CATALYST CODE: HOW TO IGNITE A PLATFORM BUSINESS AND … · Google Search Searchers Advertisers ... Common Features of Catalysts 19 Positive Network Effects ... (Google AdWords)

CATALYST CODE: HOW TO IGNITE A PLATFORM BUSINESS AND RULE A PLATFORM-CENTRIC ECOSYSTEM

20 April 2012 Catalyst Course 2012

David S. Evans Founder | Market Platform Dynamics Visiting Professor | University College London Lecturer | University of Chicago

© Market Platform Dynamics Do Not Distribute Without Permission

Platform Businesses Dominate the Economic Landscape

Catalyst Panorama 2

OpenTable: Intermediary between Two Different Kinds of Customers

3


The OpenTable Business Model Restaurants Pay and Consumers Use it for Free

4


$100 million revenue in 2010 | $1.35 billion markets cap

The Result: Positive Feedback Effects Fuel Open Table Growth

5


Ø  27 million reservations in 2011Q4 a month up from 19 million in 2010Q4

Ø  25k restaurants in 2011Q4 up from 20k in 2010Q4

Ø  More than 40% yoy growth in revenue

Many “Multi-Sided Platform” Businesses Operate Like This Positive Feedback Effects Fuel Business Growth

6

COMPANY CUSTOMER SIDE A CUSTOMER SIDE B

Windows Users Developers

Google Search Searchers Advertisers

Deutsche Bourse Liquidity providers Liquidity takers

eHarmony Men Women

Paris Match Readers Advertisers

Roppongi Hills Shops Shoppers

American Express Cardhodlers Merchants


These Multi-Sided Platforms Include Many Massive Global Businesses

7


Catalysts Create Real Value Providing a Platform Where Customers Can Meet and Transact

8

Platforms can create tremendous value by eliminating pain points in exchange

To ignite, platforms must solve extremely difficult coordination problem

But if do, they can generate tremendous profits through positive feedback effects

Sustaining those profits requires treacherous navigation in an n-dimensional universe of colliding platforms like Google Search (3-sided), Facebook’s Social

Network (4-sided) and Microsoft Windows (3-sided)


Catalysts, Platforms and Two-Sided Markets Defining Terms

9

(Economic) Catalysts are intermediaries that create value by brining two or more types of agents (businesses or people) together.

(Multi-sided) Platforms are the virtual or physical places that catalysts create to enable multiple types of agents to find and transact with each other and thereby create and exchange value.

Economists sometimes call these platforms Two-sided Markets a term that was introduced in the pioneering work by French economists Jean-Charles Rochet and Jean Tirole.

A customer type is sometimes call a platform “side”.


The Catalyst Curriculum

10

Catalyst Panorama

How Platform Businesses Dominate the Economics Landscape

Catalyst Defined

The New Economics of Two-Sided Markets

Catalyst Construction

How to Use the Catalyst Toolkit to Build a Profitable Platform Business

Catalyst Ignition

How to Start a Platform Business and Obtain Explosive Growth

Catalyst Competition

How to Compete When there are Colliding Platform Ecosystems






Catalyst Defined: 12

The New Economics of Two-Sided Markets


What Catalysts Do Add Value by Reducing Transaction Costs

13

Catalysts •  enable two or more

types of customers,

who could engage in mutually valuable exchange, •  to find each other

to transact, •  and to thereby create

and exchange value.


eBay Reduced Transaction Costs People Who Wanted to Sell Pez Dispensers Find and Trade with People Who Wanted to Buy Pez Dispensers

14


How Catalysts Do It

15

Catalysts provide a physical or virtual platform that enables different types of agents to find each other and transact

Platform

Transact Search Match


eBay A Platform for Agents to Search, Match, and Transact

16


Catalyst Value Creation

17

Catalysts create value by reducing

pain points or what economists call “transactions

costs”.

Catalysts reduce transactions costs

by making it easier for

different types of agents to get together and

exchange value.

As a result agents can engage in

mutually advantageous exchange that creates value.

That exchange and the resulting value creation

would have been more inefficient—or perhaps even

impossible—without the catalyst.


