7 Reasons Digital Platforms Fail (Asia Tech Strategy – Daily Lesson / Update)

There was a great article by the Boston Consulting Group. Some really well-thought out points. Here are some excerpts. I have added the bold and highlights.

“The traditional model of the integrated firm with its hierarchical supply chain is increasingly being replaced by business ecosystems, dynamic groups of largely independent partners that work together to deliver integrated products and services. Most of today’s business ecosystems are built around digital platforms. Our smartphones, smart cars, and smart homes are powered by ecosystems of hardware suppliers and application developers; we increasingly order our food, transportation, and accommodation on digital marketplaces; and industrial companies are revolutionizing the way they collaborate by moving to IoT platforms.”

First, they make the distinction between integrated vs. modular organizations. I have referred to integrated firms as pipelines and traditional vertically integrated firms. And how they have a tough time competing with platforms (firms that are more modular and allow external parties to plug in).

Second, they talk in terms of “business ecosystems”, which is a more general idea and term. I have mostly talked about “digital platforms”, which are a simpler, business model within this.

But if you are looking at a tech industry (semiconductors, PCs, telecommunications networks, etc.), you are going to be talking about business ecosystems, and not about platforms. The tech industry almost always requires companies collaborating to create something that is beyond what any individual company could do. They need to build partnerships and ecosystems.

  • This is IBM, Microsoft and Intel working to create the PC ecosystem in the 1980’s. Plus all the peripheral hardware makers and software developers as well.
  • This is the semiconductor value chain with ARM Holding, TSMC, Nvidia and such all working to create new semiconductors every year.

Think of ecosystems as a greater coordinated effort, usually focused on combining and coordinating innovation. And then there is lost of fighting for positions of strength within the ecosystem. If you are too powerful, nobody else wants to play with you. But if there is not an ecosystem orchestrator, things don’t work well. ARM, even though a smaller company, is an orchestrator for semiconductors. So it’s a balancing act to keep the ecosystem together. If you are in an ecosystem, you can end up a commoditized partner, like hardware accessories. That is not great. And you probably aren’t going to be the orchestrator. So for most companies, the goal is to be the most powerful and advantaged complementor possible.

Read the above paragraph again. It is very well written with lots of subtle points.

The next paragraph that got my attention was:

“There are good reasons for the success of the ecosystem model: in an ecosystem’s startup phase, this model can quickly provide access to capabilities that may be too expensive or time-consuming to build within a single firm. Once launched, ecosystems can scale much faster than an individual business because their modular structure makes it easy to add partners. Moreover, ecosystems are very flexible and resilient; their modularity enables both high variety and a high capacity to evolve.”

This is a great point. Platform business models have a lot of power at scale. Network effects. Consumer capture.

But they are particularly powerful in the start-up phase, if they can get rolling. The point BCG makes here about “quickly provide access to capabilities” is great. Platforms / ecosystems are businesses that other people build for you. The content creators provide YouTube and Facebook with content. The drivers provide their cars to Uber. And so on. That lets you grow faster than any traditional firm ever could. My standard line is that a traditional firm is a house you build yourself. A platform is a castle the village builds for you. Note their use of “modular structure”. That means it is a business others can plug into easily.

They also make a second point about flexibility and resilience. This is important.

In the start-up phase, your biggest problem is often figuring out product market fit. Finding out what consumers really want. A platform / ecosystem approach is very flexible and can shift easily. YouTube doesn’t decide what people want to watch, like movie studios. It lets the platform figure that out on its on. Twitter didn’t ever really figure out what to be. Developers started building functions like hashtags on Twitter and they noticed that is what people liked to use. Ecosystems and platform business models are flexible and adaptive, which can be helpful in the early stages of a company.

However, BCG also uses the term “resilience”. This is also about adaptability but for established firms that are dealing with changing conditions. Amazon and Alibaba didn’t really have to figure out what to do during Covid19. The merchants and brands offered tons of new products and the marketplace figured out the changing consumer patterns for them. That’s a type of resilience.

This adaptability point is discussed more:

“Designing a successful business ecosystem poses multiple challenges. For example, it is not enough to design the value creation and delivery model; the design must also explicitly consider value distribution among ecosystem members, and this requires a systems perspective. At the same time, ecosystems cannot be entirely planned and designed; they also emerge and continuously evolve. This adaptability is one of their major strengths. So ecosystem design must ensure that the basics are in place and strategic blunders are avoided, but it must also leave room for creativity, serendipitous discoveries, and emerging customer needs. Ecosystems that are successful in the long run need to be ready to modify their design in anticipation of shifts in markets, technologies, regulations, and public sentiment.”

