Platform Strategy

platform strategyMarshall Van Alstyne; Geoffrey ParkerDOI: 10.1057/9781137294678.0794Palgrave Macmillan

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platform strategy

Definition

A platform strategy is the mobilization of a networked

business platform to expand into and operate in a given

market.

Abstract

This article summarizes the PLATFORM strategy literature and

is organized around launch strategies, GOVERNANCE and

competition. A platform strategy is the mobilization of a

networked business platform to expand into and operate in

a given market. A business platform, in turn, is a nexus of

rules and infrastructure that facilitate interactions among

network users. Platforms provide building blocks that serve

as the foundation for complementary products and services.

They also match buyers with suppliers, who transact

directly with each other using system resources and are

generally subject to NETWORK EFFECTS.

A platform strategy is the mobilization of a net-worked business platform to expand into and operatein a given market (Cusumano and Gawer, 2002). Abusiness PLATFORM, in turn, is a nexus of rules andinfrastructure that facilitate interactions among net-work users (Eisenmann, Parker and Van Alstyne,2011). Stated differently, a platform is a publishedstandard, together with a GOVERNANCE model, thatfacilitates third-party participation (Parker and VanAlstyne, 2013). Platforms provide building blocksthat serve as the foundation for complementaryproducts and services (Cusumano and Gawer, 2002;Gawer and Henderson, 2007). They also matchbuyers with suppliers who transact directly with eachother using system resources (Hagiu, 2006; Hagiuand Wright, 2011) and are generally subject toNETWORK EFFECTS (Eisenmann, Parker and VanAlstyne, 2009, 2011; Boudreau, 2010). These defini-tions each have the property that reconfiguration ofplatform assets allows external parties to interact witheach other and add value. Examples include operat-ing systems, game consoles, payment systems, ride-sharing platforms, smart grids, healthcare networksand social networks.Building on Thomson’s (1967) typology of long-

linked, mediating and intensive technologies, Stabelland Fjeldstad (1998) identified network platformsas one of three elemental configurations throughwhich firms generate value. In traditional industries,bilateral exchanges follow a linear path as firmspurchase inputs, transform them to add value,

assemble components and subsystems into completeproducts and then sell the output. In platformindustries, interaction follows a triangular relation-ship (Eisenmann, Parker and Van Alstyne, 2009) asparties first affiliate with the platform then connector trade using platform resources. For example, onAirbnb, renters and hosts transact with one anotherbut they use the platform to match with one another,to perform searches, enter into contractual agree-ments, transfer payment, acquire insurance andmanage reputations to facilitate future transactions.

Platform firms share characteristics with platformproducts but operate in these triangular rather thanlinear markets. Both imply shared technology,reconfigurable elements and fixed costs that can bespread across multiple product types such as auto-mobiles with common engines, transmissions andelectronics (Cusumano and Nobeoka, 1992). Firms,however, are also characterized by the network ofvalue-adding relationships among users over andabove the physical value of platform components. Tomanage and motivate these external relations, plat-forms must have rules that promote healthy partici-pant interactions. Exchange platforms, in particular,require rules to address market failures, as notedbelow. Boundaries of this governance model distin-guish the platform firm from the ecosystem in whichit is embedded. Contributors to competing platforms,for example, are part of the ecosystem but need notabide by a focal platform’s rules.

Network platforms further differ from productplatforms because stronger network effects, switchingcosts and multi-homing costs create greater pressurefor market concentration. Firms that compete in suchmarkets need clearer guidelines by which to setstrategy in order to harness these effects. Strategies tomanage launch, openness and governance, as well ascompetition, follow below.

Launch strategies

A central problem facing platforms subject to net-work effects is how to drive user adoption enough toreach critical mass (Evans and Schmalensee, 2010).Network platforms often have users of one typewhose utilities depend on the presence of users of adifferent type (Parker and Van Alstyne, 2000b, 2005;Rochet and Tirole, 2003) as in the case of gamedevelopers and players or auction buyers and sellers.If there are not enough users of both types then the

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10.1057/9781137294678.0794 - platform strategy, Geoffrey Parker and Marshall Van Alstyne

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standalone value of the platform may not offer suf-ficient appeal to drive adoption. This leads to a‘chicken-and-egg’ problem of launch and adoption(Caillaud and Jullien, 2003; Evans and Schmalensee,2010). Firms have used a number of strategies toovercome this issue.