An eBay Example The Miracle of Value Exchange and Wealth Creation

18

Seller values pez dispenser at -$.50 (cost of having junk around)

Buyer values pez dispenser at $2.00

They enter into a trade at $1.00

Buyer gets $1.00 of value (a pez dispenser worth $2.00 minus $1.00 purchase price

Seller gets $1.50 of value ($1.00 plus gets rid of junk which costs $.50)

Total Value of $2.50 created out of thin air!!!!

A 2003 study found that eBay created $7 billion of extra value just for buyers. © Market Platform Dynamics Do Not Distribute Without Permission

Common Features of Catalysts

19

Positive Network Effects

Type A customers value platform more if there are more Type B customers and vice versa.

Pez seller gets more value if more buyers; buyer gets better selection and deal if more sellers

Critical Mass

Need to be enough customers on both side to create value for either.

If few buyers and sellers of Pez dispensers little incentive to join platform.

Money/Subsidy Side

Platforms often give one side a “break” and make their profits for the other side.

Sellers pay commission plus merchant discount for PayPal. Buyers pay nothing.






How to Use the Catalyst Tool Kit to Build a Successful Platform

Catalyst Construction: 21


The Catalyst Tool Kit

22

Platform Concept

Platform Design

Transaction Engine

Prices

Search and Matching Engines

Product Offerings

Governance Rules


Three Key Questions Platform Concept for Solving Pain Points

23

1. What’s the set of problems that need

to be solved for economic agents?

2. What’s the most efficient solution for

solving those problems?

3. Does the solution create enough

value for customers and platform?


OpenTable Platform Design Solving Pain Points in Restaurant Reservations

24


Pricing Is The Key Gets Customer Sides on Board and in Right Proportion

25

Need to get both sides on board Think selling advertising with no readers

Need to get right proportions Think nightclubs with few women

Relative pricing (“the price structure”) is key In practice many platforms have “subsidy” side


Rules of Thumb for Pricing Structure

26

Higher price

(“Money side”)

Lower price

(“Subsidy side”)

Harder to get

Needed more by other side

More elastic demand

Bottleneck asset

Needed less by other side

Inelastic demand

Economic theory shows that optimal prices may be < than MC, 0, and possibly <0. Below-cost pricing common, in fact.


Software Platforms a Good Example of Pricing Illustrates Variety of Pricing Structures

27

PLATFORM USERS DEVELOPER COMMENT

Windows Pays Subsidized App developers get API access for free and cheap or free tools

Sony PlayStation Subsidized Pays Users get consoles for no more than cost and game developers pay commissions

iPhone OS Pays Free for free apps Paid for paid apps

Users pay for phones and developers pay commissions on sales through App Store (but not from other revenue sources)


Platform Offerings

28

Offerings to Create Value for Each Side

More offerings create more value and work like price (iPhone features)

More distinct offerings bring in more customers (sections in newspapers)

Offerings to Promote Interactions and Transactions

Search and matching (eHarmony)

Information (depth of book data for exchanges)

Transactions (Google AdWords)


Design for Positive Network Externalities Platform Design/Rules Promote Positive Externalities

29

Sorting Devices to Get Right Customers

“Exclusionary vibe” (JDate discourages Gentiles)

“Exclusionary amenity” (Upscale anchor stores discourage low-end shoppers)

Search Diversion

Design rules encourage one type of agent to meet another type of agent who really values them but may not seek out by themselves

Shopping malls with anchor stores at either end


Design to Mitigate Negative Externalities Reducing Bad Behavior that Reduces Platform Value

30

Rules Prohibitions on actions that could harm other agents (usually those on other side of match/transaction)

eBay has detailed rules for buyer and seller behavior No misleading ads (sellers) and no multiple auctions for same good (buyers)

Detection and Monitoring

Systems to determine if rules are being broken

Facebook has hundreds of employees looking for bad pictures and bad language

Enforcement Platforms have and use “Bouncers Rights” to exclude violators

Google manually reduces ranks of websites that violate rules for 90 days and sometimes delists






How to Ignite a Platform Business and Obtain Explosive Growth

Catalyst Ignition: 32


YouTube Ignited in Late 2005

33

0.000

10,000.000

20,000.000

30,000.000

40,000.000

50,000.000

60,000.000

70,000.000

may 05

jun 05

jul 05

aug 05

sep 05

oct 05

nov 05

dec 05

jan 06

feb 06

mar 06

apr 06

may 06

jun 06

jul 06

aug 06

sep 06

oct 06

nov 06

dec 06

jan 07

feb 07

mar 07

apr 07

may 07

jun 07

jul 07

aug 07

sep 07

oct 07

nov 07

dec 07

jan 08

feb 08

TABLE 1 -- YOUTUBE UNIQUE VISITORS ('000)

