Ant Financial and the Sustained Innovation Trap of Network Effects (3 of 3) (Tech Strategy – Podcast 49)

This is Part 3 in a three part series about Ant Group / Ant Financial. In this part, I talk about how sustained innovation is the primary strategy for maintaining their competitive advantages.

You can listen to this podcast here or at iTunes, Google Podcasts and Himalaya.

Related podcasts and articles:

This is part of Learning Goals: Level 5, with a focus on:
  • #19: Basics of Ant Financial / Alipay and Payment Platforms

Concepts for this class.

  1. Network Effects
  2. Adaptation and Resilience
  3. SMILE Marathon: Sustained Innovation

Companies for this class:

  • Ant Financial / Alipay / Ant Group

Photo courtesy of Alibaba


I write, speak and consult about how to win (and not lose) in digital strategy and transformation.

I am the founder of TechMoat Consulting, a boutique consulting firm that helps retailers, brands, and technology companies exploit digital change to grow faster, innovate better and build digital moats. Get in touch here.

My book series Moats and Marathons is one-of-a-kind framework for building and measuring competitive advantages in digital businesses.

Note: This content (articles, podcasts, website info) is not investment advice. The information and opinions from me and any guests may be incorrect. The numbers and information may be wrong. The views expressed may no longer be relevant or accurate. Investing is risky. Do your own research.