SubsidyPlatforms with substantial resources can entice usersvia subsidy to join the platform. Subsidies can betemporary penetration prices or permanent discountsand can take several forms. Direct cash transfers arepossible, but this creates a moral hazard problemwhere users might accept the subsidy without usingthe platform. One solution is to offer subsidies, suchas technical support, that only have value whenconsumed with the platform (Parker and VanAlstyne, 2005). Subsidies may take the form of freeinformation, which has zero marginal cost (Parkerand Van Alstyne, 2000a, 2005), but can also work forcertain performance characteristics (Anderson,Parker and Tan, 2014) or even physical goods. Largerlaunch subsidies generally decline after platformusage reaches critical mass. For example, when Sonylaunched the PlayStation 3, it distributed the consolewell below marginal cost. Liu (2010) notes that thisstrategy was common in the video game consolemarket over multiple generations. The subsidy isrecovered by later taxing the sale of game comple-ments sold by game developers. Even in equilibrium,however, prices below marginal cost are commonamong search and matching platforms in order tokeep one side of the market on board the platform.

Seeding and marquee usersPlatforms typically launch with complements thatgive their interactions value. On two-sided platforms,a ‘seeding’ strategy solves participation on one side ofthe network by offering users of that type enoughvalue that they adopt (Gawer and Henderson, 2007;Boudreau, 2012). The platform sponsor can eitherdevelop complements on its own or it can work withpartners and offer them incentives to produce seedinteractions for the new platform. Seed interactionsmust be provided until both sides of the market reachcritical mass, at which point transactions volumebecomes self-sustaining. Financial service providershave used this approach, offering their own products,before opening their platform to third-party financialinstruments (Hagiu and Eisenmann, 2007). The lead

firm must also decide whether seed content willsubstitute for or complement subsequent contentprovided by partners (Hagiu and Spulber, 2013).

A launch strategy closely related to seeding is tocoax marquee users onto the platform. For example,when Microsoft launched the Xbox video gameplatform, it brought Electronic Arts (EA) to itsplatform by offering incentives that included categoryexclusivity (Eisenmann, Parker and Van Alstyne,2009). Microsoft courted EA because its existingstrength with users ensured that it could bring a largenumber of users to the platform. EA fans might havebeen unwilling to join a platform that did not includeit. SAP offered similar category exclusivity to ADPfor payroll processing when it launched its cloudservices platform (Parker and Van Alstyne, 2013).

Adobe managed a highly successful marquee seed-ing strategy by convincing the US Federal governmentto issue tax documents in its proprietary portabledocument format (PDF). Putting documents online inan unalterable format dramatically cut printing andpostage costs while creating a prospective user baseequal in size to the US tax base (Tripsas, 2001).

Micro-market launchOne effective strategy restricts launch to a smallcommunity in order to generate strong, albeitbounded, network effects. eBay started as a marketfor Pez sweet dispensers (Evans, 2003). Diner’s Clubtargeted restaurants and patrons on ManhattanIsland (Evans and Schmalensee, 2010). Facebooklaunched exclusively among Harvard undergraduatesbefore expanding to all ‘.edu’ and then ‘.com’domains (Ellison, Steinfield and Lampe, 2007). Theidea is that a more sharply defined community willexperience stronger network effects if a substantialfraction of the community adopts a particular plat-form product or service. Once adoption takes placewithin that community, the platform can be openedto adjacent groups, pulling new users onto the plat-form. In addition, this strategy has the advantage ofallowing the platform to build capacity in stages.Launching into an adjacent market from an estab-lished platform is the process of ‘platform envelop-ment’ described under competition below.

PiggybackingSmall companies that lack a user base of their ownmay seek to borrow users from another network. Thisis one of the strategies used to launch PayPal, which

platform strategy

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piggybacked on eBay before it was acquired(Penenberg, 2009). PayPal set up software bots oneBay to buy and sell merchandise, insisting that theother side of the transaction use its payment system.Buying and selling at market prices also made this alow capital cost strategy. Similarly, the room reser-vation service Airbnb launched by integrating intoCraigslist without securing permission to do so. Thepayment service square launched on top of theiPhone and Android platforms, connecting finan-cially through existing credit card networks. Bothfirms piggybacked on existing networks withouthaving to create new demand.

Governance

A governance model includes rules for participation,interaction and resolution of conflict. Participationrules govern openness, defining who can affiliate withthe platform. Interaction rules govern behaviouron the platform, division of surplus, privileges andresponsibilities.

