Pipelines, Platforms, and the New Rules of Strategy PDF

SPOTLIGHT ON HOW PLATFORMS ARE RESHAPING BUSINESS SPOTLIGHT ARTWORK Vin Rathod, Aura (series) 2012–2014, photograph Pipelines, Platforms, and the New Rules of Strategy Scale now trumps differentiation. BY MARSHALL...

SPOTLIGHT ON HOW PLATFORMS ARE RESHAPING BUSINESS SPOTLIGHT ARTWORK Vin Rathod, Aura (series) 2012–2014, photograph Pipelines, Platforms, and the New Rules of Strategy Scale now trumps differentiation. BY MARSHALL W. VAN ALSTYNE, GEOFFREY G. PARKER, AND SANGEET PAUL CHOUDARY 54 Harvard Business Review April 2016  HBR.ORG Marshall W. Van Alstyne Business. He will be a is a professor and chair of professor of engineering the information systems at Dartmouth College, department at Boston effective July 2016. University and a fellow at Sangeet Paul Choudary the MIT Initiative on the is the founder and CEO Digital Economy. Geoffrey of Platform Thinking Labs G. Parker is a professor and an entrepreneur- of management science in-residence at INSEAD. at Tulane University They are the authors of and is a fellow at the Platform Revolution (W.W. MIT Center for Digital Norton & Company, 2016). SPOTLIGHT ON HOW PLATFORMS ARE RESHAPING BUSINESS B ack in 2007 the five major mobile-phone manufacturers—Nokia, Samsung, Motorola, Sony Ericsson, and LG—collectively controlled 90% of the industry’s global profits. That year, Apple’s iPhone burst onto the scene and began gobbling up market share. By 2015 the iPhone singlehandedly generated 92% lessons for companies across industries. Firms that of global profits, while all but one of the former fail to create platforms and don’t learn the new rules incumbents made no profit at all. of strategy will be unable to compete for long. How can we explain the iPhone’s rapid domi- nation of its industry? And how can we explain its Pipeline to Platform competitors’ free fall? Nokia and the others had Platforms have existed for years. Malls link consum- classic strategic advantages that should have pro- ers and merchants; newspapers connect subscrib- tected them: strong product differentiation, trusted ers and advertisers. What’s changed in this century brands, leading operating systems, excellent logis- is that information technology has profoundly re- tics, protective regulation, huge R&D budgets, and duced the need to own physical infrastructure and massive scale. For the most part, those firms looked assets. IT makes building and scaling up platforms stable, profitable, and well entrenched. vastly simpler and cheaper, allows nearly friction- Certainly the iPhone had an innovative design less participation that strengthens network effects, and novel capabilities. But in 2007, Apple was a weak, and enhances the ability to capture, analyze, and nonthreatening player surrounded by 800-pound exchange huge amounts of data that increase the gorillas. It had less than 4% of market share in desktop platform’s value to all. You don’t need to look far operating systems and none at all in mobile phones. to see examples of platform businesses, from Uber As we’ll explain, Apple (along with Google’s com- to Alibaba to Airbnb, whose spectacular growth peting Android system) overran the incumbents by abruptly upended their industries. exploiting the power of platforms and leveraging Though they come in many varieties, platforms the new rules of strategy they give rise to. Platform all have an ecosystem with the same basic struc- businesses bring together producers and consum- ture, comprising four types of players. The owners ers in high-value exchanges. Their chief assets are of platforms control their intellectual property and information and interactions, which together are governance. Providers serve as the platforms’ inter- also the source of the value they create and their face with users. Producers create their offerings, and competitive advantage. consumers use those offerings. (See the exhibit “The Understanding this, Apple conceived the iPhone Players in a Platform Ecosystem.”) and its operating system as more than a product or To understand how the rise of platforms is trans- a conduit for services. It imagined them as a way to forming competition, we need to examine how plat- connect participants in two-sided markets—app forms differ from the conventional “pipeline” busi- developers on one side and app users on the other— nesses that have dominated industry for decades. generating value for both groups. As the number Pipeline businesses create value by controlling a of participants on each side grew, that value in- linear series of activities—the classic value-chain creased—a phenomenon called “network effects,” model. Inputs at one end of the chain (say, materials which is central to platform strategy. By January from suppliers) undergo a series of steps that trans- 2015 the company’s App Store offered 1.4 million form them into an output that’s worth more: the apps and had cumulatively generated $25 billion finished product. Apple’s handset business is essen- for developers. tially a pipeline. But combine it with the App Store, Apple’s success in building a platform business the marketplace that connects app developers and within a conventional product firm holds critical iPhone owners, and you’ve got a platform. 