——Transcription Below

Welcome, welcome everybody. My name is Jeff Towson and this is the Tech Strategy Podcast. And the topic for today, Ant Financial and the Sustained Innovation Trap of Network Effects. Now that’s kind of a long title, I’ll go through what all that means, but this is part three of three. This is the third podcast about Ant Financial, now called Ant Group, which is heading towards an IPO shortly. and sort of taking that apart from multiple angles. And I’ll summarize that a little bit. And for those of you who are subscribers, I’ve been sending out kind of a decent amount of theory on what they’re really doing. And I’ll summarize a little bit of that as well and sort of try and wrap this all together, how to think about this company and the fact that there’s some pretty important ideas here. And I think that this is really kind of on the frontier of digital strategy is what they’re doing. So I want to kind of tee up the bigger questions that they’re addressing. Now, I guess the good news here is this is a big deal. Ant Financial going public, it’s probably going to be the largest IPO in the world, let’s say $30 billion raised, 200 to $300 billion valuation. I mean, this is the big one. So this is sort of, I don’t say not say historic, but this is a massive story in terms of the digital world, not just for China, not just for Asia, but globally. So that’s cool. Second, as far as I can tell, most people don’t really get this company. I’ve been listening to a lot of what other people are saying about it at the CNBC, and I don’t think people are getting it. I really think they’re looking at it wrong. They’re not seeing this for the strategy play that it is. And so if you are, you know, been following along in this and you know, kind of get what they’re doing, and I’ll go through it again today, that’s cool. I mean, that’s kind of the point of this is for everyone who sort of stays with this class week after week, that over time you’re going to get better and better and things suddenly like Ant Financial, which are big news and very complicated, are not actually that complicated if you look at them with the right framework, which I think we have done. And if you don’t have that, then I think it’s very confusing for everyone. So that’s kind of, I think that’s cool. Like um… that this doesn’t look that complicated in terms of the framework we’ve been discussing for six, nine months now. So anyways, I’ll go through that in detail on why I think that is, but I’ve been kind of reading everything and I don’t see anyone who’s really got it and sort of figured out what they’re doing and why they’re doing, from my point of view anyways. And that really is the goal for me for this class is to turn you into the digital experts, the digital gurus, the people that can look at these complicated emerging scenarios. and see through them in a way that others can’t because you have a nice toolbox of ideas and concepts and frameworks that we have gone through and suddenly it’s not so confusing. That is really my goal here. So hopefully that’s playing out right now. For those of you who aren’t members, feel free to sign up. You can go over to, sign up there, there’s a free 30 day trial. At this point, we’re up to eight levels. So as you go through this course, as I send you emails every couple days telling you, hey, you need to read this article and you need to do this little assignment based on what level you’re on, you will steadily move up level by level. Five main concepts, rate levels, or about 40 main ideas. A lot of those are sort of theoretical, network effects, things like that. And a lot of it is just the basics of important companies like Alibaba and Financial, which we’ll talk about today. So it’s kind of a mix of those two things that add up to about 40 learning goals concepts within eight levels. Okay, let’s get into the subject here because I think this is gonna hopefully be a cool wrap up to the last couple podcasts. So the learning goals for today, for those of you moving up the levels, is network effects, which goes under learning goal 28. We’re gonna talk about sort of the downsides of network effects, which I’ve brought up before that look. Network effects are awesome, but they also kind of suck. And you kind of know the downsides as well as the upside. So one of them is network effect. And the other is the one that I discussed with Martin in the last podcast, Martin Reeves of BCG, which was this idea of competing on adaptation, innovation, and resilience. I’ll talk a little bit about that, but the concepts there are adaptation and resilience and sustained innovation. Hence the title of this. podcast, the Sustained Innovation Trap of NetworkFX. And I’ve listed this in the show notes, so you don’t need to remember any of this. OK, the first podcast I did on this series was 47, which was How Ant Financial is Revolutionizing Finance, one of three. And I basically talked about how to think about this as three platform business models combined. Podcast 48, the one right after that, was the interview with Martin Reeves of BCG about adaptation and innovation. That was kind of more of a free-form discussion, so I’m gonna try and tie that together a little bit. But really, I think the key ideas to take away from them is Ant Financial is like a robust version of Square, which is the other Jack Dorsey company in the US. I mean, it’s like a much more advanced, much bigger This is what Jack Dorsey wants to build with Square. And he’s got about 5% of what Ant Financial is, both in terms of volume and capabilities in the whole business structure. So it’s way down the road in terms of, you know, digital platforms applied to the financial services world. And I’ve argued that, look, it’s really just three platform business models that have stocked stacked on top of each other. The first one is a payment platform. I’ve sort of said, look, platform business models, very powerful when you go digital. There’s really five main types I keep an eye on. Collaboration platforms, marketplace platforms, payment platforms, learning platforms, and so on. This is a payment platform, no different than MasterCard and Visa or PayPal, which is, you have merchants on one side, one user group. You have consumers on the other side, another user group. The primary interaction is sending money to each other. you get an indirect network effect, which is the more merchants you have, the better it is and so on. You can also do a little bit of a C to C play because consumers can send money to each other and merchants can send money to each other. So you can get a little bit of a direct network effect as well and Ant Financial definitely does that. But most of the power is kind of in the indirect side. So that’s kind of the primary thing they’re doing. That’s the infrastructure, that’s what builds your network, that’s what’s making them a lot of their money at this point, which is really early stage, but I don’t think it’s where the big money is long-term. But it gets them a lot of the things they need to build a platform business model. And I’ve kind of said, look, if you look at my blue diamond charts I keep sending, the intangible assets that you build a platform business model on a digital platform business model are users. engagement and data. Those are the three assets you accumulate. You have to get a lot of people to come to your platform. You have to get them to do stuff that generates data. Out of that, hopefully you get a network effect. You get some demand side scale going. But that’s really the assets you’re accumulating. And then the fourth one, which is not really intangible is cash. It has to be monetizable so it works as a business. Okay, a platform business model. for payment doesn’t usually get you all of those things. It gets you users, which is what’s really powerful because it has a natural viral growth mechanism. Because if I want to send you money, or if you’re a merchant and you want to take my money, you have to sign up. So it’s naturally viral and that the very use of the product adds users as customers. So it’s viral and it gets you users and it gets you the network