YOUTUBE

Get both sides on board

YouTube needed content creators and content viewers

Block and tackle

YouTube tried multiple strategies to increase uploading and viewing of videos

Ignite

Slow growth from February to December 2005 when YouTube shows an inflection point


Platforms Need Critical Mass to Ignite

34

Critical mass

Critical mass refers to the minimal set of customers on each side that is large enough to attract more customers and result in sustainable positive feedback

Critical mass depends on scale and balance

Probability of customers from two sets getting together and exchanging value increases with the number of customers on each side

Platforms implode if they can’t reach critical mass

If there aren’t enough customers on the other side the probability of advantageous exchange falls and customers don’t join and the early adopters who have eventually leave


Successful Platform Launch Depends on Critical Mass

35

0

200

400

600

800

1000

1200

0 200 400 600 800 1000

Each point reflects a combination of scale (how many customers) and balance (proportion of customer types)

Critical mass corresponds to a combination of scale and balance that is minimally sufficient to ignite the platform


Platform Ignition Requirements Reaching One of Possibly Many Combinations of Scale and Balance Based Critical Mass Points

36

Catalytic Ignition and Critical Mass

Side B

D*- Long-run equilibrium

C`

C``

C*

Ignition

Points of critical mass

Movements at starting to achieve critical mass

O

In this example the critical mass points are between C’ and C”. C* is the point that would lead to optimal platform launch. Points to the NW of the vector 0-C’ and to the SW of vector 0-C” would result result in platform implosion.


B2Bs Died Because They Didn’t Get to Critical Mass No Model to Get the Right Scale and Proportion of Suppliers

37

0

50

100

150

200

250

0 200 400 600 800 1000 1200

Points Show Supplier (X) and Buyer (Y) Combinations for B2B Exchanges (Illustrative Example)

Most B2Bs ended up with Too few suppliers and imploded

Critical mass points that could lead to ignition


Platform Ignition Has a Stopwatch

38

Limited Time for Reaching Critical Mass

Early adopters have limited patience

Diffusion must be rapid enough for momentum

Competitors, new technology, and market changes can dose ignition

Critical Time Period Depends on Type of Platform

More time if sides can be sequenced (e.g. build up advertisers then gets readers)

Less time if sides much show up simultaneously (dating clubs, exchanges, payments systems)

Evans’s Law of Ignition Timing

Platforms that can’t be sequenced have two years or they’re toast

Completely unscientific law but can’t think of many that were successful with longer fuse and lots died who didn’t ignite in that time


Platform Failures: Video Sharing Sites That Imploded (13 Largest as of February 2008)

39

Video Sharing Company Feb 04 May-04 Aug-04 Nov-04 Feb-05 May-05 Aug-05 Nov-05 Feb-06 May-06 Aug-06 Nov-06 Feb-07 May-07 Aug-07 Nov-07 Feb-08

YOUTUBE.COM 900 4,230 12,669 19,089 25,471 34,413 41,035 44,894 53,521 63,921

MSN Video 5,830 5,003 8,211 9,760 10,921 9,971 14,762 11,738 12,453 16,350 15,414 13,250 15,769 14,488 14,987 13,606 13,543

Internet Broadcasting, Internet Broadcasting Systems 11,620 9,257 9,573 9,393 10,329 12,302 10,709 12,658 12,742 10,898

CSTV: College Sports TV 3,747 5,277 7,383 5,504 4,724 5,797 7,373 5,433 4,370 5,943 8,318 4,804

