Over the last few years, we have witnessed the meteoric rise of new businesses such as Airbnb, Uber and Alibaba, which have been able to build a global presence in just a few years. A common feature of these upstarts is that they operate as a mediator between value creators and value consumers that would not, or to a much lesser extent, have interacted without the platform.
The virtual nature of the networks and meeting places means that it is much easier to grow these businesses than businesses that employ physical assets. The world's five largest companies in terms of market capitalization today, i.e. Apple, Alphabet, Microsoft, Amazon and Facebook, are all platform companies and have become household names in a very short time.
Platforms are not a modern invention. Real physical platforms like bank branches, airports or restaurants and bars have been around for quite some time. Physical market places, which go back to early civilization, can perhaps be considered the archetype of the platform business model.
What distinguishes modern platform companies from archetypal platform companies is the evolutionary leap forward in business reach made possible by the exponential increase in connectivity of the last 15 to 20 years. Modern information and communication technologies have turbo-charged the old platform business model and expanded its reach from mainly local to truly global. Commercial and social interaction that was impossible or prohibitively expensive in the past can now take place almost instantly and at very low cost. This has proven to be a huge game changer.
Platforms can generate a lot of economic value for their users. However, capturing a part of that economic value can be challenging for platform operators. An important part of the economic value created by the platform operator is the reduction of search costs. However, once a potential consumer and producer have found each other, there can be an incentive to go off platform, negotiate a private deal and avoid having to pay a commission to the platform operator. This is especially a problem for platforms that connect service providers with service consumers where often substantial sums of money are involved and the likelihood of repeat transactions is low.
In principle, platform operators can try to monetize by charging a transaction fee, charging for access, for enhanced access (e.g. premium articles on online newspapers) or for enhanced curation (e.g. vetting services for online dating services).
An additional monetization possibility is analyzing, leveraging and selling the data that platform traffic generates. This can potentially represent huge commercial value, but is fraught with privacy issues.
The market is characterized by some very large companies that completely overshadow the rest. This is a manifestation of increasing returns caused by the network effect that tends to lead to winner-takes-most/all outcomes.
Platform companies have already invaded many markets and increasingly start-ups adopt a platform business model. Where we can expect platforms to pop up next? In their book ‘Platform Revolution’ Choudary, Parker and Van Alstyne list four characteristics that make markets susceptible to platform disruption: information intensiveness, non-scalable gatekeepers, high level of fragmentation and large information asymmetries. Industries that tick many of the boxes are education, energy, finance, healthcare, labor services, logistics, and transportation.
Platform companies have generated extraordinary returns. Most of them have massively outperformed both the S&P500 and MSCI All Countries World Index over one, three and five years. This can largely be attributed to network effects, as a source of growth and competitive advantage. Once increasing returns from network effects kick in, growth becomes self-sustaining and requires very little capital. As a result, returns on invested capital improve and economic value creation soars.
In markets with winner-takes-most/all characteristics, growth is only limited by the market’s size. As the network’s size grows, scale advantages grow as well, raising entry barriers and extending the competitive advantage period while further compounding profitability. Finally, as users become ever more embedded in the network, switching costs tend to rise as well, adding to the competitive advantage.
The main task for investors is to develop an understanding of the nature of the network effect in combination with the cost of multi-homing and switching costs for users. In addition, careful examination of the monetization and governance model a company employs, is required to get a full understanding of the strengths and weaknesses of platform companies.
Once a platform has reached critical size, it becomes very difficult to dislodge, provided company management doesn't slip up too badly. Investors can usually look forward to a long period of value creation. Two risks should be monitored, however. One is the introduction of Schumpeterian improvements in functionality by competing platforms. While this does happen from time to time, it seems a fairly remote risk as a platform’s main functionality is finding a match, which, by definition, a successful platform already does.
The second is the risk of envelopment by another platform. This means that one platform provider moves into another one's market, combining its own functionality with the target's, to form a multi-platform bundle. This is possible if there is significant overlapping in user bases and/or there are significant economies of scope. Envelopment is a risk investors should be aware of.
This report is not available for users from countries where the offering of foreign financial services is not permitted, such as US Persons.
Your details are not shared with third parties. This information is exclusively intended for professional investors. All requests are checked.
The content displayed on this website is exclusively directed at qualified investors, as defined in the swiss collective investment schemes act of 23 june 2006 ("cisa") and its implementing ordinance, or at “independent asset managers” which meet additional requirements as set out below. Qualified investors are in particular regulated financial intermediaries such as banks, securities dealers, fund management companies and asset managers of collective investment schemes and central banks, regulated insurance companies, public entities and retirement benefits institutions with professional treasury or companies with professional treasury.
The contents, however, are not intended for non-qualified investors. By clicking "I agree" below, you confirm and acknowledge that you act in your capacity as qualified investor pursuant to CISA or as an “independent asset manager” who meets the additional requirements set out hereafter. In the event that you are an "independent asset manager" who meets all the requirements set out in Art. 3 para. 2 let. c) CISA in conjunction with Art. 3 CISO, by clicking "I Agree" below you confirm that you will use the content of this website only for those of your clients which are qualified investors pursuant to CISA.
Representative in Switzerland of the foreign funds registered with the Swiss Financial Market Supervisory Authority ("FINMA") for distribution in or from Switzerland to non-qualified investors is ACOLIN Fund Services AG, Affolternstrasse 56, 8050 Zürich, and the paying agent is UBS Switzerland AG, Bahnhofstrasse 45, 8001 Zürich. Please consult www.finma.ch for a list of FINMA registered funds.
Neither information nor any opinion expressed on the website constitutes a solicitation, an offer or a recommendation to buy, sell or dispose of any investment, to engage in any other transaction or to provide any investment advice or service. An investment in a Robeco/RobecoSAM AG product should only be made after reading the related legal documents such as management regulations, articles of association, prospectuses, key investor information documents and annual and semi-annual reports, which can be all be obtained free of charge at this website, at the registered seat of the representative in Switzerland, as well as at the Robeco/RobecoSAM AG offices in each country where Robeco has a presence. In respect of the funds distributed in Switzerland, the place of performance and jurisdiction is the registered office of the representative in Switzerland.
This website is not directed to any person in any jurisdiction where, by reason of that person's nationality, residence or otherwise, the publication or availability of this website is prohibited. Persons in respect of whom such prohibitions apply must not access this website.