that the model is built upon, but it doesn’t get you that much frequency. doesn’t get you that much engagement, doesn’t get you that much data because you generally don’t know what people are buying, you just get a receipt that I spent a dollar at Starbucks. You might know that I bought coffee, but it doesn’t tell you that. So the data is actually not terribly rich, but it gets you some stuff you need. The second platform, marketplace platform for simple high-frequency services, that’s Meituan, that’s Olima, that’s kind of like Gojek in Indonesia now. You know, that’s all the basic, hey, I’m gonna pay my bills, I’m gonna get a ride to the airport, I’m gonna make movie reservations, I’m gonna make a restaurant reservation. All of that basic super app type daily life services bit. That’s their marketplace platform, which is different than a payment platform, has different dynamics. Okay, so they have that. Now, why did, it used to be Ullama, but they’ve rolled it into this. So it’s starting to look a little bit more like a super app like WeChat. Why is that important? Because it gets you high frequency simple services. So these are the things you use all day long. You get a lot more engagement, you get a lot more data that’s useful and tells you about people. And then the third platform is a marketplace platform for financial services, which are infrequent complicated services. You don’t take out that many loans in life. You don’t buy that many insurance products. You don’t buy that many mutual funds. You do it every… six months maybe. So you don’t get a lot of frequency, it’s very hard to get a lot of engagement, therefore it’s very hard to get data. But it does get you big money because there’s a lot of money in capturing a percentage of the assets under management of Chinese middle class families. That’s a huge number. Now the credit market is actually pretty interesting, but it gets you that other part of the equation. You put all three of those together. I think if you had any of three of those separately, they wouldn’t be nearly as powerful. I don’t think the marketplace platform for financial services would probably be viable without the other two. But together, you get a nice series of complimentary platforms and the compliments that go between them are things like you can use the IT system for all three. That’s got some economies of scale. You have lower customer acquisition costs. You can do data sharing. You can shift money back and forth. There’s a lot of compliments you can move back. I usually call these like linked business models where the three of them together are actually more powerful than separate. So that was kind of the first argument and that was podcast 47. The second argument which was sent out as an email to the subscribers but didn’t go public was basically the idea that the big money in all of this, payment is good. Right, payment, you get a little piece of every time someone spends $5. So that’s nice, it’s like a little toll bridge on all the transactions of China and increasingly cross border payments outside of China because that’s happening a lot by and. There’ll probably be some government regulations maximizing that and I suspect they’re gonna keep that very low because you don’t wanna take a big. percentage of those transactions like say PayPal does which is ridiculous Because you want to get usage and you want people to join the platform So you want to probably make that as cheap as possible and I think that’s what they’ll do long term Right now it’s you know, 50 plus percent of their revenue, but these are early days. No the law the big money long term is Chinese consumers families middle-class families buying investment products and using credit All right, that’s huge money. Now insurance is a possibly big idea, because in theory, those are the three things they’re selling on their marketplace for financial services. They’re selling insurance, financial products, and then credit. In theory, insurance is a big idea. In practice, it’s still pretty small. The two that are really big in the near term are credit and also assets under management where you’re linking up all these mutual funds. you take a percentage as the platform of all the assets under management of Chinese families. That’s huge money. So the big money is probably in credit and assets under management. And what I thought was very cool is they’ve done this in a very asset light way. The same way Alibaba likes to build platforms and likes to be the digital backbone that enables interaction, because they are pure platform players. They don’t like to own. the heavy assets, they don’t like to have big balance sheets. So, you know, for Sineo, their logistics network, those warehouses are not on Alibaba’s books. Those are partners own all the physical assets, they own the data infrastructure that enables the connections, the data technology. It’s the same for these platforms that they’re not, you know, all these loans, all these credit, all this money deployed into mutual funds, that is by and large not on and financials balance sheets. So it’s what I called asset light credit tech, where they’re just processing and taking a percentage as a technology fee, but everything else is sitting on, the banks are the one carrying the loans for consumers or for merchants. The mutual funds are the ones carrying the assets. I mean, they’re not doing any of that. They’re just doing the data and all that. So it’s a credit light version, I’m sorry, an asset light version of credit tech. and investment tech, which is pretty clever because they are endlessly clever. So that was kind of the other article. And then just to round this out, the podcast from last week, Podcast 48, which was the discussion with Martin Reeves, that was really about adaptation, innovation, and resilience. And This is actually really, really important, but it’s one of these areas of digital strategy where the thinking is still unclear. It’s still being formed. So you’ll hear these words all kind of mixed together. You’ll hear, oh, this company, we need to be adaptive. Adaptation, adaptation strategy. You’ll hear that a lot. Well, what does that mean? Well, it means you respond to the changes of the marketplace or consumer behavior very, very quickly. And the argument is, look, the world’s changing a lot faster than it used to. Fashion trends change quickly. Movies come and go, TV comes and go, behavior’s changing, which is all true. So you have to learn to be very, very adaptive. And as the market shifts, you shift. Okay. The other words you tend to hear discussed in this is shaping, that you can have an adaptive strategy or you can have a shaping strategy. And that’s kind of like fashion, that, you know, Why suddenly in one year do all the women of the world start wearing UGG boots? Which they did. You know, why a couple years ago if you got on the subway in Beijing suddenly everybody, the men and the women, all were wearing like athletic gear. They were all wearing sweats and trainers. Because it was a fashion trend. And so the UGGs were a fashion trend. Okay, is that a company being adaptive where they see these trends are happening and they, you know, they do a lot of data analysis? They track closely, they launch new products quickly, they’re adaptive, or are they actually shaping the trend? I mean, isn’t that what kind of fashion companies do? Like Gucci and Prada, they have their big fashion shows in Paris and Milan, and now Shanghai and New York, and they try and create the trend. And then, you know, then they release that season’s goods and they do real well. So it’s this idea of, look, are you an adaptive strategy or are you a shaping strategy? Music tends to be shaping. TV, television, entertainment tends to be shaping. Fashion tends to be shaping. Other things tend to be important. Okay, that’s kind of two sides of the same coin. So you hear those two words, adaptation strategy and shaping strategy. And all of that is becoming more doable with digital because you can have influencers causing and creating trends and tracking data. Okay, the other idea you hear is resilience. that look, the world is