are better than three, but
only if Gillette says so. In other words, technological
improvements don’t drive the pace of change in the
industry—marketing clout does.
Market change can be evolutionary, generational,
or revolutionary, and each type can be understood in
terms of consumer psychology. Evolutionary changes
push the boundaries of existing criteria of purchase:
higher horsepower or better fuel efficiency for cars,
faster processing speeds for semiconductor chips,
23. more-potent pills. Generational changes introduce
new criteria that complement old ones, often open-
ing up new market segments: sugar-free soft drinks,
hybrid vehicles, pull-up diapers, once-a-day medica-
tions where multiple pills were previously required.
Revolutionary changes don’t just introduce new
criteria, they render the old ones obsolete: The new
video-game controllers from Nintendo Wii changed
how people interact with their games; touch screens
and multitouch interfaces changed what customers
expect from a smartphone; a vaccine for tuberculosis,
AIDS, or malaria would make current treatments al-
most redundant within a couple of decades.
The power required to push a revolutionary
change through the market is greater than that re-
quired to move a market through a generational
change, and that power in turn is greater than the
market muscle required to introduce an evolution-
ary change. In each case, the quality of the product
innovation—the increased benefits relative to cur-
rent products—helps move the market, but it does
not guarantee a shift. High failure rates for new prod-
ucts in many industries suggest that companies are
continuing to invest heavily in product innovation
but are unable to move customer purchase criteria.
Technology is a necessary but insufficient condition
in …
Scale now trumps differentiation.
BY MARSHALL W. VAN ALSTYNE, GEOFFREY G.
PARKER,
AND SANGEET PAUL CHOUDARY
24. ARTWORK Vin Rathod, Aura (series)
2012–2014, photographSPOTLIGHT
Pipelines,
Platforms,
and the
New Rules
of Strategy
54 Harvard Business Review April 2016
SPOTLIGHT ON HOW PLATFORMS ARE RESHAPING
BUSINESS
Marshall W. Van Alstyne
is a professor and chair of
the information systems
department at Boston
University and a fellow at
the MIT Initiative on the
Digital Economy. Geoffrey
G. Parker is a professor
of management science
at Tulane University
and is a fellow at the
MIT Center for Digital
Business. He will be a
professor of engineering
at Dartmouth College,
effective July 2016.
Sangeet Paul Choudary
is the founder and CEO
25. of Platform Thinking Labs
and an entrepreneur-
in-residence at INSEAD.
They are the authors of
Platform Revolution (W.W.
Norton & Company, 2016).
HBR.ORG
SPOTLIGHT ON HOW PLATFORMS ARE RESHAPING
BUSINESS
By 2015 the iPhone singlehandedly generated 92%
of global profits, while all but one of the former
incumbents made no profit at all.
How can we explain the iPhone’s rapid domi-
nation of its industry? And how can we explain its
competitors’ free fall? Nokia and the others had
classic strategic advantages that should have pro-
tected them: strong product differentiation, trusted
brands, leading operating systems, excellent logis-
tics, protective regulation, huge R&D budgets, and
massive scale. For the most part, those firms looked
stable, profitable, and well entrenched.
Certainly the iPhone had an innovative design
and novel capabilities. But in 2007, Apple was a weak,
nonthreatening player surrounded by 800-pound
gorillas. It had less than 4% of market share in desktop
operating systems and none at all in mobile phones.
As we’ll explain, Apple (along with Google’s com-
peting Android system) overran the incumbents by
26. exploiting the power of platforms and leveraging
the new rules of strategy they give rise to. Platform
businesses bring together producers and consum-
ers in high-value exchanges. Their chief assets are
information and interactions, which together are
also the source of the value they create and their
competitive advantage.
Understanding this, Apple conceived the iPhone
and its operating system as more than a product or
a conduit for services. It imagined them as a way to
connect participants in two-sided markets—app
developers on one side and app users on the other—
generating value for both groups. As the number
of participants on each side grew, that value in-
creased—a phenomenon called “network effects,”
which is central to platform strategy. By January
2015 the company’s App Store offered 1.4 million
apps and had cumulatively generated $25 billion
for developers.