56 Harvard Business Review April 2016  PIPELINES, PLATFORMS, AND THE NEW RULES OF STRATEGY HBR.ORG Idea in Brief THE SEA CHANGE THE NEW RULES THE UPSHOT Platform businesses that With a platform, the critical In this new world, competition bring together producers asset is the community can emerge from seemingly and consumers, as Uber and and the resources of its unrelated industries or from Airbnb do, are gobbling up members. The focus of within the platform itself. market share and transforming strategy shifts from controlling Firms must make smart competition. Traditional to orchestrating resources, choices about whom to let businesses that fail to create from optimizing internal onto platforms and what platforms and to learn the new processes to facilitating they’re allowed to do there, rules of strategy will struggle. external interactions, and from and must track new metrics increasing customer value to designed to monitor and maximizing ecosystem value. boost platform interactions. As Apple demonstrates, firms needn’t be only Sometimes that requires subsidizing one type of a pipeline or a platform; they can be both. While consumer in order to attract another type. plenty of pure pipeline businesses are still highly These three shifts make clear that competition is competitive, when platforms enter the same market- more complicated and dynamic in a platform world. place, the platforms virtually always win. That’s why The competitive forces described by Michael Porter pipeline giants such as Walmart, Nike, John Deere, (the threat of new entrants and substitute products and GE are all scrambling to incorporate platforms or services, the bargaining power of customers and into their models. suppliers, and the intensity of competitive rivalry) The move from pipeline to platform involves still apply. But on platforms these forces behave dif- three key shifts: ferently, and new factors come into play. To manage 1. From resource control to resource orches- them, executives must pay close attention to the in- tration. The resource-based view of competition teractions on the platform, participants’ access, and holds that firms gain advantage by controlling scarce new performance metrics. and valuable—ideally, inimitable—assets. In a pipe- We’ll examine each of these in turn. But first let’s line world, those include tangible assets such as mines look more closely at network effects—the driving and real estate and intangible assets like intellectual force behind every successful platform. property. With platforms, the assets that are hard to copy are the community and the resources its mem- The Power of Network Effects bers own and contribute, be they rooms or cars or The engine of the industrial economy was, and re- ideas and information. In other words, the network mains, supply-side economies of scale. Massive of producers and consumers is the chief asset. fixed costs and low marginal costs mean that firms 2. From internal optimization to external achieving higher sales volume than their competi- interaction. Pipeline firms organize their internal tors have a lower average cost of doing business. labor and resources to create value by optimizing That allows them to reduce prices, which increases an entire chain of product activities, from materi- When a platform als sourcing to sales and service. Platforms create value by facilitating interactions between external producers and consumers. Because of this external orientation, they often shed even variable costs of production. The emphasis shifts from dictating pro- enters the market cesses to persuading participants, and ecosystem governance becomes an essential skill. of a pure pipeline business, the 3. From a focus on customer value to a focus on ecosystem value. Pipelines seek to maximize platform virtually the lifetime value of individual customers of prod- ucts and services, who, in effect, sit at the end of a linear process. By contrast, platforms seek to maxi- mize the total value of an expanding ecosystem in a circular, iterative, feedback-driven process. always wins. April 2016 Harvard Business Review 57  SPOTLIGHT ON HOW PLATFORMS ARE RESHAPING BUSINESS volume further, which permits more price cuts— more platform participants) offer a higher average a virtuous feedback loop that produces monopolies. value per transaction. That’s because the larger the Supply economics gave us Carnegie Steel, Edison network, the better the matches between supply Electric (which became GE), Rockefeller’s Standard and demand and the richer the data that can be