changing so fast, maybe the strategy is not to play to win, but to play not to lose. And we just gotta make sure when the world gets crushed, like in COVID, we are resilient. We can survive that. We are designed to survive as opposed to designed to thrive. That’s another way of thinking. And you could argue that’s a matter of adaptation. Okay. Two other phrases you hear, you hear innovation. Okay, we’ve got to innovate. We’ve got to create new products. We’ve got to do spicy Snickers because we think consumers like spicy Snickers, which it turns out they do in China. We need to invent new motors, sort of technological innovation, consumer product innovation, business model innovation. We need to go from renting bicycles to doing bike sharing. Vision, there’s a lot of levels of innovation. And then the other one is rate of learning, which is okay, we need to just be studying the market and our main advantage is that we can learn faster than others, which is a lot about human plus machine learning mechanisms. So there’s kind of the, all those ideas are floating around. You hear these terminologies. I have already sort of planted my flag in this. I think the two in this that matter are innovation and rate of learning. And those are in my little smile marathon. When I say, look, you have to compete along five dimensions and you have to live in one or two, you know, S-M-I-L-E, so scale, which scales go effectiveness and efficiency, that’s S, M is machine learning, artificial intelligence, I is innovation, sustained innovation. L is rate of learning, and then E is ecosystem, shaping, orchestration, and management. Now I think it’s those two, of rate of learning and innovation, that really explain most of this. But you will hear this idea of adaptation, resilience, and all of this. And that’s a lot what Martin was talking about. So you can see that was kind of freeform, but a lot of people are really struggling with this as an idea. And I will sort of put down my flag on what I think it is. more and more over the next couple weeks as we talk about that. But I did want to tee up that idea. So the other two learning goals for today were adaptation and resilience and then sustained innovation. Which brings me back to the Ant Financial discussion. Guy basically said, Ant Financial has a network effect problem, which I called the sustained innovation trap. Hence, They have to do a lot of sustained innovation, not just continuous innovation, ongoing innovation. And they state this all throughout their IPO filing. You’ll see the phrase sustained innovation all throughout that filing as the core of their strategy. And they listed in their risk section as one of their major risks, as a failure to effectively do sustained innovation. So why is that phrase everywhere? And my reason is, basically because they are a platform business from top to bottom, and they are about building and capturing network effects from top to bottom. And network effects have a lot of downsides. They have a lot of risks. And their solution to those risks is sustained innovation. And I’ll explain how they got to that conclusion. Now, I published a podcast, number 41, which was about three ways that network effects suck. Because everyone thinks they’re great. Venture capitalists love network effects. Has a lot to do with the fact that they get out pretty quick. You know, they build companies, they get network effects going, that fuels the growth. It creates some degree of competitive advantage, and then it IPOs and most of them go away. And you know, so when network effects get into problems later, They’re usually not around anymore, so they don’t talk as much about that. So VCs always talk about the good sides of network effects. They’re like the experts on this question, but never the downsides. Now what are some of the downsides of network effects? A couple of them I’ve talked about before, that they’re actually very hard to get going, that you have what they call the chicken and the egg problem. To get the merchants, you have to get the consumers. To get the consumers, you have to get the merchants. You have to get to critical mass. Generally, if you have a YouTube or a TikTok-like site and you don’t have a lot of content, or if you have a messenger like WeChat and WhatsApp and nobody’s on it, until you, it’s not very valuable to anybody. So until you get to a critical mass of volume, the service doesn’t really function and it’s not very good. Then once you get to critical mass, then the market generally collapses to you, the flywheel kicks in, you take off and everything’s great. And so there’s some problems on the early side. Problems later on include the fact that the network effect doesn’t go on forever. This idea that the more people that are on my service, consumers or merchants, the better it is for that other user group. Well, that phenomenon doesn’t go on forever. At a certain point when you start adding more and more merchants, it doesn’t get any better for the consumers. And when you add consumers, it doesn’t get any better for the merchants. These things do flatline at a certain point. for most things, right? Even powerful mechanisms, no powerful mechanism goes on forever. Trees don’t grow to the sky, eventually everything taps out. So they do flatline and some of them flatline quite early like DD and Uber. It turns out once there’s five cars near my house in the morning and I don’t have to wait more than three minutes to get a ride, anything more than that. doesn’t really help me. If there’s 50 cars nearby, it doesn’t create any more value to me. Local ride hailing flat lines out pretty quick, which flat lines out means the value doesn’t keep going up sort of flat lines. So that’s one. You can see other businesses use generally speaking like social networks, which we’ll talk about. I’ve avoided this subject for 48 podcasts now. I’ll get into social networks soon because I don’t really think they exist. But in theory, having a social network flatlines pretty quickly. Nobody has a thousand friends. They talk about Dunbar’s number, which is the average number of humans that you can be in contact with in your life. And it used to be like one or 200. Now with digital, it’s probably up to a thousand. But nobody has a hundred thousand friends. So. It happens quickly in social networks. Utilities tend to go on a lot longer. The more people I can send money to, merchants, which is a utility, payments a utility, that one tends to keep going up and up. The number of hotels I can get into around the world if I’m on vacation, that tends to go up and up. So some flatline early, some go on for a long, long time. Utilities tend to be better, generally speaking. Okay. So, asymptotic. A network effect is a problem. The leaky bucket, this is I’m summarizing podcast 41 here. The leaky bucket, which is the problem of, look, you’re always gonna lose users. People are gonna cancel their credit cards, they’re gonna stop going on Facebook, they’re gonna stop using this ride service, they’re gonna stop listening to your, I don’t know, YouTube videos, TikTok, whatever. You’re always gonna lose viewers and you’re always gonna lose content creators. If that was the network effect you were going to. So your bucket is always leaky, but your network effect depends on continual activity. So you always have to be finding new users. And that can be a real problem for some businesses like Ctrip and Expedia, where people just don’t rent hotels very often. So they’re always out there trying to acquire new users, which is very difficult sometimes. So. Let’s see another one, interaction failure at scale. When you have, you know, the whole point of a network effect, a platform is to complete interactions successfully. If you go on to get a taxi and you can’t find one on DD, that would be an interaction failure. You didn’t consummate the interaction, there was no match. People get pretty annoyed by that pretty fast and they tend to leave. If you go on dating sites and you can’t meet anyone, People dump that pretty quick. So the failure rate of the interaction, like I looked for a good and I couldn’t find the good on Taobao, or