Apple’s success in building a platform business
within a conventional product firm holds critical
Back in 2007 the five major mobile-phone manufacturers—
Nokia, Samsung, Motorola, Sony Ericsson, and LG—
collectively
controlled 90% of the industry’s global profits.
That year, Apple’s iPhone burst onto the scene
and began gobbling up market share.
lessons for companies across industries. Firms that
fail to create platforms and don’t learn the new rules
of strategy will be unable to compete for long.
Pipeline to Platform
27. Platforms have existed for years. Malls link consum-
ers and merchants; newspapers connect subscrib-
ers and advertisers. What’s changed in this century
is that information technology has profoundly re-
duced the need to own physical infrastructure and
assets. IT makes building and scaling up platforms
vastly simpler and cheaper, allows nearly friction-
less participation that strengthens network effects,
and enhances the ability to capture, analyze, and
exchange huge amounts of data that increase the
platform’s value to all. You don’t need to look far
to see examples of platform businesses, from Uber
to Alibaba to Airbnb, whose spectacular growth
abruptly upended their industries.
Though they come in many varieties, platforms
all have an ecosystem with the same basic struc-
ture, comprising four types of players. The owners
of platforms control their intellectual property and
governance. Providers serve as the platforms’ inter-
face with users. Producers create their offerings, and
consumers use those offerings. (See the exhibit “The
Players in a Platform Ecosystem.”)
To understand how the rise of platforms is trans-
forming competition, we need to examine how plat-
forms differ from the conventional “pipeline” busi-
nesses that have dominated industry for decades.
Pipeline businesses create value by controlling a
linear series of activities—the classic value-chain
model. Inputs at one end of the chain (say, materials
from suppliers) undergo a series of steps that trans-
form them into an output that’s worth more: the
finished product. Apple’s handset business is essen-
tially a pipeline. But combine it with the App Store,
the marketplace that connects app developers and
28. iPhone owners, and you’ve got a platform.
56 Harvard Business Review April 2016
PIPELINES, PLATFORMS, AND THE NEW RULES OF
STRATEGY
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 market-
place, 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 orches-
tration. The resource-based view of competition
holds that firms gain advantage by controlling scarce
and valuable—ideally, inimitable—assets. In a pipe-
line 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 mem-
bers 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
29. an entire chain of product activities, from materi-
als 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 pro-
cesses 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 prod-
ucts and services, who, in effect, sit at the end of a
linear process. By contrast, platforms seek to maxi-
mize 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 dif-
ferently, and new factors come into play. To manage
them, executives must pay close attention to the in-
teractions on the platform, participants’ access, and
new performance metrics.
We’ll examine each of these in turn. But first let’s
look more closely at network effects—the driving
force behind every successful platform.
30. The Power of Network Effects
The engine of the industrial economy was, and re-
mains, supply-side economies of scale. Massive
fixed costs and low marginal costs mean that firms
achieving higher sales volume than their competi-
tors have a lower average cost of doing business.
That allows them to reduce prices, which increases
Idea in Brief
THE SEA CHANGE
Platform businesses that
bring together producers
and consumers, as Uber and
Airbnb do, are gobbling up
market share and transforming
competition. Traditional
businesses that fail to create
platforms and to learn the new
rules of strategy will struggle.
THE NEW RULES
With a platform, the critical
asset is the community
and the resources of its
members. The focus of
strategy shifts from controlling
to orchestrating resources,
from optimizing internal
processes to facilitating
external interactions, and from
increasing customer value to
maximizing ecosystem value.
THE UPSHOT
In this new world, competition
can emerge from seemingly
31. unrelated industries or from
within the platform itself.
Firms must make smart
choices about whom to let
onto platforms and what
they’re allowed to do there,
and must track new metrics
designed to monitor and
boost platform interactions.
When a platform
enters the market
of a pure pipeline
business, the
platform virtually
always wins.
HBR.ORG
April 2016 Harvard Business Review 57
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 increas-
ing 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.
32. 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 develop-
ment, 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 cre-
ates 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 custom-
ers, 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.
