One of my favorite articles about platform strategy is a 2020 article by the Boston Consulting Group. It was a really solid investigation of an important question: Why do platform business models fail?
Just about about client I talk to about digital strategy and transformation wants to build a platform. Especially retailers who want to add a marketplace to their omni-channel operations. And I don’t blame them. For an online-offline retailer, a marketplace is a big gun. It creates a major strategic advantage.
The problem is that only a few companies in a region get to have a robust marketplace. It’s a “winner take most” situation. You have to get there early and build aggressively, which is expensive.
The other problem is that digital platforms are just really tough to build. They are far more complicated. Most fail. If a traditional business is a car, a digital platform is an airplane.
So BCG’s study of why platforms fail is really helpful.
A Quick Summary of the BCG Study
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 use the term integrated firms, which I have referred to as pipelines and traditional vertically integrated firms. But the point is that these business models have had a tough time competing with platforms and more complicated ecosystems.
Second, BCG mostly talks in terms of “business ecosystems”, which is a more general idea and term. I have mostly talked about “digital platforms”, which I consider a simpler, business model within this category. And I have outlined 5 common types.
But if you are looking at a tech-focused 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 almost always need to build partnerships and ecosystems.
- Think 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.
- Think the semiconductor value chain of ARM Holding, TSMC, Nvidia and such all working to create new semiconductors every year.
Ecosystems require far greater coordinated effort, usually focused on combining and coordinating ongoing innovation and improvements. And there is usually lots of fighting for positions of strength within the ecosystem. That’s an interesting dynamic. You usually need an ecosystem orchestrator for things to function. But if it is too powerful, nobody else wants to play.
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. 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. Note their use of “modular structure”. That means other businesses can plug in 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 more flexible and can shift more easily. YouTube doesn’t have to 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 watched what people liked to use. Ecosystems and platform business models are more flexible and adaptive, which can be helpful in the early stages of a company. And at major transition points.
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 extend out into the world and facilitate interactions among 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. Ecosystem businesses are a lot like living organisms. And they need to balance rules and systems with openness and evolution.
“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.
- They cite 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 Twitter and YouTube, its about how to moderate bad content at large scale. For Alibaba, it’s about getting rid of the fake goods.
And now, we get to their main point. Which is that most platform business models and ecosystems fail. And that this is a problem because the stakes are now so high.
“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.”
Interestingly, they say that failure is mostly a design problem, not an execution problem.
“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.”
With that, let me summarize their 7 reasons for failure:
Failure Reason 1: Insufficient Problem to Solve
This one is pretty straight forward.
You need a big, big problem. Platforms really do need scale to work as you need lots of users and interactions. You can’t build a viable platform against a small or even medium opportunity. It needs to be big.
So think big dating sites. And big marketplaces for entire countries. Huge numbers of mobile payments on payment platforms. This are all big spaces with lots of users and activity. You don’t want to try to build a marketplace just for hotels in Cambodia. It’s too small.
Failure Reason 2: Wrong Ecosystem Configuration
“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 who 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 movers in credit cards. That was Diner’s Club and then American Express.
The first mover rarely wins in platforms because it is so difficult to figure out the governance, roles, and incentives 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 Reason 3: Wrong Governance Choices
Let’s say you got the ecosystem configured. And users are participating. In a big space.
But that means lots of interactions and you quickly become the judge and rule-maker for behavior. 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 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 Reason 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 Reason 5: Weak Launch Strategy
“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.”
Not a point bad. But this is actually much easier for incumbents. They already have an established customer base.
Failure Reason 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 Reason 7: Bad Execution
Ok. That’s it. That was quite a bit of text today.
I really encourage you to read this paper if you get a chance. It has lots of nice subtle points.
Photo by Chris Griffith, Creative Commons license with link here.
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