I did buy the good and it turned out to be bad, it was a fake. All that would be interaction failure. Those problems tend to grow as you get bigger. So they call it interaction failure at scale. When you suddenly have millions and millions of items being sold on Taobao, their fake goods problem is a real problem. because you get a higher failure rate from the eyes of consumers because they bought something turned out to be sucks. And it’s a very hard problem to solve at scale. I mean, do you check everything? Difficult. Mismatched or crippled scale, which is one of our concepts, the idea that certain parts of your business scale better than others, you can upload content forever on YouTube and TikTok. It scales beautifully on content publishing. It does not scale well on content editing or moderation. So as people put up horrible stuff, it’s harder and harder to weed out the horrible stuff when it’s millions of videos every hour. So one half of the business scales better than the other half. Multi-homing, anyways, the real bad one here, which is the one we wanna talk about, is reverse network effects. The idea that… that flywheel can start going the other way and it’s just as powerful on the way down as it is up. So social networks probably have the biggest problem with this where very successful social networks like Friendster and MySpace, they did well, they got big and then they just plummeted down and people just, it just cratered. And you don’t see that on marketplaces so much. You don’t see that on utilities like payment. But you do see this problem of, you know, you start to lose consumers, okay. As the consumers go away, then the site is less valuable to the merchants. So the merchants go away. And then because there’s fewer merchants, it’s less valuable for the consumers and they go away. So you do see this reverse flywheel kick in and that is a big, big problem. So the way I typically explain this, is a network effect is a competitive advantage. It means if I have, it’s like a structural advantage. If I have a network effect, my service is superior to a competitor. Okay. But one of the reasons network effects are called demand side economies of scale is my advantage is predicated on me being bigger than the competitor. It’s not an absolute advantage. I’m only more valuable as a site when I’m larger than the other company. So if that’s a small marketplace and I’m a big marketplace, my service isn’t superior. So it’s a lot like supply side economies of scale. I have a bigger factory than my competitor. Therefore my fixed costs, the production costs, some of the electricity, water, things like that is spread out over a larger volume. of produce goods, so when I take the number of goods and divide it, or I take the sort of the fixed costs and divide it by the number of goods, my per unit cost is lower than a smaller factory. But again, my cost advantage on that situation, it only exists as long as I’m bigger than the other player. So we call that supply side economies of scale. Well, demand side is the same. My marketplace… as Taobao is only better than the smaller marketplace as long as I maintain my scale advantage. And so people usually talk about market share. I have 60% of the market, they have 20% of the market. That generally means I have demand side economies of scale via network effect, my service is actually superior. But if I drop to 40% of the market and they get up to 40% My advantage has gone away. Now we’re equal. That’s the problem. You have to maintain the difference of scale. And it’s the same for the factories. I’m cheaper than that company because my factory is bigger. But if they get their volume up to match mine, suddenly I lose my cost advantage. Okay. What Ant Financial talks about is this idea of we have to maintain our market share. We have to maintain our market share, so our network effect is superior to competitors and our users don’t leave us for other sites that offer the same thing. So they talk about maintaining market share. What they’re really talking about is that demand side economies of scale. And their network effect is what makes that happen. So what happens if you start to lose market share? It’s a big, big problem. And the way I explain this to people is, A supply side economies of scale is like, I’m competing with someone in factories, we make glasses or something. When I get bigger than them, I start to get an advantage. That is like me going from riding a bicycle and they’re riding a bicycle to suddenly I’m driving a car. I have a structural advantage where I am now faster than them, because I’m in a car, but they’re still in the bicycle because of the difference of size. It’s different when you go to the network effects discussion of this because that’s not like going from a bicycle to a car. It’s like going from a bicycle to an airplane. Network effects are more powerful. You are going a lot faster. You have a massive structural advantage when you have a network effect, i.e. demand side economies of scale. However, so that’s the airplane. An airplane is better than a car, true. Here’s the problem. Once you get this going and you’re zipping along with your network effect, and then you realize, okay, I’m starting to lose users, I have a leaky bucket. I’m not retaining people, I’ve got churn, I’m not acquiring, my volume on my platform is starting to go down. That’s like the airplane starting to lose altitude. And that’s the difference between a car and an airplane. If you start to slow down as a car, it’s not catastrophic. If you start losing altitude as an airplane, it’s catastrophic because there’s no way to land that thing. The network effects will start spinning in reverse and you will crater into the mountainside. And that’s what happens to these companies. So yes, it’s more powerful to have a network effect. Yes, it’s a better advantage. It is also more perilous. And what you start to see is when these companies that have built their businesses based on network effects start to lose users, they start to use. lose activity, they start to lose altitude, they panic. And they start to do things like jacking up their marketing spend. Look, we’re losing users. Nobody’s coming to our short video platform to watch the videos anymore. And because people aren’t watching the videos, we’re starting to lose content creators. And therefore, they panic. So what do they do? They start to jack up their marketing spend and try and buy users. Where they start to give away free cups of coffee. or they start to do all these, and a lot of stuff they do is fraudulent sometimes, but they start jamming their marketing spend and doing all these games, and they’re basically panicked. Network effects are dangerous. And I think the analogy with airplanes is pretty good, and I think a lot of what you see is these companies losing altitude and they freak out. So what do you really need to win this game? You actually kinda need three things. If you’re gonna play the network effect, I’ve got superior scale on the demand side game. That’s my main advantage. One, you need to get that superior scale, that larger market share in a circumscribed market. You don’t wanna just be bigger. I have 60% of the market, they have 20, in terms of activity or user or whatever. I need the market to be circumscribed. and ideally without much growth, because I don’t want that person who’s got 20% to have any room to grow to my size. I need a fixed market with a hard barrier. If I’m in a sprawling market with lots of avenues for growth, they can get from 20 to 40 to 60% by going into that new space. Or if we’re in one market like payment, but it’s growing at 20% a year, they can expand into that growth. I have to maintain my size advantage. So it’s better if I’ve got 60% of the market, they’ve got 20% of the market, and the market is not growing and it’s got a hard circumscribed barrier. That gives them nowhere to get that extra scale unless they can take it from me. you usually need both of those things. The other thing you need is you need smart management. This was the classic Coca-Cola versus Pepsi scenario where Coke always had a scale advantage over