This is a hugely important point.

Ecosystems and platform business models are extensions of a firm out into the world and among its users. It is not a self-contained, stand-alone entity like a restaurant or factory. And as the outside world is always changing, these businesses must also continually adapt and evolve. Facebook today is different than five years ago. These ecosystem businesses are like living organisms. And they need to balance rules and systems with openness and evolution. The other interesting factor is that development is usually path dependent. What you can do tomorrow depends on where you are today.

One of the biggest arguments for ecosystem and platform approaches these days is adaptability. That we are in an age of increasing uncertainty and changing consumer behavior, technology and politics. Hence, the idea that firms need to be adaptable. I’m not really sure that is true. But you hear this argument often.

“Managing a business ecosystem also presents distinct strategic challenges: solving the chicken-or-egg problem of building supply or demand during launch; preventing the explosion of costs during scale-up, which can be very fast when network effects kick in; protecting quality during fast growth; and defending against competitors that use the low entry barriers of many digital platform models to copy and improve your model and encourage your complementors or users to multihome or even fully switch their allegiance.”

This paragraph is right out of my playbook. I have talked about most all of these points in the class. They site the chicken-or-egg problem, which I have talked a lot about. They talk about protecting quality during fast growth. I called this mismatched and / or crippled scale, which is basically the quality curation problem most platforms have when they get really big. For dating sites, this is kicking off bad behavior. For content sites, its about bad content. For Alibaba, it’s about fake goods.

They also make a good point about the ease of entry for competitors when you have a purely digital business. This is something we see in China often because the digital giants have users and are able to replicate the software quickly. So your best protection is often the physical assets (like logistics, scooters, and customer service reps) that are difficult to copy. I called these companies digital-physical hybrids.

“The stakes are high because the failure of ecosystem-based business models tends to be particularly costly. Many ecosystems are driven by strong direct or indirect network effects and have winner-takes-all characteristics. They may require substantial upfront investments to build the platform and attract a critical mass of suppliers and customers, but once they take off, they can scale very fast and at low marginal cost. Focusing on scale before focusing on profitability, then, can be justified, but this means that failure becomes apparent only after a significant delay. According to PitchBook, out of the more than 100 companies worth more than $1 billion that have gone public since 2010, 64% were unprofitable at the time of listing, including ecosystems such as Uber, Lyft, Snapchat, and Spotify.

These challenges are exacerbated by the current hype around ecosystems. Herd behavior fosters shallow imitation and the transfer of successful models to locations or domains where they do not apply. And the abundance of cheap venture capital has perhaps supported some questionable investments in zombie businesses that have no inherent right to survive.”

These two paragraphs are a great summary of much of the craziness of the last couple of years in China. We see these crazy VC-funded fights by start-ups. Such as Didi vs. Uber. And Grab vs. Gojek. There are actually very good business reasons to blitzscale in the early stages. And this is amplified by a lot of the hot money sloshing around.

***

And now, we get to their main point. Which is that most platform business models and ecosystems fail. And that this is mostly a design problem, not execution.

“Remarkably, six of the seven failure modes—and 85% of observed failures—related to weaknesses in ecosystem design, while only 15% were attributable to bad execution.”

They list 7 reasons for failure:

Failure Mode 1: Insufficient Problem to Solve

This one is pretty straight forward. You need a big, big problem. Platforms really do need size to work as you need lots of users and interactions. So big dating sites. Big marketplaces for entire countries. Lots of chatting. Tons of mobile payments. This are all big problems to solve. But don’t try to build a vertical B2B marketplace just for hotels in Thailand. It’s too small.

Failure Mode 2: Wrong Ecosystem Configuration

From BCG:

“Assuming that an ecosystem has found a substantial problem to solve, the next challenge is to configure the ecosystem to deliver the targeted value proposition. This involves defining the required activities and partners, their responsibilities, and the links among them, and assigning roles to various partners—in particular, the role of orchestrator, which coordinates members, defines standards and rules, and arbitrates conflict. The initial configuration should focus on the core value proposition and incorporate the minimum number of partner types required for its delivery.”

That is a really good paragraph. Ecosystems and platforms are about enabling interactions and lowering Coasean transaction costs. But you have get the users and their participation right. Which is really hard.