Open platform business modelsMany scholars have focused on the firm’s decisionswith respect to sharing intellectual property andopening its systems to external firms and individuals(Edwards, 2001; Chesbrough, 2003; Eisenmann,Parker and Van Alstyne, 2009; Boudreau, 2010).Shapiro and Varian (1999) and West (2003) describethe tension between adoption, which calls for moreopenness, and appropriation, which calls for morecontrol. The levels of openness and threat of sub-sequent appropriation can significantly affect parti-cipation and investment incentives of platformpartners (Parker and Van Alstyne, 2009).Rules allowing unrestricted openness allow part-

ners easy access to, and usually exit from, the plat-form. Rules restricting access limit participationpartners by number or type and often lock partnersinto longer-term relationships (Kauffman andMohtadi, 2004). Types of partners can include (i)users or consumers, (ii) developers or suppliers, (iii)platform providers and (iv) platform sponsors(Eisenmann, Parker and Van Alstyne, 2009). Mobilephone platforms provide a representative illustrationwith callers as users, application developers as sup-pliers, an app store as the provider (who serves aspoint of contact) and the intellectual property rightsholder as the sponsor (who decides the rules ofthe governance model). A two-sided model would

consider how the platform manages buyers andsuppliers. A multi-sided model might also considerhardware manufacturers and telecommunicationsfirms (West and Mace, 2010).

Rules for openness often include the issue of com-patibility and multi-homing (Rysman, 2009). As acondition of participation, an ecosystem partner maybe required to affiliate exclusively with one platform –that is, a single-home. More open rules allow partnersto affiliate with competing platforms – that is, multi-home. Evidence suggests that multi-homing of appli-cations hurts sales of a given platform (Landsman andStremersch, 2011). If resource heterogeneity works tothe advantage of one platform, then multi-homing ofplatform partners can reduce that advantage as cap-abilities spread to competing platforms (Sun and Tse,2009). Platforms thus prefer that ecosystem partnerssingle-home and offer novel content on their ownplatform exclusively. Platform entrants, however, hopeto attract popular content that is already resident onan incumbent platform. Entrants thus seek to persuadepartners of incumbent platforms to multi-home. Aplatform sponsor may also choose to centralize keydecisions to limit negotiation costs and optimize thehealth of the ecosystem. Apple’s decision to standar-dize and cap prices in its iTunes store provides anexample (Rochet and Tirole, 2003; Ye, Priem andAlshwer, 2012).

Open strategies can achieve ‘permissionless inno-vation’ (Cerf, 2012; Parker and Van Alstyne, 2013)whereby third parties add new value to the platformwithout having to negotiate with the platform owner.Recognizing the risk of appropriation by the leadfirm, complementors can be reluctant to share theirtechnology or invest in the platform. In response, thelead firm opens the platform and offers a defaultcontract whereby the complementor receives longerlead time before facing competition. Cisco and SAPhave both used this strategy to induce third-partyinvestment. The best innovations might then beabsorbed into the platform in the future as the leadfirm builds, buys or partners to secure new featuresfor its platform. Empirically, complementors thathave stronger intellectual property (IP) rights havemore successful initial public offerings (IPOs) andmore easily resist having their innovations bundledby the platform owner (Huang et al., 2013).

A platform sponsor may share control when itlacks sufficient resources to act alone in pursuit of itsobjectives (Gawer and Henderson, 2007). Sponsors

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also share control to increase adoption, improveinnovation and reallocate resources (Jacobides andBillinger, 2006). Sharing control, however, increasesrisk that the sponsor fails to capture platform value.Risk of platform fragmentation also rises (Yoo et al.,2012). Rules, both technical and social, must then beused to maintain coherence and curb rent seeking byplatform partners (Garud, Jain and Tuertscher, 2008).Platform maturity can also drive regulation. Atlaunch when market share is small, governance tendsto be less permissive in participation but more per-missive in behaviour in order to encourage keypartners to innovate and explore. At maturity whenmarket share is large, governance tends towardtighter control over behaviour but looser control overparticipation as revenue comes less from third-partyinnovation and more from rent extraction (O’Reilly,2010).

Regulation and private orderingThe need for regulation arises from the fact thatplatforms facilitate exchange. Analogous to standardexchange markets, platforms are subject to marketfailures stemming from factors such as networkeffects, information asymmetry, uninsured risks andcongestion. Regulation combines contractual, tech-nical, informational and economic instruments tominimize these market failures (West, 2003;Boudreau and Hagiu, 2009; Evans, 2012). Strategicimportance follows from the ability of the platformto create greater wealth and thereby win marketsvia users’ voluntary participation in the open plat-form. In order to capture the benefits of ecosystemgrowth, the platform must impose certain regulationson the user participants. This need was anticipatedby Teece (1986) in his seminal work on the condi-tions necessary for firms to profit from technologicalinnovation.