Pepsi for decades. And that got them superior marketing span, it got them some production cost and distribution advantages, things like that. But it was a scale advantage for the most part. They never defended. And as Pepsi got bigger and bigger, they kind of ignored them. They didn’t think they were worthy to mention their name. And Pepsi slowly got bigger and bigger. They didn’t defend when someone started to… decreased their scale advantage. And then one day in the 70s and 80s, they woke up to the fact that Pepsi was almost as big as they were in the cola business. And then they turned their guns on them. They said, I’m gonna use my scale advantage to hurt you. I’m gonna drop my per unit, you know, my pricing down to my per unit cost, because my per unit costs are lower than your per unit cost, because I’m bigger. We’re gonna do a price war. I’m gonna try and outspend you on marketing. And it didn’t work because Pepsi had already closed the gap. So they got into a price war and Coke discovered they couldn’t beat them anymore. So if you have a scale advantage, you have to actively defend. And sometimes management doesn’t do that. So if I’ve got 60 and they’ve got 20 and they start to get to 25, I’ve got to hit them with everything I’ve got. Price war, outspend the market. I’ve got to use all my advantage against them to keep them down at 20%. And then generally you want fixed costs or something. You need… something that gives you a superior scale like that. So really two points there, larger market share in a circumscribed market, ideally with little growth, and smart management that actively defends, which you don’t always get, which is kind of ironic because oftentimes when a company is doing real well because they have a structural advantage, you often get lazy management who is so used to having life so easy, they’ve kind of forgotten stuff, maybe it’s the kid or the grandson’s running the company. So you actually do see that a little bit. Great structural companies with loser, lazy management that doesn’t defend. Let’s get to Ant Financial. So why did they mention sustained innovation so much? So think about it from Ant Financial sort of situation. They’ve basically built three platforms that are all tied together, and each of those platforms has network effects. I think they have… For those of you who saw my blue diamond charts for this, I think I put the network effects in there. I think one, two, three, four, at least four different network effects that are being built into this. And that’s not even counting their ties with Taobao and the other Alibaba ecosystem stuff. So, three platforms, at least three network effects that they all have to keep going. They don’t really have a circumscribed market. I mean, this is sprawling. It’s going from payment to insure tech, to investment tech, to credit tech, to, you know. So there’s not any real circumscribed hard barriers to this market that’s gonna let them keep their market share sort of dominance. Okay, it’s high growth. I think it’s gonna be very high growth in credit. I think it’s gonna be very high growth in insurance and in payment. So you don’t really have that either. So how do you maintain your market share? Now they mention all throughout their document that we’re like number one. We’re the number one payment processor, we’re the number one credit source, we’re the number one, they’ll use different metrics. They’re one, two or three for all of these things, usually one or two. Okay, so we have the market share. How are we gonna keep that so that we keep our sort of demand side scale, network effect advantage? And God forbid we avoid a reverse network effect kicking in at some point, because that’s always the risk. What’s the strategy? How do you do that? And their strategy is sustained innovation. That’s it. You have to keep activity levels on both sides of the platform, which means you have to keep the consumers and the merchants keep coming back, keep being active more than your competitors. How do you do that? Well, sustained innovation, which is, they argue that in order to maintain their market share and therefore their network effect, they must continually increase the value they provide to the users of the platform. And that means continually adding more value to the consumers, continually adding more value to the merchants, continually adding more value to the creditors. the asset managers and in theory one day the insurance companies via sustained, continuous innovation. We’re gonna have to outrun our competitors along this dimension, which gets me back to my smile marathon. Their daily operating requirement is sustained innovation to their core user groups and that’s their best defense for their structure. So these things all tie together, the operational marathon and the structural advantages, competitive advantages, all kind of tied together. But that’s pretty much their argument. And I think it’s a pretty, that’s some pretty solid thinking, right? That’s, you know, and that’s why if you look at their risk section in the IPO filing, one of the things they talk about is culture, which I thought was very interesting, that you don’t usually see culture mentioned as a risk. We must maintain our innovative and unique. culture that we have built, which is what Alibaba has as well, because it’s really the same company more or less. That’s how you get innovation. That’s how you get a rapid rate of learning, depending what words you want to use. That’s how you get adaptability, shaping, all of those words. It’s culture, it’s organization, it’s human resources, and it’s sustained innovation over long periods of time that enable you to continually add more and more value to your merchants. your insurance companies, your creditors, and your consumers such that they always keep coming back. That’s their strategy. And I thought that was, you know, that was some good clean thinking and it tells their whole company what they have to do every single day, day after day, basically forever. They’re a sustained innovation company. And if they do that well, then they maintain their structural advantages and their airplane flies high and fast. And if they start to fail at that, they slow down, they’re not as effective at their innovation, then maybe they start to lose altitude. That’s the game they’re in. And that’s really the theory I wanted to go through for today, so for those of you who are subscribers, the three ideas for today, Learning Goal 28 is network effects. Now we’re gonna keep hitting this question over and over because they’re very important, but they’re a lot more complicated than people think. Learning goal 32, which is adaptation, innovation, and resilience. You know, this is this kind of fuzzy area of rate of learning leading to innovation, and that makes you adaptable and resilient. It’s all kind of fuzzy, but there’s that idea. Within there, the key thing is sustained innovation. Now, there’s actually other stuff going on here. I’ve sort of focused on the demand side, you know, competitive advantages, but there’s other things you can do here. The switching costs, you can build in switching costs with merchants and that’s obviously what Ant Financial is trying to do, which is okay, you’ve got this sort of platform business model, you’re connecting merchants with consumers in payment platform, you’re connecting them with a marketplace platform for daily life services and you’re connecting them in credit and other things. Okay, fine. You can start to build in switching costs on the merchant side. you can do things like offer them free software that let these small merchants, which is a lot of what Alibaba serves as small merchants, you know, the operating systems for their little stores. Here’s an inventory management system for you. You can plug it in. Here’s a POS device you can put on your counter. As you start to provide more and more services, particularly on the merchant side, you start to sort of integrate operationally with them and that creates switching costs. That’s actually pretty durable. If you look at a company like Didi, their network effect is actually quite weak. It flatlines