Successful digital marketplaces tend to attract other players too, not just buyers and sellers. When a market reaches a certain scale, suddenly all sorts of new services and business concepts emerge:
promoters, marketers, customer acquisition experts, packagers and merchandisers, advertisers and campaign managers, data brokers, and vendors of tools to manage the bidding process and tools to search across multiple marketplaces. In order for everyone to participate, they must speak the same language, use the same currency, and abide by the same laws. These disparate parties demand a standardized way to transact. When this occurs, the switchboard market evolves again. It becomes a platform.
We use the term “platform” because the market quite literally provides a base for others to build a business. Platforms are different from basic switchboard markets because they are multi-sided. They connect many different types of companies transacting with many different types of customers, and many ways to get paid or exchange value of some kind.
This is not a new idea. Computing platforms have existed as long as there has been software.
Personal digital assistants (PDAs) and game consoles are types of platforms. The first and most fundamental digital platform is the computer operating system.
In the early days of mainframe computers, when instructions were hand-fed into the computer via punch cards and later magnetic tape, there were no operating systems. Instead, each program
contained a complete set of instructions to the machine. But as computing proliferated and many more users began to demand a variety of software programs for specific purposes, this arrangement quickly grew inefficient. The solution was to write a set of instructions that provided general-purpose
commands to the computer that were consistent across every program. This was the genesis of the operating system (OS).
The OS emerged as a kind of buffer layer between the central processor and the software programs.
While running in the background, it enabled all of the applications to work smoothly and consistently, and so provided a valuable service both to developers and the people who used computers. Then, during the era of personal computers (PCs), operating systems evolved into a proprietary wedge of software between the hardware and the applications. This gave Microsoft, the leading provider of operating systems for personal computers, a measure of control over the application developers.
Developers’ software couldn’t talk to the machine without going through Microsoft’s proprietary OS, Windows. In order to get access to the core function of the computer, developers had to deal with Microsoft. That’s one way that Microsoft managed to exert control over the PC business.
The combination of applications and operating system made the PC much more useful to the end consumer. And that meant that the combination was also immensely valuable to the companies that made the hardware: without an operating system and a rich array of applications, there would be zero demand for the personal computer. That’s another way that Microsoft exerted control over the PC
business: it was able to extract huge license fees from the companies that made computers.
The operating system became a software platform. In essence, the Windows operating system served as a switchboard market that connected computer manufacturers with application developers.
Microsoft turned the operating-system-cum-platform into a value control point and extracted monopoly rent from both sides for decades.
With the smartphone, this platform concept goes into overdrive—more than a million apps are no further away than a pocket or a purse. Every day, no matter the situation, there is an app to help. And
every one of those apps adds to the perceived value of the software platform in the mobile device. To reach customers and provide that value, the app maker must go through the company that controls the operating system on the mobile device.
It can be risky to expose the operating system to outside parties: in the hands of an incompetent or malicious coder, the computer could be damaged. For this reason, an OS provider like Microsoft will typically provide developers with a set of tools called application programming interfaces (APIs).
These tools act as a buffer, providing a way for applications to talk (interface) with the operating system safely without opening the computer up to harmful commands; APIs also serve as the glue that binds all of the creative activity to the platform. When developers use the API and toolkits to write their apps, the end result is hardwired to the OS: if the APIs are cut off, the app simply won’t work.
The APIs enable the platform owner to aggregate the collective efforts of lots of developers. That makes the platform more valuable to the end user, and the platform owner in the middle can then rake a fee or tax off all transactions.
BUILDING A STICKY DIGITAL PLATFORM BUSINESS
Switchboards compete by being the most efficient connection mechanism. An entire industry really only needs one: the one that matches sellers the fastest and most efficiently with the market they seek.
This is the first step towards winner-take-all. When it works, this switchboard blocks the second-best by locking in the best customers.
Marketplaces compete on efficient transactions; by having the biggest collection of buyers and sellers, or seekers and providers. The most efficient market crowds out the others as it attracts more participants and reduces the time to revenue.
Launching a platform business means thinking carefully and imaginatively about pricing,
specifically where to charge and how much, and who to charge. Who gets in free? Who pays? And how much? Every day, startup ventures attempt to become platforms. Many fail because they don’t master the switchboard + market principle first.
