The Danger of Betting Your Business On a Platform

There are very good reasons why there are so few great platform businesses. JL

Greg Satell reports in Digital Tonto:

Platform businesses don't need significant investment in physical assets to get started, (but) have few barriers to entry. Although network effects make platform businesses almost infinitely scalable, they also result in winner-take-all markets in which one player does well, but many others go bankrupt. The combination of low-barriers to entry and winner-take-all markets makes platform businesses hyper-competitive, which often leads to extremely high marketing costs.
Hertz is a nearly 100 year-old business valued at about $2 billion. Uber is an 8 year-old business valued at $50 billion. Marriott is a 90 year-old business, with hotels all over the world, and is valued at $39 billion, while AirBnB achieved a similar value in just 11 years and doesn't own any rooms at all.
As Barry Libert, Megan Beck, and Jerry Wind point out in an article in Harvard Business Review, many businesses today are finding that they can achieve massive valuations by leveraging platforms based on "digital, intellectual, and relationship assets" rather than physical assets to "harness the power of networks."
They're not the only ones. A number of recent books, including The Network Imperative, by the aforementioned authors, Matchmakers and The Platform Revolution, tout the benefits on low-asset platform businesses over traditional "pipeline" businesses. Yet platforms are not a panacea and businesses based on them have a number of vulnerabilities that aren't always obvious.
1. Lack Of Barriers To Entry
While it's true that platform businesses don't need significant investment in physical assets to get started, they also have few barriers to entry. Traditional pipeline businesses, on the other hand, are often able to leverage significant competitive advantages from their physical assets.
A company like Marriott, for example, owns hotels in prime locations in business districts and resort areas. If you want to plan a conference, event or to have your every need catered to on a beach getaway, you have little choice but to go to Marriott or one of its competitors. Because of high barriers to entry, Marriott's investment in prime real estate provides it with an advantage.
AirBnB, on the other hand, is great if you just want a room with few amenities, but can't do much else for you. That's a significant limitation. AirBnB's estimated revenues of $2.8 billion are impressive, but still represent less than 1% of the $500 billion hospitality industry. There's a lot of money to be made in the other 99% of the market.
2. Winner-Take-All Leaves A Lot Of Losers
Although network effects make platform businesses almost infinitely scalable, they also result in winner-take-all markets in which one player does well, but many others go bankrupt. Meanwhile, while traditional pipeline business like Walmart and Disney might lack the pizazz of platforms, they tend to be far more stable.
This asymmetry often leads to rosy perceptions because, while we all notice the Amazons and YouTubes of the world, we scarcely notice all the less fortunate companies that didn't make it. This results in survivorship bias that often skews investment decisions.
To understand the danger, remember the ill-fated AOL-Time Warner merger. Back then, the capital intensive Time Warner business looked like a dinosaur compared to AOL's ability to position itself in between consumers' eyeballs and the content they craved. Yet as it quickly became clear, Time Warner's business was far more valuable.
What investors missed was that while AOL had built an impressive brand that attracted large audiences, those customers could easily go somewhere else. Time Warner, on the other hand, with its media libraries and production facilities, had the ability to produce unique value that can't easily be duplicated.
3. Rabid Competition Leads To High Costs
The combination of low-barriers to entry and winner-take-all markets makes platform businesses hyper-competitive, which often leads to extremely high marketing costs. Unlike investing in physical capital, this kind of investment produces little lasting value and can make platform businesses incredibly capital intensive.
To understand how this can play out take a look at Uber.  Yes, the company has driven down the cost of taxis, but it has lost billions in the process. It's not at all clear whether it has actually built a sustainable business model or is just in a predatory race to drive competitors out of the market so that it can use its monopoly power to drive prices back up again.Sure, it may eventually become profitable, but there is no guarantee that it ever will. Ten years from now, we might wonder how Uber, much like Groupon and many others, managed to burn through so much money and create so little value. With so much risk inherent in platform businesses, nice safe physical assets can start to look pretty attractive.
The True Value Of Platforms
None of this should be taken to mean that platforms aren't valuable. They clearly are and some wonderful business have been built on top of them them. But the real value of platforms isn't that a few kids with laptops can disintermediate industries but, as I explain in my book Mapping Innovation, that they allow us to connect with ecosystems of talent, technology and information.
For example, technology companies often open source their technologies in order to access far more talent than they ever could internally. At the same time, platforms like Linux, Apache and others allow firms to access ecosystems of technology. BloomReach is a platform that helps retail businesses access ecosystems of information to better compete with Amazon online.
Sun Microsystems cofounder Bill Joy famously said that "no matter who you are, most of the smartest people work for someone else" and that's clearly true, but it doesn't go nearly far enough. The best of almost everything resides outside your firm and the best way to access all of that good stuff is by using platforms to access ecosystems.
However, the basic laws of business have not changed. You still need to create, deliver and capture value in order to compete. In some cases, the best way to do that will be a platform, but in the vast majority of cases it will not be.