Positive externalities, as in the case of softwaredevelopers attracting users to an operating system,have been addressed by offering price subsidies tothe group generating beneficial spillovers (Parker andVan Alstyne, 2000b; Rochet and Tirole, 2003).Negative externalities, as in the case of on-platformtraffic congestion, has been addressed with conges-tion pricing (Evans, 2012). Information asymmetry,as in the case of counterfeit goods on auction plat-forms or insider trading on stock platforms, has beenaddressed using penalties, arbitration and exclusion.Platforms address missing transactions born of

information asymmetry via improved search andmatching (Evans, 2012). Game platforms and socialnetworks have addressed a ‘lemons problem’ of lowquality driving out high quality by using technolo-gical lock-out mechanisms, quality review, reputationsystems and ‘bouncer’s rights’ to exclude based onlow quality goods or bad behaviour (Strahilevitz,2006; Boudreau and Hagiu, 2009). Financial plat-forms have absorbed users’ risk of fraud by offeringinsurance (Evans, Hagiu and Schmalensee, 2006).

Externalities, especially two-sided and multi-sided,are endemic in platforms due to participation bymultiple types of users who attract or repel oneanother. Platforms internalize these externalities tocreate social value, which substantially drives pricingand monetization decisions (Parker and Van Alstyne,2000a, 2000b, 2005; Rochet and Tirole, 2003; Nocke,Peitz and Stahl, 2007). Rules that divide the pie dif-ferently change the size of the pie (Evans, 2012).

Regulation by the platform can potentially besuperior to regulation by state or federal govern-ments. The mechanism for such contracts is articu-lated in the law and economics literature on ‘privateordering’, which is governance via private contractthat seeks to achieve welfare gains higher than thatprovided by a system of public laws (Eisenberg,1976). Due to information asymmetry and one-size-fits-all regulation, private ordering by firms can yieldbetter results than uniform laws (Williamson, 2002).Platforms often have considerably greater visibilityinto user behaviour than public regulators, providingan opportunity to sanction behaviour earlier and withgreater accuracy (Evans, 2012).

A platform firm may choose to absorb developers’ideas into the core system, while at the same timemaking these new technologies available for partnersto build upon. Absorbing new features and publish-ing them has the goal of fostering higher rates of useradoption and developer innovation by promotingR&D spill-overs (Parker and Van Alstyne, 2013).Sharing ideas across a developer pool fosters aknowledge externality analogous to that whichincreases the productive capacity of a region(Audretsch and Feldman, 1996; Edwards, 2001).In 3D printing, for example, designers can build onconcepts of other designers, a process made feasibleby requiring innovations to be reusable. Knowledgespillovers recursively increase the output of ecosys-tem partners through an iterative cycle of recombi-nation, reabsorption and republication.

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Competition

Competition occurs at three levels of a platformecosystem. It exists from one platform to another, asin the video game console battles of Sony, Microsoftand Nintendo (Evans, Hagiu and Schmalensee, 2006).Competition can also exist between a platform and itspartners as in the case of Microsoft appropriatingsuch partner innovations as browsers, multi-threading, streaming media and instant messaginginto its operating system (Jackson, 1999; Nalebuff,2004). Finally, competition can exist among partnerseach vying for position within a focal platform, as inthe case of two games reaching for the same con-sumers on the same console (Boudreau and Hagiu,2009; Markovich and Moenius, 2009). Strategybecomes vastly more complex as firms considerdynamic interactions of a multi-layered BUSINESS

ECOSYSTEM (Teece, 2012).Competition between platforms tends towards

winner-take-all concentration in the context of largedemand or supply economies of scale, high multi-homing costs and the absence of niche specialization(Eisenmann, Parker and Van Alstyne, 2006). Demandeconomies of scale, equivalently network effects,favour the firm with stronger feedback as users attractusers. Higher multi-homing costs reduce a user’sability to straddle two platforms, forcing a choice ofone platform. Niche specialization can facilitate sur-vival despite network effects and multi-homing costsas in the case of Apple’s retreat into graphic designfor desktop operating systems during the 1990s.Platform-to-platform competition is one of the

principal drivers of openness as each platform seeksto recruit more allied developers (Chesbrough, 2003;West, 2003). Competition among platforms in turninteracts with governance as this motivates the divi-sion of rents and the level of R&D spillovers thatdrive innovation (Parker and Van Alstyne, 2013).Strategy also suggests courting large marquee part-ners who can bring technology or large blocks ofusers (Cusumano and Gawer, 2002; Eisenmann,Parker and Van Alstyne, 2006) and, at the same time,deny these resources to competing platforms.Large platforms can enter smaller markets pro-

tected by network effects and switching costs viathe process of ‘platform envelopment’ (Eisenmann,Parker and Van Alstyne, 2006, 2011). An attackingplatform bundles product features that exist on atarget platform, that are new to the attacking plat-form and that exhibit a high degree of user overlap.