It’s a game of “attract ’em and keep ’em.” To attract customers, a business must offer better value for the money, time, or effort invested and superior ease of use. To attract developers, the platform owner must offer well-documented, stable APIs; a scalable software platform with superior
performance; the shortest time to revenue; and the greatest base of likely prospects.
To keep them, the platform owner must make it painful to switch to another system. The term
“switching costs” is used to describe tactics that lock both sides of the market into the platform. One switching cost is the time it takes a new customer to learn how to use the platform. The consumer’s learning curve is an investment in learning how to use the service; if she switches to another service, she must sacrifice the time and effort invested in learning. Likewise, the merchant’s investment in building up a presence in the marketplace is expensive in terms of time and effort: if it were to switch to another platform, the process would be quite painful.
Unless the marketplace fails spectacularly, the twin forces of inertia and stickiness tend to keep users locked in. Generally consumers don’t switch until somebody builds a much better mousetrap.
And if that happens, be prepared for a mass exodus.
STRATEGIES FOR MIDDLEMEN
In many industries, intermediaries control most of the transactions. Digital networks are different
because they tend to push the levers of control from the middle out towards the ends of the value chain: to creators and consumers. In offline markets (what we sometimes call real-world markets), there is often information asymmetry that reinforces the power of the middlemen. Agents and brokers, the middlemen in a transaction, tend to know more than any buyer or seller what is happening in the broader marketplace, which gives them the ability to influence and control individual transactions.
For instance, the Multiple Listing Service (MLS) of properties for sale was previously available only to real estate agents: this inside information enabled brokers to control transactions in the real estate market. Similarly, market makers who control trading on the NASDAQ Stock Market are another
example.
The information asymmetry advantage enjoyed by middlemen is a kind of inefficiency. But in the vaporized world, the switchboard is designed to remove inefficiency. Free-flowing information is available to all participants. As a result, switchboard marketplaces tend to erode the power of middlemen, brokers, agents, and bundlers, sometimes eliminating them entirely. In the end there is only one big middleman: the platform owner, who extracts a toll on every transaction.
What if your business is a broker-type of business? Can you still play a role? Sure. You just need to find a new way to add more value when customers have access to the same information you do.
Brokers still have expertise, experience, insight, know-how, historical knowledge, and pattern
recognition: they may end up offering a different service but that can be valuable in a noisy, complex market with lots of diverse offerings that are hard to compare.
One middleman survival strategy is to complexify the market or the products so that only experts can play the game. That’s what Wall Street bankers managed to do with derivatives, a financial instrument whose price depends upon one or more underlying assets subject to changing conditions that are nearly impossible to predict. Wall Street brokers lost their information advantage when the Internet made it possible for day traders to execute simple trades on desktop computers at home. So Wall Street began to create products like derivatives that were so complex that the punters at home couldn’t play.
Another strategy is to use government. Regulations distort markets. Many regulations are written or influenced by insiders: these tend to favor incumbents who write the rules. For example, real estate brokers still manage to get paid nowadays when everyone has a mobile house-hunting app. That’s because the law requires that a lot of complicated paperwork be signed by both parties. Although these piles of paper are mandated by regulations, ostensibly to protect consumers, they have the side effect of making it harder for people to do their own real estate transactions without a broker.
Sometimes regulations can force a digital transaction back into the physical world. For instance, a customer might shop for a car online, work out all the details on price, and then learn that she still must drive to the dealership to sign the lease. The idea is to force the consumer out of the digital world back into the old physical world where the incumbents still have an advantage. The same thing happens when a customer shops for a loan on the Internet: typically she is obliged to visit the bank in person to complete the transaction.
But these tactics are anti-consumer. They go against the grain of freedom and flexibility
characteristic of digital media. And they are inefficient. In the long run, they are doomed because the benefits of operating efficiently in the Vaporized Economy are so much greater that some innovator somewhere will devise a way to bypass the roadblocks. In Chapter 8 we’ll explore some of these innovations.
There is an alternative to complexification. It’s a pro-consumer strategy: offer better service, solve a problem, find something unique or different, deliver a much better price than the consumer can find on her own, or sort through all of the many confusing options for him. When I book my air travel, I tend to get a better price or a better seat through my travel agent than I am able to find online. As a result, I am quite happy to pay her commission. It takes a lot of hustle, but it is possible for a broker or agent to thrive without ripping off consumers.