Yahoo! Video 21,141 22,059 19,802 20,855 23,571 6,467 3,982

EBAUMSWORLD.COM 3,654 3,086 2,947 3,166 3,926 4,365 4,394 5,047 4,453 5,316 5,069 4,280 3,363 3,408 4,894 5,224 3,489

HEAVY.COM 490 759 1,927 2,087 2,970 5,589 5,480 6,208 7,518 6,840 3,391 5,241 5,758 4,349 5,092

DAILYMOTION.COM 436 691 1,298 1,952 3,196 2,751 3,729 3,747

VEOH.COM 207 667 293 784 1,857 3,537 3,457 3,196

ATOMFILMS.COM 732 329 1,359 1,845 1,132 1,371 1,154 1,178 1,257 3,065 1,213 2,057 1,534 2,233 2,576 1,847 2,374

NICK.COM TurboNick 1,870 2,101 1,815 2,106

IFILM.COM 2,522 2,757 2,731 2,873 2,241 2,467 2,876 2,846 3,594 3,275 2,979 3,443 3,484 2,124 2,272 1,753 1,115

BRIGHTCOVE.COM 181 334 2,016 1,418 1,578 1,641 2,736

No separate data available on Google Video which also imploded.


Foundations of an Ignition Strategy Determining Relative Prices and Value Propositions

40

Who’s Needed Most and Why?

What value is being provided to

each side?

What alternatives does each side

have and what is demand elasticity?

How much is each side valued by the

other side?


MPD’s Strategic Framework for IgnitionTM

Business Model Getting to Ignition Whose Done It

Sequential entry Get one side on board first, then use it to get the other side on board. OpenTable

SImultaneous entry The platform is opened up right away with both sides on board, usually done when there is an obvious problem to be solved and it is simply making both sides aware

of the business proposition that gets both sides to show up at the same time.

Facebook

Static precommittment strategy

Make credible commitment to each side that the other side will show up Diners Club

Dynamic precommittment

strategy

Have both sides in play by approaching one side and getting them to agree to show up if there is evidence that the other side is on board. Then, go to the other

side and promise that the side they are most interested in is on board.

Xbox

Basic zigzag Incremental growth. Engage in a variety of strategies to get one side and then the other to join the platform over a space of time

YouTube

Marquee strategy Secure a small number of really influential players on one side or both. Mall of America

Zig zag with self supply

Launch platform by initially providing one side yourself. Palm Pilot

Partner with another platform

Partner with a platform that has the most critical side of your platform already on board.

Android

Developer strategy

Create APIs and give a let developers access the platform to create value for the platform’s customers

PayPalX

These are methods that platforms have used successfully in solving coordination

problems and reaching critical

mass.

The appropriate method depends on

the economic situation of the

particular platform.


Catalyst Competition: 42

How to Survive, Compete and Disrupt in a Multi-Dimensional Ecosystem


The Winner-Take-All Myth in Platform Markets Most platforms operate in competitive ecosystems

43

Long-lived platform monopolies are rare

• Many successful platforms face direct competition

Positive feedback effects don’t insure a

single winner

•  They limit the number of successful firms but multiple platforms survive by appealing to different types of customers on both sides

Positive feedback effects work in

reverse

•  They drive rapid growth but competition can lead to a death spiral when they work in reverse

Only the Smart Worrywarts Survive

The MySpace “Monopoly” Leaders often seem entrenched until they aren’t

44

The long-lived Windows dominance on PCs is the exception to the rule that platform markets usually aren’t winner take all.

Facebook Friendster MySpace 2011 Social Network Analysis Report, http://www.ignitesocialmedia.com

“MySpace is far and away the de facto standard for social

networking and is highly entrenched in the youth culture of

today.”

IMEDIACONNECTION, 2006

MASHABLE, 2006

“We see MySpace as the new

MTV, with one crucial difference: the users are the stars.”

Symmetric vs. Asymmetric Competition Multi-dimensional nature of platforms results in new concepts of competition

45

Symmetric Competition

•  Competitors have same number of sides and types of users

•  Competitors have similar pricing structures including decisions on money vs. subsidy side

Asymmetric Competition

•  Rival has extra side(s); both have same side but one has a different one

•  Rival has one side in common but one side different

•  Rival has radically different pricing structure

Examples of Asymmetric Competition

46

Enveloping Platform Rival has extra side

•  Microsoft has 2-sided user/developer software platform

•  Google had 2-sided search/advertising platform plus 2-sided user/developer software platform

•  Google could provide free software, Microsoft couldn’t because that was rev source.