Oil, and many other industrial era giants. used to find matches. Greater scale generates more In supply-side economies, firms achieve market value, which attracts more participants, which cre- power by controlling resources, ruthlessly increas- ates more value—another virtuous feedback loop ing efficiency, and fending off challenges from any that produces monopolies. Network effects gave of the five forces. The goal of strategy in this world is us Alibaba, which accounts for over 75% of Chinese to build a moat around the business that protects it e‑commerce transactions; Google, which accounts from competition and channels competition toward for 82% of mobile operating systems and 94% of other firms. mobile search; and Facebook, the world’s dominant The driving force behind the internet economy, social platform. conversely, is demand-side economies of scale, also The five forces model doesn’t factor in network known as network effects. These are enhanced effects and the value they create. It regards external by technologies that create efficiencies in social forces as “depletive,” or extracting value from a firm, networking, demand aggregation, app develop- and so argues for building barriers against them. In ment, and other phenomena that help networks demand-side economies, however, external forces expand. In the internet economy, firms that achieve can be “accretive”—adding value to the platform higher “volume” than competitors (that is, attract business. Thus the power of suppliers and custom- ers, which is threatening in a supply-side world, may be viewed as an asset on platforms. Understanding when external forces may either add or extract value in an ecosystem is central to platform strategy. THE PLAYERS IN A PLATFORM ECOSYSTEM How Platforms Change Strategy A platform provides the infrastructure and rules for a marketplace In pipeline businesses, the five forces are relatively that brings together producers and consumers. The players in the defined and stable. If you’re a cement manufacturer ecosystem fill four main roles but may shift rapidly from one role to or an airline, your customers and competitive set another. Understanding the relationships both within and outside the ecosystem is central to platform strategy. are fairly well understood, and the boundaries sepa- rating your suppliers, customers, and competitors CREATORS OF THE PLATFORM’S OFFERINGS BUYERS OR USERS are reasonably clear. In platform businesses, those (FOR EXAMPLE, APPS ON ANDROID) OF THE OFFERINGS boundaries can shift rapidly, as we’ll discuss. Forces within the ecosystem. Platform par- ticipants—consumers, producers, and providers— PRODUCERS CONSUMERS typically create value for a business. But they may VALUE AND DATA EXCHANGE defect if they believe their needs can be met better AND FEEDBACK elsewhere. More worrisome, they may turn on the platform and compete directly with it. Zynga began as a games producer on Facebook but then sought to migrate players onto its own platform. Amazon INTERFACES FOR and Samsung, providers of devices for the Android THE PLATFORM PROVIDERS (MOBILE DEVICES ARE PROVIDERS ON ANDROID) platform, tried to create their own versions of the operating system and take consumers with them. CONTROLLER OF PLATFORM IP AND The new roles that players assume can be either OWNER ARBITER OF WHO MAY PARTICIPATE accretive or depletive. For example, consumers AND IN WHAT WAYS (GOOGLE OWNS ANDROID) and producers can swap roles in ways that gener- PLATFORM ate value for the platform. Users can ride with Uber today and drive for it tomorrow; travelers can stay with Airbnb one night and serve as hosts for other 58 Harvard Business Review April 2016  PIPELINES, PLATFORMS, AND THE NEW RULES OF STRATEGY HBR.ORG Networks Invert the Firm Pipeline firms have long outsourced aspects of their internal functions, such as customer service. But today companies are taking that shift even further, moving toward orchestrating external networks that can complement or entirely replace the activities of once-internal functions. Inversion extends outsourcing: Where systems, increasingly supports external adopting blockchain technology that firms might once have furnished design social and community networks. allows ledgers to be securely shared specifications to a known supplier, they Threadless, a producer of T-shirts, and vetted by anyone with permission. now tap ideas they haven’t yet imagined coordinates communication not just Participants can inspect everything from third parties they don’t even to and from but among customers, from aggregated accounts to individual know. Firms are being turned inside who collaborate to develop the best transactions. This allows firms to, for out as value-creating activities move product designs. example, crowdsource compliance beyond their direct control and their Human resources functions at with accounting principles or seek organizational