Digital Platforms Primer: What are Platforms? (Part 1)

The term platform business can be vague, and experts can debate the precise definition. For our purposes, a platform business generally refers to a business that facilitates value-creating interactions between a large set of external parties that use the platform. They connect various external parties, such as sellers, buyers, readers, advertisers, recruiters, and job seekers, with each other. When referring to platform businesses, we will take a broad approach and include certain businesses that pre-date the internet to help highlight the effects of digitization in the next blog.

A newspaper’s classified ads section is an example of a platform business. The classified ads section connects advertisers with people looking for these ads, while the newspaper typically makes money selling ad space in this section. Many tech companies leverage the platform business model. Modern platform businesses include social media sites, smartphones linking users with apps, and online marketplaces connecting buyers and sellers.

Platform businesses often have few assets and employees relative to their market value since they rely heavily on external parties to create content, goods, and services for users. A platform business’s success often depends heavily on the success of these external parties, such as the creators of must-have apps or bestselling products accessible on the platform. Many of the key decisions a platform makes will be based on the ecosystem and relationship it wants to build with external parties.

Platform businesses must make several critical decisions regarding their business and organizational structure. These decisions play a key role in guiding user interaction and value creation on the platform. Several questions platform business executives should answer include:

• What external parties should the platform connect? A platform business must decide what external parties it should connect. A platform might decide to connect recruiters with job seekers, drivers with riders, app makers with users, or other possible combinations.
• What is the right balance of external parties on the platform? A platform that connects different groups together must find the right balance between them to create a good user experience. For instance, a ridesharing platform will have to ensure it has the right mix of riders and drivers. If it gets this balance wrong, it can result in overly long wait times for the riders or drivers.
• How will the platform attract users, especially in the beginning? A platform without users has little utility, so it must attract people. This is particularly challenging in the early stages, so platforms try to deploy strategies to attract users. For instance, the pairing of a classified ads section with the rest of the newspaper can be a strategy to attract readers to the classified ads.
• How should the platform make money? A platform business must decide how to make money and who to charge. A business directory could charge businesses that want to be listed in it, readers that want to read it, or both.
• How should the platform’s internal architecture be designed? A platform business must determine its design or architecture to facilitate user interactions. A business directory may decide to list all ads together in alphabetical order, break them down by category, or use some other system for organizing.
• Should the platform curate content or filter users, and if so, how? A platform must decide whether and how to filter users or curate content. A gaming console will have to decide what video games should be carried on the platform and could decide to prohibit games that are too controversial to promote a family friendly image.

A platform business’s overall success or failure and the value it creates for its users will depend heavily on these decisions. Policymakers should study how and why platforms make these decisions to better understand their implications for competition and public policy.

Network effects occur when the value of a product is dependent on the number of users, and they are common in platform businesses. Network effects can take different forms. Direct network effects occur when the value of a product or service grows because the number of users increases. A social media site connecting friends can exhibit direct network effects. A social media site is almost useless if only one person is on it, but much more valuable when many people are on it. Network effects can also be indirect and occur when one group on a platform benefits based on participation from a different group on the platform. Credit cards can exhibit indirect network effects. The more customers have a specific credit card, the greater incentive merchants have to accept that credit card. The more merchants accept that credit card, the more incentive people have to use it. Successful credit card networks tend to be very large as a result of network effects.

Network effects can encourage scale and often lead to “winner take all” or “winner take most” markets. However, certain factors can counter this dynamic. A niche competitor can take away business from a large platform. For instance, a niche business directory focused on real estate can compete with a general business directory like the Yellow Pages. The ability to more easily switch or use multiple platforms can make it harder for a single platform business to dominate. For instance, people can have multiple credit cards and merchants can accept multiple credit cards, so a single dominant credit card may not emerge if there are multiple options and switching costs are low. These countervailing forces are stronger in some markets and weaker in others, which is a reason why platform businesses’ dominance and market power vary across industries.

Platform businesses play a central role in the modern economy and have unique properties that can differentiate them from traditional businesses. Many large tech companies leverage the platform business model. A platform’s design and structure play a significant role in determining the value it creates for its stakeholders. Platforms often benefit from network effects that can tip the balance towards “winner take all” and “winner take most” markets, but there are also countervailing forces that can prevent this in many markets. Future blogs in this series will look at how these dynamics influence market competition, but the next blog will look at digitization and the effects it has had on platform businesses and the broader economy.