very early, it’s not terribly powerful. Where they do have a lot of strength is building and switching costs between them and drivers. Giving them loans, services, things like that. Well, clearly when you look at what Alibaba talks about and financial talks about in terms of international, the two things they talk about is, we’re going cross border, we’re going into the Philippines, we’re going into Thailand. You know, they talk about cross-border payments and they talk about merchant services. Merchant services is let us help you run your business. We’ll give you free software. And how are they doing that? Well, they have AliCloud. So you can start to move aspects of your business up to AliCloud and run it from there, which is great for the business, especially if you’re a small business. and maybe they start helping you with your supply chain, maybe they start doing your procurement, your inventory management, they give away free software to mom and pop shops all over China to run their little stores on. All of that is very, very helpful. Meituan does this with restaurants because they’re in the business of connecting restaurants and food delivery, so they’re giving them lots of operating software for these small restaurants. And that’s great, and that’s a way of adding value, which it does. But so that sort of helps you on the network effect bit, but it also builds in switching costs because it’s hard to swap out the company, you know, that you’re running your whole business on. So that’s also going on there. And I think they’re gonna do a lot of that with small merchants. I think they wanna do that with banks. If you look at their digital finance marketplace, the third platform, you know, that’s connecting consumers with banks to do credit tech and it’s connecting consumers with asset management companies to do investment tech and then insurance companies to do insurance tech. Well, they clearly want to do the same on that digital finance platform. The banks are a little bit problematic because of the regulatory requirements and I suspect they’re not going to get very far saying, hey, you’re a large, you know, you’re a rural bank in China. Let us do your operating system. Okay, maybe it could happen. Let us move your business up to the cloud. A lot of these businesses, these banks are not very good at their tech, their apps tend not to be any good. Maybe they’ll have some success there. I could also see them getting a lot of pushback from the powers that be and not getting too far in terms of integrating operationally with the banks, like I think they will with the small merchants. Asset management companies, probably the place that’s easiest is credit risk analysis, because if you’re gonna offer a loan, to a small business, you have to kind of do the underwriting and Alibaba has all the data. So there’s gonna be a lot of co-underwriting. So the area I think you’re gonna see probably the most integration in terms of that data knowledge is probably credit. But we’ll see, I mean, they’re clever and they’re endlessly coming up with new stuff. So think about like other advantages you can build in here. That would be one. Another one you can obviously do is they can start to get economies of scale on their IT spending. Now that’s a big fixed cost. We’re building out all this IT tech. We spend more on IT tech for digital finance and insure tech than anyone on the planet. We have huge economies of scale there. That’s another type advantage. So when you get demand side scale, I’ve talked about this quite a few times, as you get demand side scale, which is one type advantage, you can build other advantages. You can build switching costs. You can build in scarce resources. You can build on supply side advantages like fixed costs of production, distribution, logistics, content creation, which is very important for companies like Netflix and Youku. And you can just build out IT and web services. So there’s a lot, you can play this on both sides. So you don’t have to be totally, I’m actually a little more positive about Chinese and Asian companies in this regard than I am say about Silicon Valley. Silicon Valley companies like to be pure digital creatures. They don’t want to have any physical assets or day-to-day operations. You know, they just like to be people staring at screens coding. And if you’re a purely digital animal, you tend to become very dependent on network effects. I tend to like companies that are sort of a digital physical hybrid that are half digital and half operational, where you have warehouses and people filming shows, and you have people delivering things on bikes. because you can build in a lot more advantages on the supply side. Now, it means your economics aren’t as pretty, because if you’re a purely digital company, your economics are beautiful, but I think you tend to be a lot more protected. I’ve always sort of, and I think that’s what companies, Asia’s do in particular, Chinese companies do that, Southeast Asia, Russia, people tend to do that a lot more. Maybe it’s just because labor costs are so much cheaper, but I tend to like that mix a lot more. I think you’re a lot more protected. Couple last thoughts on Alibaba. Some of the risks, some of the things to think about. Clearly, the regulatory uncertainty is a big deal with this company. Jack Ma is kind of famous for doing this play where he has a successful business, like let’s say Taobao, and then he looks for an area that’s regulatorily gray, like offering a money market fund. And so what he does is he launches UABAU, which was a money market fund coming out of Alipay, and he offers it to consumers, and they all sign up in huge numbers, 80 million in a couple months, something like that. And it was kind of regulatorily gray, and then the government chimes in six months later and says, hey, what are you doing? And they generally then start creating rules because they don’t want everyone doing this. Well… that’s fine, they start creating rules, they generally stop it or slow it down. But because he’s got so many users there, they generally don’t tell those people, you gotta kick those people off their U of O accounts. They kinda get grandfathered in. So it’s like he climbs up the ladder first and then the government pulls up the ladder behind him. He does that kind of a lot into healthcare and regulatory stuff, so they definitely did this. They sort of jumped into the financial space of China. when it was a bit gray and then the government responded, you know, years later and set some more stringent rules but he got grandfathered in with a couple others like Tencent. But it’s very hard for anyone else to then get into that space. You see him do that kind of a lot. But yeah, the regulatory risk here could be significant. We don’t know what the big four banks are going to do. We don’t know what the new Chinese digital currency is going to mean. There are some people who understand that stuff, but very, very few. If you’re going to do financial services in China, that is a whole specialty. You can spend your whole life studying that. The regulatory aspects, the political sort of state capitalism aspects, the state-owned bank aspects, it is just a mess of complexity. I can’t figure it out beyond a certain point. but we don’t know what they’re gonna do. So we could see some major changes to their business in terms of payment, in terms of credit, in terms of asset management, any given day of the week. So that’s a big unknown with this company and there are a rare few who know the details inside to figure that out, I’m not one of them. The other bit was, risk-wise, uncertainty-wise, was Ant Financial was really a global play. It was arguably the most globally ambitious of any of China’s digital companies over the last four years. They were doing deals everywhere. It was kind of quiet. People didn’t really report on it very much. They were buying shares of banks in Thailand and around the world and putting up cross border payment, joint ventures in Myanmar and Pakistan and Sri Lanka. I mean, they’re everywhere. And, you know, the goal was to create digital finance company. And you begin with