boundaries. companies increasingly leverage the input on their financial management Marketing is no longer just about wisdom of networks to augment internal from a broad network outside the creating internally managed outbound talent. Enterprise software giant SAP has company. Opening the books this way messages. It now extends to the creation opened the internal system on which taps the wisdom of crowds and signals and propagation of messages by its developers exchange problems and trustworthiness. consumers themselves. Travel destination solutions to its external ecosystem—to Operations and logistics traditionally marketers invite consumers to submit developers at both its own partners and emphasize the management of just-in- videos of their trips and promote them its partners’ clients. Information sharing time inventory. More and more often, on social media. The online eyeglasses across this network has improved that function is being supplanted by retailer Warby Parker encourages product development and productivity the management of “not-even-mine” consumers to post online photos of and reduced support costs. inventory—whether rooms, apps, or themselves modeling different styles Finance, which historically has other assets owned by network and ask friends to help them choose. recorded its activities on private participants. Indeed, if Marriott, Yellow Consumers get more-flattering glasses, internal accounts, now records some Cab, and NBC had added platforms to and Warby Parker gets viral exposure. transactions externally on public, or their pipeline value chains, then Airbnb, Information technology, historically “distributed,” ledgers. Organizations Uber, and YouTube might never have focused on managing internal enterprise such as IBM, Intel, and JPMorgan are come into being. customers the next. In contrast, providers on a plat- such shape-shifting, a platform can abruptly trans- form may become depletive, especially if they decide form an incumbent’s set of competitors. Swatch to compete with the owner. Netflix, a provider on knows how to compete with Timex on watches but the platforms of telecommunication firms, has con- now must also compete with Apple. Siemens knows trol of consumers’ interactions with the content it of- how to compete with Honeywell in thermostats but fers, so it can extract value from the platform owners now is being challenged by Google’s Nest. while continuing to rely on their infrastructure. Competitive threats tend to follow one of three As a consequence, platform firms must con- patterns. First, they may come from an established stantly encourage accretive activity within their eco- platform with superior network effects that uses its systems while monitoring participants’ activity that relationships with customers to enter your industry. may prove depletive. This is a delicate governance Products have features; platforms have communi- challenge that we’ll discuss further. ties, and those communities can be leveraged. Given Forces exerted by ecosystems. Managers of Google’s relationship with consumers, the value its pipeline businesses can fail to anticipate platform network provides them, and its interest in the in- competition from seemingly unrelated industries. ternet of things, Siemens might have predicted the Yet successful platform businesses tend to move tech giant’s entry into the home-automation market aggressively into new terrain and into what were (though not necessarily into thermostats). Second, once considered separate industries with little warn- a competitor may target an overlapping customer ing. Google has moved from web search into map- base with a distinctive new offering that leverages ping, mobile operating systems, home automation, network effects. Airbnb’s and Uber’s challenges to driverless cars, and voice recognition. As a result of the hotel and taxi industries fall into this category. April 2016 Harvard Business Review 59 SPOTLIGHT ON HOW PLATFORMS ARE RESHAPING BUSINESS HBR.ORG The final pattern, in which platforms that collect to maximize value creation. To that end, platform the same type of data that your firm does suddenly executives must make smart choices about access go after your market, is still emerging. When a data (whom to let onto the platform) and governance (or set is valuable, but different parties control different “control”—what consumers, producers, providers, chunks of it, competition between unlikely camps and even competitors are allowed to do there). may ensue. This is happening in health care, where Platforms consist of rules and architecture. Their traditional providers, producers of wearables like HARNESSING owners need to decide how open both should be. An Fitbit, and retail pharmacies like Walgreens are all SPILLOVERS open architecture allows players to access platform re- launching platforms based on the health data they Positive spillover effects sources, such