Intersecting Platforms Rival has different side

•  Tencent provides IM for users, sells advertising

•  Qihoo provides anti-virus software for users, sells advertising

•  They compete for users by providing different products to attract users but both looking to sell advertising

Different Pricing

•  Google provides free software to users, Microsoft doesn’t

•  nytimes.com charges viewers, cnn.com doesn’t

•  Developers don’t pay to develop PC games, but do to develop console games

Overtaking the Leader When Competing on the Same Sides Entrants have several strategies for displacing or at least competing with the leader

47

Differentiate by serving subsets of users on each side

better

Feature competition that increases value platform

participants can exchange—better search, matching, and

exchange

Identify better pricing structures that create stronger positive

feedback effects

•  Square entered by identifying tiny merchants and cash users

•  New financial exchanges succeeded through more efficient computerized trading mechanisms

•  Munsey Magazine in late 19th century dropped prices dramatically to users thereby dramatically increasing demand for advertising.

Enveloping the Leader by Adding a New Side Adding another side encircles the incumbent platform and boxes the leader in

48

Major disruptive innovation involves bringing another side to a platform

Provides another source of value to existing sides

Enables n+1 sided platform to lower prices/increase value to the n-sides of the incumbent

Android enveloped iPhone initially because it had the prospect of search-ad revenue and therefore could enter at a low price

Envelopment Strategy Adding a side can surround a rival platform

49

Users

Dev

elop

ers

Users

Deve

lope

rs

Staying in the Lead when Competing on the Same Sides Incumbents can keep the competitors far away—or at least try

50

Feature competition

•  Keep adding and improving features that increase the value platform participants can share in

Focus on strategies that make it hard for new firms

to attract customers

•  Make one or more sides very sticky via platform-specific investments

•  Create a side that requires platform-specific investments

•  Example: applications are sticky and are hard for entrants to duplicate quickly

Lock up liquidity

•  Make if difficult for competitors to attract critical mass by

•  Locking up customers on one or both sides with long-term contracts or

•  Making customers very sticky

Most of all keep growing on both sides as this increases value of platform compared to all followers

Staying Ahead When Rivals Go Asymmetric Asymmetric competition is highly treacherous for incumbents

51

Differentiation Create value prop so strong that lower price of rival doesn’t matter

(WSJ creates unique value so it can charge subscribers)

Price discrimination—lower price to customers most at risk

Expand Platform to Achieve Symmetry

Integrate into additional side to compete directly

(e.g. Apple into ads, Google into hardware)

Expand Platform to Achieve Another Revenue Stream

Integrate into a new side that rival lacks but than can provide similar offsetting revenue


Only the (Smart) Worrywarts Survive Successful platforms are tough but not impossible to beat

52

Constantly worry about the

competition; no matter how successful you are it is possible for you to lose your

lead

A rival has even faster

positive feedback

loops

You have a reverse positive

feedback

loop

Not so clear the paranoid survive

Be smart about what you worry about and

how you react

The Microsoft Syndrome: paranoia

over every possible platform

competitor resulted in

missing major disruption

Lots of rivals have no

chance of success and you shouldn’t waste effort

Realistic assessment of

who could overtake you

Focus a lot on competition

from the n+1 dimensions





Catalyst Conclusion 54


© Market Platform Dynamics & Evans & Schmalensee, The Catalyst Code (HBS Press, 2007)

The Catalyst FrameworkTM


Concluding Thoughts

56

•  All about solving pain points between agents •  Can have explosive growth through positive feedback •  Hard to design because solving many masters •  Hard to ignite because coordination makes it difficult to achieve critical

mass

Catalysts can create tremendous value for themselves and their customers


For More Detail and Background Catalyst Reading List

57

Evans and Schmalensee, Catalyst Code: The Strategies Behind the World's Most Dynamic Companies Harvard Business School Press.

Evans, Platform Economics, CPI Press.

Evans, “How Catalysts Ignite: The Economics of Platform-Based Startups,” in Gawer, Platforms, Markets, and Innovation, Elgar Publishing, 2009.

Evans, Launching New Payments Businesses: The Role of Critical Mass and Ignition Strategies, PYMNTS.com, 2010.

www.catalystcode.com


Thank You!

58

DAVID S. EVANS

Market Platform Dynamics | Founder

[email protected]

Mobile: +1 617 320 8933

Skype: david.s.evans


Documents

CATALYST CODE: HOW TO IGNITE A PLATFORM BUSINESS AND … · Google Search Searchers Advertisers ... Common Features of Catalysts 19 Positive Network Effects ... (Google AdWords)