Platform Economics

From the Economist this week:

As a result, the rules in many industries, from construction equipment to cars, are changing: making things matters less and knowing things more. In many cases the successful companies will no longer be the ones that make the best products, but the ones that gather the best data and combine them to offer the best digital services. And the biggest winners of all may be those that control a “platform”, a layer of software that combines different kinds of devices, data and services, on top of which other firms can build their own offerings…

A more detailed explanation of platform economics can be found here in the MIT Technology Review, which answers,

How can I tell if a business is a platform?

If you produce the value, then you are a classic product company. But there are new systems where value is being created outside the firm, and that’s a platform business.

Apple gets 30 percent of the cut from other people’s innovations in its app store. I define a platform as a published standard that lets others connect to it, together with a governance model, which is the rules of who gets what.

Business platforms are often engaged in consummating a match. It’s a match between riders and drivers with Uber. It’s between travelers and spare capacity of guest rooms in Airbnb.

There is a strong argument that platforms beat products every time. Think of how the iPhone is absorbing the features of the voice recorder, the calculator, and game consoles. The reason for this is that as a stand-alone product, you’re going to have a certain pace of innovation. But if you have opened your product so that third parties can add value, and you have designed the rules of the ecosystem such that they want to, your innovation curve is going to be faster.

To me this means there are huge opportunities to take away business from existing players in all different kinds of goods. Or for existing players to expand their markets if they are paying attention.

In many cases, the governance models have not been established. For instance, population density can be determined by mobile-phone distribution. A telecom company owns that data. How do you motivate them to share it?

All these sensors are capturing data, but how do you divide the value?

Those are the rules that need to be worked out, and that’s the missing piece of most of these discussions about the Internet of things. You have to build economic incentives around it, not simply connectivity.

From Coase and The Sharing Economy,

Thus it is important to recognise that the changes we are observing are not simply driven by passive, exogenous changes in transactions costs.

Coase (2000) was himself rather scornful of the notion that transactions costs were a definable, measurable variable that should be seen as driving economic change. The key factor is the innovation in software platforms that reduce the costs of the entire transaction to the point where that activity is now profitable for the entrepreneur and beneficial for the consumer.

The transaction is paid for within the software itself, and both you and the renter (who may just be a private citizen who happened to have a drill) will rate each other. Services like this already exist in many cities for high-quality bicycles, luggage, clothing and appliances.

As transactions costs are reduced by software platforms, enormous value is created for consumers and entrepreneurs grow rich.

 

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