as app developer tools, and create new help platforms rapidly own. They can be expected to compete for control of sources of value. Open governance allows players increase the volume a broader data set—and the consumer relationships of interactions. Book other than the owner to shape the rules of trade and that come with it. purchases on a platform, reward sharing on the platform. Regardless of who Focus. Managers of pipeline businesses focus on for example, generate sets the rules, a fair reward system is key. If managers growing sales. For them, goods and services deliv- book recommendations open the architecture but do not share the rewards, that create value for ered (and the revenues and profits from them) are potential platform participants (such as app develop- other participants on the units of analysis. For platforms, the focus shifts it, who then buy more ers) have the ability to engage but no incentives. If to interactions—exchanges of value between pro- books. This dynamic managers open the rules and rewards but keep the ducers and consumers on the platform. The unit of exploits the fact that architecture relatively closed, potential participants exchange (say, a view of a video or a thumbs-up on a network effects are have incentives to engage but not the ability. often strongest among post) can be so small that little or no money changes These choices aren’t fixed. Platforms often interactions of the same hands. Nevertheless, the number of interactions type (say, book sales) launch with a fairly closed architecture and gover- and the associated network effects are the ultimate than among unrelated nance and then open up as they introduce new types source of competitive advantage. interactions (say, package of interactions and sources of value. But every plat- With platforms, a critical strategic aim is strong pickup and yardwork in form must induce producers and consumers to in- different cities mediated up-front design that will attract the desired partici- teract and share their ideas and resources. Effective by the odd-job platform pants, enable the right interactions (so-called core TaskRabbit). governance will inspire outsiders to bring valuable interactions), and encourage ever-more-powerful Consider ride sharing. intellectual property to the platform, as Zynga did in network effects. In our experience, managers often By itself, an individual bringing FarmVille to Facebook. That won’t happen fumble here by focusing too much on the wrong ride on Uber is high if prospective partners fear exploitation. value for both rider type of interaction. And the perhaps counterintui- Some platforms encourage producers to create and driver—a desirable tive bottom line, given how much we stress the im- core interaction. As the high-value offerings on them by establishing a policy portance of network effects, is that it’s usually wise number of platform of “permissionless innovation.” They let producers to ensure the value of interactions for participants participants increases, invent things for the platform without approval but before focusing on volume. so does the value Uber guarantee the producers will share in the value cre- delivers to both sides of Most successful platforms launch with a single ated. Rovio, for example, didn’t need permission to the market; it becomes type of interaction that generates high value even if, easier for consumers to create the Angry Birds game on the Apple operating at first, low volume. They then move into adjacent get rides and for drivers system and could be confident that Apple wouldn’t markets or adjacent types of interactions, increas- to find fares. Spillover steal its IP. The result was a hit that generated enor- ing both value and volume. Facebook, for example, effects further enhance mous value for all participants on the platform. the value of Uber to launched with a narrow focus (connecting Harvard However, Google’s Android platform has allowed participants: Data from students to other Harvard students) and then opened riders’ interactions with even more innovation to flourish by being more open the platform to college students broadly and ulti- drivers—ratings of drivers at the provider layer. That decision is one reason mately to everyone. LinkedIn launched as a profes- and riders—improves the Google’s market capitalization surpassed Apple’s in sional networking site and later entered new markets value of the platform to early 2016 (just as Microsoft’s did in the 1980s). other users. Similarly, with recruitment, publishing, and other offerings. However, unfettered access can destroy value data on how well a given Access and governance. In a pipeline world, ride matched a rider’s by creating “noise”—misbehavior or excess or low- strategy revolves around erecting barriers. With needs helps determine quality content that inhibits interaction. One com- platforms, while guarding against threats