How to compete and beat network effects (PART 2)
Updated: Nov 14, 2020
Increasingly we are seeing markets being disrupted by platform businesses of different natures, to the point that more often than not we see multiple firms with network effects compete against each other.
I remain convinced that every firm in the world today falls in one of these three categories:
1. Platform businesses
2. Businesses that are planning to transform into a platform
3. Businesses who plan to collaborate with platforms
As the question sifts from "how to build a marketplace with network effects" to "how to beat an already thriving marketplace", the second blogpost of this series aims to explore three interrelated ways of competing against firms with network effects.
Be the Platform not the Marketplace
There is a subtle but key difference between these two models. While marketplaces can be extremely disruptive in a relatively short amount of time, platform tend to be more successful in the long run.
Marketplaces generally tend to aggregate one side of the market, (usually supply), and commoditise the other, (usually demand). Taxi rides here are a good examples, as passengers don’t really care who drives them from A to B, as long as the service is standardised, (safe, timely and attractively priced). On the other hand in many cities car drivers depend heavily on firms like Uber to bring them passengers and have close to zero negotiating power.
We have seen a similar dynamic in the hotel sector with Booking.com. The Dutch firm has been extremely good at gaining huge market share, which has made many hoteliers depend on the flow of customers coming from their website, (which often generated more than 35% of total stays). This in turn put Booking.com in the position of demanding and getting a very high share of revenue. Amazon’s model is almost identical: the retail giant has aggregated huge demand, to the extent that some retailers can’t afford not to be present on the platform, even if it means being commoditised and competing directly on price, (often vs Amazon itself).
This model works, It’s undeniable, but it comes with limitations.
Much has been written about the cannibalistic / conflictual relationship between such marketplaces and its customers. First the product is offered for free, then it’s charged for, then customers are replaced entirely. Think Amazon with its own brand of batteries, Google with advertisers, or Uber planning to replace drivers with autonomous vehicles. This sort of relationship leads to what’s called “bad profit”: a dynamic whereby customers may decide to be present within a platform because they need to, but they will try and avoid it in any way possible.
Platform businesses, (vs marketplaces), operate differently. Their goal is to attract supply by giving them the tools to reach demand. Platforms may be completely obscure to the final customer on the demand side, Shopify being a prime example here, (possibly Amazon’s main competitor in e-commerce).
Shopify gives retailers the tools to develop an online sales channel: website builder, marketing tools, logistic support, admin services, integration into digital distribution channels and creative services. Many services are then outsourced with a marketplace model: Shopify’s customers have access to a broad range of website designers, (templates), apps, photographers etc. Shopify is also partnering with Walmart to enhance online sales and with facebook to power the new e-commerce channel for brands. Unlike Amazon, Shopify is designed for attraction and collaboration: customers of Shopify have no incentive to leave the platform.
Uber has been extremely successful in its expansion, less so in delivering profits, to the point that some argue the jury is still out on whether it can be considered a successful business. What I find particularly interesting is how they are trying to transform themselves.
In 2014, Travis Kalanick, Founder and then CEO of Uber said at the Re/code conference that he would happily replace his Uber drivers with a fleet of autonomous vehicles. At the Hyper Growth conference in 2019 in San Francisco the following slide was presented by an Uber exec:
And in December 2019 the following content appeared on their website:
This goes to show the U-turn in approach from Uber to its drivers. From conflictual, (we will replace you as soon as we can), to “we care about you and your family” and “we give you the tools to build your future”. While they may not be a true platform yet, Uber’s intent in going into that direction is clear. In Asia, Grab, a mobility player who build a closer relationship with drivers, has managed to become a super-app offering services that go well beyond mobility - and with a much higher profit margin!
While transformation is never an easy task, adopting a platform model is a viable options for incumbent players looking to compete with existing marketplaces.
Build and own the delivery channel
This is about building hardware. When a firm owns the right technical capabilities, it's an extremely powerful strategy.
If Search was dominated by Google, Amazon created a new interface for interrogation: the Amazon echo. The echo is a voice activated interface which completely disrupts the Search experience for some user cases. Today there is an ecosystem of app developers working to enhance the Alexa user experience through the Alexa app store (platform play).
This strategy does not come without risk however - Amazon attempt at launching a mobile phone device failed quickly.
My favourite example in this category is the fitness space, where we see four things happening:
1. Marketplaces popping up joining trainers and trainees. This is accelerated by the pandemic but most of these initiatives are likely to fail, as naturally a market can only sustain a few marketplaces
2. Firms using AI to replace fitness instructors
3. Firms enabling gyms to go online (these can classify as platforms)
4. New connected and interactive devices for training
In this fourth category Peloton is the most well-known: the connected home exercise bike. In my opinion however the most interesting firm is Mirror.co
The company has build a new type of device: a flat touch-screen with an added voice functionality. When not in use the device is non intrusive and has its purpose as a full body mirror. In use it can be a television, a voice or touch activated computer and of course a training platform, where on one side is a trainer and on the other a trainee. The two of course can be connected through a marketplace model.
(Mirror.co was recently purchased by sportswear brand Lululemon, a company who had no capability in building hardware. It will be interesting to see how this develops).
Vaha is a German start-up that has built a similar device to mirror.co and have recently launched. While they may a be late joiner in the fitness marketplace competition, their hardware product can give them a meaningful edge over most existing players who may have already developed network effects.
Another example of this strategy is Snap.inc getting into glasses to compete with Instagram.
Disruption and S curves
3D printing, AR/VR, blockchain, quantum computing, AI, 5G, IoT are just some of the new technologies that are about to revolutionise our world – but for the most part we don’t yet know how.
What we have learned from disruption theory is that initially a new technology solves a particular user case for a niche audience. Generally the new solution under performs in many dimensions compared to other products in the market, but because it solves well a specific problem for a particular set of users, it finds a market. With time and money the technology improves, catching up on all dimension with existing market players and superseding them in overall value created thanks to the innovative use of new technologies.
Leveraging technological developments to disrupt markets can take many routes. As we have seen above, in the fitness space some start-ups are using AI to replace personal trainers, others are using voice recognition to create new interfaces. There are also hybrid solutions, for example using AI to empower trainers in delivering better results, (platform approach), or using big data and AI for better matchmaking between trainer and trainee (marketplace).
Fundamentally whenever new technology enables value creation along one of the dimensions that facilitate a marketplace, there is an opportunity for disruption. The amazon echo is a search engine that leverages speech recognition. Other examples can be blockchain for trust, AI for automation, speed and cost savings, AR/VR for enhancing the UX. Delic is a start-up in the music business that is using blockchain technology to radically improve royalties management - this naturally facilitates collaboration between different parties, creating attraction of an ecosystem that can develop into network effects.
Implementing new technology or building hardware both require certain capabilities which ma not be within the company - these however can be bought, (see Lululemon), or developed in partnership.
Stay tuned for the next post (number 3) on competing vs network effects !