In business, it is often the first mover that wins. But that is not usually true for platforms. Facebook was not first mover in social networks. That was Friendster and MySpace. Visa and MasterCard were not first in credit cards. That was Diner’s Club and then American Express. The first mover rarely wins is because it is so difficult to figure out the governance and roles to make a platform work. I call this figuring out the magic equation that balances everyone’s interests and gets everyone to participate and invest.

Failure Mode 3: Wrong Governance Choices

Let’s say you got the ecosystem configured. And users are participating. But that means lots of interactions and you quickly become the judge and rule-maker for behavior. A platform operates a lot like a private government. You are in the governance business. Setting the roles. Making the rules and standards. And enforcing. Note: a lot of the people that work at Facebook and YouTube have government backgrounds. This whole section of the report is worth reading:

“The most prevalent failure mode in our database—responsible for more than a third of the ecosystem failures we studied—was wrong governance choices. The governance model is a critical design choice for an ecosystem because it replaces the hierarchical forms of control in traditional vertical supply chains with indirect forms of control appropriate to the complexity and dynamism of an ecosystem. Governance establishes the standards, rules, and processes that define an ecosystem’s formal or informal constitution. Specifically, it needs to regulate access (Who can become a member of the ecosystem and under what conditions?), participation (How are decision rights distributed among ecosystem partners?), and commitment (What level of ecosystem-specific investments and cospecialization is required?).

According to our analysis, the biggest challenge in ecosystem governance is finding the right level of openness. More-open ecosystems can benefit from faster growth, particularly around launch. They enable a greater diversity of participants and variety of offerings and encourage decentralized innovation. However, they are difficult to control. In the case of high failure cost, and a corresponding need to limit the downside, more-closed ecosystem governance may be the better choice because it allows for a more deliberate design of the ecosystem and for closer control of partners and of the quality of the offering.

We found that social networks were particularly prone to missing the right level of openness. Most of them failed because they opted for a high degree of openness in an attempt to quickly increase the number of users.”

Failure Mode 4: Inadequate Monetization

Pretty obvious. Just because you get a lot of participation and activity doesn’t mean you are making money. News sites have this problem.

Failure Mode 5: Weak Launch Strategy

Not a point bad.

“A strategic challenge for many business ecosystems during launch is to solve the chicken-or-egg problem of securing enough participation from both buyers and suppliers. The goal is to achieve a critical mass for network and data flywheel effects to kick in, whereby scale begets further scale. Success factors include focusing first on the core value proposition and building a minimum viable ecosystem around it that can be expanded over time; emphasizing building a dense network rather than a large network in order to improve the quality of interactions; and focusing investments on the side of the market that is more difficult to convince to join the ecosystem (most ecosystems we observed were initially supply-constrained).

More than two thirds of the failed ecosystems we investigated struggled with solving the chicken-or-egg problem.”

Failure Mode 6: Weak Defensibility

I like this one. It’s basically a competitive dynamics question, which is my area. They touch on a lot of the ideas I talk about: chicken-or-egg problem, network effects, and scale advantages on cost and data.

“Ecosystems that solve the chicken-or-egg problem frequently enjoy winner-takes-all effects. Once they have achieved a dominant market position, strong barriers to entry can result from network effects and scale advantages on costs and data. However, we still identified 10% of ecosystems in our database that went down because they did not build effective defenses into their design.”

“The failed ecosystems suffered from one or several of the following five basic mechanisms of attack: multihoming (suppliers or customers participate in multiple competing ecosystems at the same time or easily switch between ecosystems), disintermediation (partners from two sides of a transaction ecosystem bypass the matching platform and connect directly), differentiation (a subset of users has distinctive needs or tastes that can support a separate ecosystem that takes away market share from the dominant player), ecosystem carryover (a successful business ecosystem expands into a neighboring domain), and backlash (from incumbents, consumers, suppliers, or regulators that challenge the business model or practices of the ecosystem). Successful ecosystems respond to these threats by designing user lock-in into their models, incentivizing customer and supplier loyalty, increasing switching costs, and designing their ecosystems not only for legal compliance but also for long-term social acceptance.”

I really want to know which author wrote that last paragraph. Definitely my type of person. They are really talking about incumbent vs. attacker advantages in platform vs. platform competition. And how competitive barriers are different for attackers and incumbents. And when it is between two platforms, where ideas like differentiation, switching costs, and multihoming matter more.

Failure Mode 7: Bad Execution

Ok. That’s it. I really encourage you to read this paper again. It has just tons of nice subtle points.

Cheers, -jeff

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