Because the attacking platform already has a largeruser base, the problem of mobilizing one side of thenetwork is substantially solved. Stronger networkeffects of the larger network typically win marketshare. For example, when Microsoft enveloped Real’saudio streaming technology into Windows, Microsoftenjoyed more than 90 per cent market share indesktop operating systems. Each new release ofWindows caused Real Audio to lose streaming mar-ket share among content consumers and contentcreators because neither would pay the incrementalcost of Real’s now duplicate functionality (Eisen-mann, Parker and Van Alstyne, 2011). Platformentrants can also overcome an incumbent’s advantagein network effects if quality is sufficiently great orusers’ willingness to wait for a stream of new qualityis sufficiently high (Zhu and Iansiti, 2012). Entrantscan also seek to avoid direct platform competition byidentifying distinctive and underserved user segments(Suarez and Kirtley, 2012).

Managing the partner-to-platform competitionand partner-to-partner competition is an even moredynamic problem owing to the need to cooperate aswell as compete. Eisenmann (2008) draws animportant distinction between the platform ‘sponsor’and the platform ‘provider’. A sponsor controls rightsto the technology and designs the platform rules. Theprovider has the direct customer relationship. Forexample, Microsoft and Google sponsor theirrespective Windows and Android platforms while HPand Samsung provide the hardware that customersuse to experience the platform. Platform sponsorsoften engender competition among providers whodeal with customers to increase the affiliated userbase. Greater openness at the sponsor layer does, infact, accelerate the rate at which platform providersship new products (Boudreau, 2010). Cusumano andGawer (2002) provide a number of strategies thatplatforms use to motivate and cope with externalcomplementors: (i) platform standards shouldremain open in order that complementors continueto invest, (ii) the platform owner should not playfavourites with news or surprise complementors withchanges in strategy, (iii) the interests of partnersshould be treated fairly relative to interests of theleading platform firm. Intel, for example, created aseparate internal division to represent goals of part-ners at a level equal to that of other internal divisions,(iv) platforms can share risk by investing along withpartners in uncertain innovations, (v) the platform

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should promote the long-term financial health ofpartners, especially smaller ones. Boudreau andHagiu (2009) further advise platform firms to, (vi)devise rules that balance partner inducements toparticipate against self-enrichment and (vii) limit thefinancial competition among complementors topromote investment but encourage prestige compe-tition among individuals to promote effort. A plat-form may allow increased competition amongsupply-side partners if it can separately charge foraccess on its demand side. But if free entry occurs onthe demand side, platforms prefer to limit supply-side competition (Armstrong, 2006). If users on oneside of the market single-home but suppliers on theother side multi-home, then a ‘competitive bottle-neck’ exists. Suppliers compete away their profitssuch that platform decisions typically favour thesingle-homing users (Armstrong, 2006). Individualsuppliers can lose buyers vis-a-vis one another butstill gain overall if their collective investments causetheir host platform to win market share (Markovichand Moenius, 2009).

Platforms prefer to limit competition from transac-tions that partners take off-platform. For example, the‘no surcharge’ rule forbids merchants from chargingbuyers higher prices for use of the platform’s creditcard relative to cash or other cards (Rochet and Tirole,2002; Wright, 2003). Similarly, app stores impose a‘most favoured nation’ rule that forbids developersfrom charging less when selling directly or throughcompeting platforms. Platform strategy resembles tra-ditional strategy in the manner that three-dimensionalchess resembles the standard game (Eisenmann, Parkerand Van Alstyne, 2011). Firms negotiate dynamicmulti-layered trade-offs from platform to platform,from platform to partner, and from partner to partner.

GEOFFREY PARKER AND MARSHALL VAN ALSTYNE

See also

BUSINESS ECOSYSTEM; GOVERNANCE; INDIRECT NETWORK EFFECTS;

INNOVATION NETWORKS; INTERNET STRATEGIES; NETWORK EFFECTS; N-SIDED

MARKETS; OPEN INNOVATION; PLATFORM; PLATFORM INNOVATION; WINNER-

TAKE-ALL-MARKETS

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platform strategy



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Platform Strategy