33. How Platforms Change Strategy
In pipeline businesses, the five forces are relatively
defined and stable. If you’re a cement manufacturer
or an airline, your customers and competitive set
are fairly well understood, and the boundaries sepa-
rating your suppliers, customers, and competitors
are reasonably clear. In platform businesses, those
boundaries can shift rapidly, as we’ll discuss.
Forces within the ecosystem. Platform par-
ticipants—consumers, producers, and providers—
typically create value for a business. But they may
defect if they believe their needs can be met better
elsewhere. More worrisome, they may turn on the
platform and compete directly with it. Zynga began
as a games producer on Facebook but then sought
to migrate players onto its own platform. Amazon
and Samsung, providers of devices for the Android
platform, tried to create their own versions of the
operating system and take consumers with them.
The new roles that players assume can be either
accretive or depletive. For example, consumers
and producers can swap roles in ways that gener-
ate 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
SPOTLIGHT ON HOW PLATFORMS ARE RESHAPING
BUSINESS
THE PLAYERS IN A PLATFORM ECOSYSTEM
A platform provides the infrastructure and rules for a
marketplace
that brings together producers and consumers. The players in
the
34. ecosystem fill four main roles but may shift rapidly from one
role to
another. Understanding the relationships both within and
outside
the ecosystem is central to platform strategy.
PLATFORM
PROVIDERS
OWNER
PRODUCERS CONSUMERS
BUYERS OR USERS
OF THE OFFERINGS
CREATORS OF THE
PLATFORM’S OFFERINGS
(FOR EXAMPLE, APPS ON ANDROID)
INTERFACES FOR
THE PLATFORM
(MOBILE DEVICES ARE
PROVIDERS ON ANDROID)
CONTROLLER OF
PLATFORM IP AND
ARBITER OF WHO
MAY PARTICIPATE
AND IN WHAT WAYS
(GOOGLE OWNS ANDROID)
VALUE AND DATA EXCHANGE
35. AND FEEDBACK
58 Harvard Business Review April 2016
customers the next. In contrast, providers on a plat-
form may become depletive, especially if they decide
to compete with the owner. Netflix, a provider on
the platforms of telecommunication firms, has con-
trol of consumers’ interactions with the content it of-
fers, so it can extract value from the platform owners
while continuing to rely on their infrastructure.
As a consequence, platform firms must con-
stantly encourage accretive activity within their eco-
systems while monitoring participants’ activity that
may prove depletive. This is a delicate governance
challenge that we’ll discuss further.
Forces exerted by ecosystems. Managers of
pipeline businesses can fail to anticipate platform
competition from seemingly unrelated industries.
Yet successful platform businesses tend to move
aggressively into new terrain and into what were
once considered separate industries with little warn-
ing. Google has moved from web search into map-
ping, mobile operating systems, home automation,
driverless cars, and voice recognition. As a result of
such shape-shifting, a platform can abruptly trans-
form an incumbent’s set of competitors. Swatch
knows how to compete with Timex on watches but
now must also compete with Apple. Siemens knows
how to compete with Honeywell in thermostats but
now is being challenged by Google’s Nest.
36. 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 communi-
ties, and those communities can be leveraged. Given
Google’s relationship with consumers, the value its
network provides them, and its interest in the in-
ternet of things, Siemens might have predicted the
tech giant’s entry into the home-automation market
(though not necessarily into thermostats). Second,
a competitor may target an overlapping customer
base with a distinctive new offering that leverages
network effects. Airbnb’s and Uber’s challenges to
the hotel and taxi industries fall into this category.
PIPELINES, PLATFORMS, AND THE NEW RULES OF
STRATEGY
Networks Invert the Firm
Pipeline firms have long outsourced aspects of their internal
functions, such as customer service. But
today companies are taking that shift even further, moving
toward orchestrating external networks that
can complement or entirely replace the activities of once-
internal functions.
Inversion extends outsourcing: Where
firms might once have furnished design
specifications to a known supplier, they
now tap ideas they haven’t yet imagined
from third parties they don’t even
know. Firms are being turned inside
out as value-creating activities move
beyond their direct control and their
37. organizational boundaries.