remains optimal pricing across pany that ran into this problem was Chatroulette, critical, the focus of strategy shifts to eliminating the platform—another which paired random people from around the world important spillover effect. barriers to production and consumption in order for webchats. It grew exponentially until noise 60 Harvard Business Review April 2016 SPOTLIGHT ON HOW PLATFORMS ARE RESHAPING BUSINESS HBR.ORG In 2016 private equity caused its abrupt collapse. Initially utterly open— it had no access rules at all—it soon encountered the markets gave Uber “naked hairy man” problem, which is exactly what it sounds like. Clothed users abandoned the platform in droves. Chatroulette responded by reducing its openness with a variety of user filters. Most successful platforms similarly manage a valuation higher openness to maximize positive network effects. Airbnb and Uber rate and insure hosts and drivers, Twitter and Facebook provide users with tools to pre- than GM’s. vent stalking, and Apple’s App Store and the Google Play store both filter out low-quality applications. governance tools to stem them by, for example, Metrics. Leaders of pipeline enterprises have withholding privileges or banishing troublemakers. long focused on a narrow set of metrics that capture Finally, platforms must understand the financial the health of their businesses. For example, pipe- value of their communities and their network effects. lines grow by optimizing processes and opening bot- Consider that in 2016, private equity markets placed tlenecks; one standard metric, inventory turnover, the value of Uber, a demand economy firm founded tracks the flow of goods and services through them. in 2009, above that of GM, a supply economy firm Push enough goods through and get margins high founded in 1908. Clearly Uber’s investors were look- enough, and you’ll see a reasonable rate of return. ing beyond the traditional financials and metrics As pipelines launch platforms, however, the num- when calculating the firm’s worth and potential. bers to watch change. Monitoring and boosting the This is a clear indication that the rules have changed. performance of core interactions becomes critical. Here are new metrics managers need to track: BECAUSE PLATFORMS require new approaches to Interaction failure. If a traveler opens the Lyft strategy, they also demand new leadership styles. app and sees “no cars available,” the platform has The skills it takes to tightly control internal re- failed to match an intent to consume with sup- sources just don’t apply to the job of nurturing ply. Failures like these directly diminish network external ecosystems. effects. Passengers who see this message too often While pure platforms naturally launch with will stop using Lyft, leading to higher driver down- an external orientation, traditional pipeline firms times, which can cause drivers to quit Lyft, resulting must develop new core competencies—and a new in even lower ride availability. Feedback loops can mindset—to design, govern, and nimbly expand strengthen or weaken a platform. platforms on top of their existing businesses. The Engagement. Healthy platforms track the partici- inability to make this leap explains why some tradi- pation of ecosystem members that enhances network tional business leaders with impressive track rec­ords effects—activities such as content sharing and repeat falter in platforms. Media mogul Rupert Murdoch visits. Facebook, for example, watches the ratio of bought the social network Myspace and managed it daily to monthly users to gauge the effectiveness of the way he might have run a newspaper—from the its efforts to increase engagement. top down, bureaucratically, and with a focus more Match quality. Poor matches between the needs of on controlling the internal operation than on foster- users and producers weaken network effects. Google ing the ecosystem and creating value for participants. constantly monitors users’ clicking and reading to In time the Myspace community dissipated and the refine how its search results fill their requests. platform withered. Negative network effects. Badly managed plat- The failure to transition to a new approach ex- forms often suffer from other kinds of problems that plains the precarious situation that traditional busi- create negative feedback loops and reduce value. nesses—from hotels to health care providers to taxis— For example, congestion caused by unconstrained find themselves in. For pipeline firms, the writing network growth can discourage participation. So is on the wall: Learn the new rules of strategy for a can misbehavior, as Chatroulette found. Managers platform world, or begin planning your exit. must watch for negative network effects and use HBR Reprint R1604C 62 Harvard Business Review April 2016 Copyright © Harvard Business Publishing. All Rights Reserved. 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