payment, which is what they started with, and then you add merchant services, and then you add credit, and you kind of step up, step up, and you build one platform on top of each other, just like they did in China. That was clearly the play. There was the idea that this could end up being the largest bank on the planet, very, very quickly. And they were moving pretty steadily in that regard. And then the political landscape of the world changed in the last two years. Now the idea that Ant Financial could go in and buy MoneyGram or buy a major bank in London without a political discussion taking place is very unlikely. So that has clearly shifted. You know, they did famously get shut down from buying MoneyGram in the United States on political concerns. But yeah, that, that international aspect, which was a huge part of their story up until two years ago, doesn’t really show up in the IPO document at all. The only thing mentioned is payments and merchant services. So it looks like the payment and the merchant service bit is going to sort of follow Taobao and AliExpress and Lazada as they expand geographically. But it’s not the big, we’re going idea that was floating around a couple years ago. But we’ll see, that could all change very quickly. And I think that’s it for Ant Financial. This has been three podcasts, how many articles? Four podcasts, four articles, five articles. Yeah, it’s been a lot of Ant Financial in the last couple weeks, but I think we’ve kind of covered it. A lot of important ideas here, and I did want to tee up this whole idea of adaptive versus shaping strategy, which I’m gonna start talking a lot more about. going forward, especially as we go into new manufacturing. New manufacturing is a huge deal. China is the leader in this. Alibaba is rocking and rolling. That has a lot to it in terms of adapting and even shaping the markets for some manufactured goods. And the product category that Alibaba has launched new manufacturing in is apparel, which is just ripe for adaptation and shaping strategies. So I wanted to tee that up as well. Okay, but that’s it for Aunt Fine Angel. So I had kind of a great, but maybe strange week. I flew down to the south of Thailand and it’s really, I mean, it’s obviously beautiful. I was sort of near Koh Phi Phi and Rye Lay and Ao Nung and Koh Lanta. And I mean, it is, it’s spectacular, but traditionally when you go down there, The issue is these are really beautiful places, but they’re actually quite small. So they’re just packed with tourists. Like it’s so many people packed onto one beach and that tends to happen a lot, which is a bit annoying. Well, it was empty. I mean, I was the only person on the beach. And now that’s actually kind of sad because these local hotels and shops are just getting pounded by the sort of closing of the borders. to Thailand. So there’s like a lot of small business people are having a really rough time and that’s you know that’s really bad. But it was actually kind of nice in terms of just not having the overrun tourist situation which sometimes happens. Now I should hedge that a little bit I guess. The packed tourist situation can be a lot of fun like if you go on to I don’t know Kosa Muir Co-PP on a Friday night and it’s just a sea of people and everyone’s kind of wasted anyways and there’s music and Fire dancers. Okay. That’s a pretty good Friday night generally speaking But yeah, it’s not so awesome when you try and go to the famous beach and it’s just packed with people So it was very odd. It was like it was beautiful, but it was also a little bit depressing To see all the business people struggling So I was down there for a week and now I’m back. And the good news is the border is finally opening with China so I can get back on the ground. Finally, they started to open it just recently. So I’m starting to think of projects there and doing some stuff. And on my short list, absolutely, Shunxi, the new manufacturing facility that Alibaba has launched in Hangzhou. I definitely want to see that. So I’m gonna reach out to them and see if I can go do that and do some video and stuff from on the ground there. So that should be fun. Actually, let me ask you a question. As I was down there for the week, I did a ton of reading and sort of ton of thinking about this class. And I mean, there was two things I really kinda I think need help with. One is I’m coming up with a sort of Uber grand PowerPoint that lays out. all the main ideas in a nice simple picture. So you can see, I’ve done it sort of in levels right now, which is, it’s all right, it’s not awesome. And you can kind of see, okay, I’m gonna finish block one, I’m gonna finish level two, and you can just see yourself moving up and completing each block. So it gives a sense of progress, which is important. But it also, as we do more and more content, it’s, we’re talking about 40 different. learning goals at this point. It’s so easy to get lost in the content and I think a lot of people are struggling with that. So I sort of lay it out as a graphic so people can always see where it fits together. One, I gotta think up a graphic for how to do that. If you’re interested in talking about that and maybe offering suggestions, I’d really appreciate some feedback. Or we could work on it together to come up with one simple picture that lays out what you wanna accomplish. So that’s one. The other thing is, you know, I’ve broken this up into eight levels, or it could be eight blocks. you know, how to go from one block to the next and how to sort of have a sense of completion and okay, I’m gonna study really hard over the next month and I’m gonna finish level one. Do the articles, do the writing and then what? Take a test? People don’t really wanna take tests. Something such that you work for it, do something past the level, get a, well, we’ll do a certificate and then, you know, take a break for a week or two and rest your brain and then say, okay, now I’m gonna come back, now I’m gonna tackle level two. but to sort of break that apart and have a level of completion, level one, level two, level three, which is not really doing right now. The rain’s coming down now. And so I’m not sure what to do with that. If you’re open discussing that or maybe working on it together, send me a note, whether it’s a test or maybe doing some writing. In some of my classes, what I’ve had people do is where people work in teams and then they actually do videos and post them. answering certain questions that rely on the material. There’s a lot of ways we could do that, but I would like to have more of a near-term goal that gets you a sense of completion, and then boom, okay, let’s go on to level two, let’s go, you know. So I’m thinking about that. I’m thinking a test is not right, and that people wouldn’t enjoy that very much. I do actually sort of follow closely what people are doing, and I know if I ask too much, I can see when people click on things and read and not. I can tell when I ask too much, people don’t click on it and don’t do it. So I know there’s a level I can push you. You know, try it, write a couple paragraphs, listen to this, read this article. And I know there’s a certain point where I’ve asked too much, people are like, eh, and it just doesn’t happen. So I’m trying to find that point there. If you have any thoughts on that, you wanna talk about it. If you’re in Bangkok, you wanna sit down, have a cup of coffee, you know, send me a note. I’m always on LinkedIn, very easy to reach there. That’s probably the easiest way to reach me as opposed to email. Just go on LinkedIn and send me a note and say you’re in the class and I’ll always get back to you. Anyways, okay, just two ideas I’m sort of thinking about this week. But I think that is it for me. I hope this has been helpful. That was a lot. Three classes, four articles on Ant Financial. So. I think we’re all ahead of the curve on this one relative to, like, turn on CNBC and hear them talk about this. Like, we’re way ahead of them. That always feels kind of nice. Anyways, that’s it for me. Have a great week, and I will talk to you next week.

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