Marketing is no longer just about
creating internally managed outbound
messages. It now extends to the creation
and propagation of messages by
consumers themselves. Travel destination
marketers invite consumers to submit
videos of their trips and promote them
on social media. The online eyeglasses
retailer Warby Parker encourages
consumers to post online photos of
themselves modeling different styles
and ask friends to help them choose.
Consumers get more-flattering glasses,
and Warby Parker gets viral exposure.
Information technology, historically
focused on managing internal enterprise
systems, increasingly supports external
social and community networks.
Threadless, a producer of T-shirts,
coordinates communication not just
to and from but among customers,
who collaborate to develop the best
product designs.
Human resources functions at
companies increasingly leverage the
wisdom of networks to augment internal
talent. Enterprise software giant SAP has
opened the internal system on which
its developers exchange problems and
solutions to its external ecosystem—to
developers at both its own partners and
38. its partners’ clients. Information sharing
across this network has improved
product development and productivity
and reduced support costs.
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.
Operations and logistics traditionally
emphasize the management of just-in-
time inventory. More and more often,
that function is being supplanted by
the management of “not-even-mine”
inventory—whether rooms, apps, or
other assets owned by network
participants. Indeed, if Marriott, Yellow
Cab, and NBC had added platforms to
39. their pipeline value chains, then Airbnb,
Uber, and YouTube might never have
come into being.
April 2016 Harvard Business Review 59
HBR.ORG
SPOTLIGHT ON HOW PLATFORMS ARE RESHAPING
BUSINESS
The final pattern, in which platforms that collect
the same type of data that your firm does suddenly
go after your market, is still emerging. When a data
set is valuable, but different parties control different
chunks of it, competition between unlikely camps
may ensue. This is happening in health care, where
traditional providers, producers of wearables like
Fitbit, and retail pharmacies like Walgreens are all
launching platforms based on the health data they
own. They can be expected to compete for control of
a broader data set—and the consumer relationships
that come with it.
Focus. Managers of pipeline businesses focus on
growing sales. For them, goods and services deliv-
ered (and the revenues and profits from them) are
the units of analysis. For platforms, the focus shifts
to interactions—exchanges of value between pro-
ducers 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
40. source of competitive advantage.
With platforms, a critical strategic aim is strong
up-front design that will attract the desired partici-
pants, 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 counterintui-
tive bottom line, given how much we stress the im-
portance of network effects, is that it’s usually wise
to ensure the value of interactions for participants
before focusing on volume.
Most successful platforms launch with a single
type of interaction that generates high value even if,
at first, low volume. They then move into adjacent
markets or adjacent types of interactions, increas-
ing both value and volume. Facebook, for example,
launched with a narrow focus (connecting Harvard
students to other Harvard students) and then opened
the platform to college students broadly and ulti-
mately to everyone. LinkedIn launched as a profes-
sional networking site and later entered new markets
with recruitment, publishing, and other offerings.
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
41. “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 re-
sources, 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 develop-
ers) 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 gover-
nance and then open up as they introduce new types
of interactions and sources of value. But every plat-
form must induce producers and consumers to in-
teract 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.
Some platforms encourage producers to create
high-value offerings on them by establishing a policy
of “permissionless innovation.” They let producers
invent things for the platform without approval but
guarantee the producers will share in the value cre-
ated. Rovio, for example, didn’t need permission to
create the Angry Birds game on the Apple operating
42. system and could be confident that Apple wouldn’t
steal its IP. The result was a hit that generated enor-
mous value for all participants on the platform.
However, Google’s Android platform has allowed
even more innovation to flourish by being more open
at the provider layer. That decision is one reason
Google’s market capitalization surpassed Apple’s in
early 2016 (just as Microsoft’s did in the 1980s).
However, unfettered access can destroy value
by creating “noise”—misbehavior or excess or low-
quality content that inhibits interaction. One com-
pany that ran into this problem was Chatroulette,
which paired random people from around the world
for webchats. It grew exponentially until noise
HARNESSING
SPILLOVERS
Positive spillover effects
help platforms rapidly
increase the volume
of interactions. Book
purchases on a platform,
for example, generate
book recommendations
that create value for
other participants on
it, who then buy more
books. This dynamic
exploits the fact that
network effects are
often strongest among
interactions of the same
type (say, book sales)
than among unrelated
interactions (say, package
43. pickup and yardwork in
different cities mediated
by the odd-job platform
TaskRabbit).
