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 Robeco Capital Growth Funds have not been registered under the United States Investment Company Act of 1940, as amended, nor or the United States Securities Act of 1933, as amended. None of the shares may be offered or sold, directly or indirectly in the United States or to any U.S. Person (within the meaning of Regulation S promulgated under the Securities Act of 1933, as amended (the “Securities Act”)). Furthermore, Robeco Institutional Asset Management B.V. (Robeco) does not provide investment advisory services, or hold itself out as providing investment advisory services, in the United States or to any U.S. Person (within the meaning of Regulation S promulgated under the Securities Act).
This website is intended for use only by non-U.S. Persons outside of the United States (within the meaning of Regulation S promulgated under the Securities Act who are professional investors, or professional fiduciaries representing such non-U.S. Person investors. By clicking “I Agree” on our website disclaimer and accessing the information on this website, including any subdomain thereof, you are certifying and agreeing to the following: (i) you have read, understood and agree to this disclaimer, (ii) you have informed yourself of any applicable legal restrictions and represent that by accessing the information contained on this website, you are not in violation of, and will not be causing Robeco or any of its affiliated entities or issuers to violate, any applicable laws and, as a result, you are legally authorized to access such information on behalf of yourself and any underlying investment advisory client, (iii) you understand and acknowledge that certain information presented herein relates to securities that have not been registered under the Securities Act, and may be offered or sold only outside the United States and only to, or for the account or benefit of, non-U.S. Persons (within the meaning of Regulation S under the Securities Act), (iv) you are, or are a discretionary investment adviser representing, a non-U.S. Person (within the meaning of Regulation S under the Securities Act) located outside of the United States and (v) you are, or are a discretionary investment adviser representing, a professional non-retail investor. Access to this website has been limited so that it shall not constitute directed selling efforts (as defined in Regulation S under the Securities Act) in the United States and so that it shall not be deemed to constitute Robeco holding itself out generally to the public in the U.S. as an investment adviser. Nothing contained herein constitutes an offer to sell securities or solicitation of an offer to purchase any securities in any jurisdiction. We reserve the right to deny access to any visitor, including, but not limited to, those visitors with IP addresses residing in the United States.
This website has been carefully prepared by Robeco. The information contained in this publication is based upon sources of information believed to be reliable. Robeco is not answerable for the accuracy or completeness of the facts, opinions, expectations and results referred to therein. Whilst every care has been taken in the preparation of this website, we do not accept any responsibility for damage of any kind resulting from incorrect or incomplete information. This website is subject to change without notice. The value of the investments may fluctuate. Past performance is no guarantee of future results. If the currency in which the past performance is displayed differs from the currency of the country in which you reside, then you should be aware that due to exchange rate fluctuations the performance shown may increase or decrease if converted into your local currency. For investment professional use only. Not for use by the general public.