Consider ride sharing.
By itself, an individual
ride on Uber is high
value for both rider
and driver—a desirable
core interaction. As the
number of platform
participants increases,
so does the value Uber
delivers to both sides of
the market; it becomes
easier for consumers to
get rides and for drivers
to find fares. Spillover
effects further enhance
the value of Uber to
participants: Data from
riders’ interactions with
drivers—ratings of drivers
and riders—improves the
value of the platform to
other users. Similarly,
data on how well a given
ride matched a rider’s
needs helps determine
optimal pricing across
the platform—another
important spillover effect.
60 Harvard Business Review April 2016
44. HBR.ORG
60 Harvard Business Review April 2016
SPOTLIGHT ON HOW PLATFORMS ARE RESHAPING
BUSINESS
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 pre-
vent stalking, and Apple’s App Store and the Google
Play store both filter out low-quality applications.
Metrics. Leaders of pipeline enterprises have
long focused on a narrow set of metrics that capture
the health of their businesses. For example, pipe-
lines grow by optimizing processes and opening bot-
tlenecks; one standard metric, inventory turnover,
tracks the flow of goods and services through them.
Push enough goods through and get margins high
enough, and you’ll see a reasonable rate of return.
As pipelines launch platforms, however, the num-
bers to watch change. Monitoring and boosting the
performance of core interactions becomes critical.
45. Here are new metrics managers need to track:
Interaction failure. If a traveler opens the Lyft
app and sees “no cars available,” the platform has
failed to match an intent to consume with sup-
ply. Failures like these directly diminish network
effects. Passengers who see this message too often
will stop using Lyft, leading to higher driver down-
times, which can cause drivers to quit Lyft, resulting
in even lower ride availability. Feedback loops can
strengthen or weaken a platform.
Engagement. Healthy platforms track the partici-
pation of ecosystem members that enhances network
effects—activities such as content sharing and repeat
visits. Facebook, for example, watches the ratio of
daily to monthly users to gauge the effectiveness of
its efforts to increase engagement.
Match quality. Poor matches between the needs of
users and producers weaken network effects. Google
constantly monitors users’ clicking and reading to
refine how its search results fill their requests.
Negative network effects. Badly managed plat-
forms often suffer from other kinds of problems that
create negative feedback loops and reduce value.
For example, congestion caused by unconstrained
network growth can discourage participation. So
can misbehavior, as Chatroulette found. Managers
must watch for negative network effects and use
governance tools to stem them by, for example,
withholding privileges or banishing troublemakers.
Finally, platforms must understand the financial
46. 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 look-
ing beyond the traditional financials and metrics
when calculating the firm’s worth and potential.
This is a clear indication that the rules have changed.
BECAUSE PLATFORMS require new approaches to
strategy, they also demand new leadership styles.
The skills it takes to tightly control internal re-
sources just don’t apply to the job of nurturing
external ecosystems.
While pure platforms naturally launch with
an external orientation, traditional pipeline firms
must develop new core competencies—and a new
mindset—to design, govern, and nimbly expand
platforms on top of their existing businesses. The
inability to make this leap explains why some tradi-
tional business leaders with impressive track rec ords
falter in platforms. Media mogul Rupert Murdoch
bought the social network Myspace and managed it
the way he might have run a newspaper—from the
top down, bureaucratically, and with a focus more
on controlling the internal operation than on foster-
ing the ecosystem and creating value for participants.
In time the Myspace community dissipated and the
platform withered.
The failure to transition to a new approach ex-
plains the precarious situation that traditional busi -
nesses—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
47. platform world, or begin planning your exit.
HBR Reprint R1604C
In 2016 private equity
markets gave Uber
a valuation higher
than GM’s.
62 Harvard Business Review April 2016
HBR.ORG
62 Harvard Business …