V
viewpoints
DOI:10.1145/3372918
Michael A. Cusumano
Technology Strategy
and Management
‘Platformizing’ a Bad
Business Does Not
Make It a Good Business
Transaction platforms link third-party applications and services providers with users.
U
as well as
Airbnb, WeWork (We Co.),
and other sharing-economy
startups, offer valuable services, albeit with different
levels of financial success (see “The
Sharing Economy Meets Reality, Communications, January 2018). What most
of these ventures have in common is
they function as transaction platforms.
That is, they bring together two or more
market sides to exchange information,
goods, or services, including advertisements. The businesses can grow
rapidly through the power of network
effects whereby one market actor (for
example, sellers) attracts another side
(for example, buyers) in a self-reinforcing positive feedback loop. The more
populated one side becomes, the more
value and participation we see on the
other side. Transaction platforms contrast with innovation platforms, such as
Microsoft Windows, Apple iOS, Google
Android, or the Facebook and WeChat
APIs. These foundational products or
technologies generate network effects
by linking users with third-party providers of applications and services.5
All platforms connect multiple
market participants and can get big
fast if they generate strong network effects and do not have a lot of digital or
conventional competition. But there
IMAGE BY AND RIJ BORYS ASSOCIAT ES, USING SH UTT ERSTOC K
BER AND LYFT,
are significant differences in business
models. Microsoft and Apple mostly
sell products. Google gives away software and digital services but then sells
advertisements. Airbnb matches people with rooms for rent to possible
renters and charges a fee when a
match occurs. WeWork is really a “onesided company platform” in that it
leases office space and then resells it
on short-term arrangements.
The most valuable publicly listed
firms in the world today—Microsoft,
Apple, Amazon, Alphabet-Google, Facebook, Alibaba, and Tencent—are all
“hybrids” that combine transaction and
innovation platforms. Several colleagues
and I recently measured their performance, comparing the largest 43 publicly listed platform companies to 100 of
the largest firms in the same businesses
over a 20-year period. They all had comparable annual revenues in 2015 (the
year we compiled our list) of between
$4.3 billion and $4.8 billion. But platforms achieved these sales with half the
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Median values for Forbes Global 2000 industry control sample and platforms, 1995–2015.
Variable
Industry
Control Sample
Innovation and
Transaction Platforms
Number of Firms
100
43
Sales (Million$)
$4,845
$4,335
Employees
19,000
9,872*
Operating Profit %
12%
21%*
Market Value (Million$)
$8,243
$21,726*
Mkt Value-Sales Multiple
1.94
5.35*
Sales Growth vs. Prior Year
9%
18%*
Observations
1,018
374
Source: Michael A. Cusumano, Annabelle Gawer, and David B. Yoffie,
The Business of Platforms (2019), p.23.
Notes:
* Differences significant at p < 0.001 for Industry Sample vs. Platforms using
two-sample Wilcoxon rank-sum (Mann-Whitney) test.
Mkt Value-Sales Multiple = ratio of market value compared to prior year sales.
Average of 13 years of data for 18 innovation platforms and five years for 25 transaction platforms.
number of employees, generated nearly
twice the operating profits, had market
values more than twice as high, and were
growing about twice as fast (see the accompanying table).
Not surprisingly, investors and entrepreneurs keep looking for the next
blockbuster platform. In fact, we estimate 60% to 70% of the billion-dollar private “unicorn” companies are platform
ventures.5 But “platformizing” (creating
a platform) in a “bad” business (an industry with low profit margins due to
high costs, low entry barriers, or other
structural factors) does not make it a
good business. Profits depend on supply and demand, which impact prices,
as well as economies of scale and scope
or other efficiencies, which impact
costs. Moreover, a business that delivers a physical good or service is unlikely
to generate the same high profits as a
platform that sells digital goods such
as software, content, or advertisements,
which have close to zero marginal costs.
Let’s look more carefully at Uber, the
most valuable sharing-economy platform. It went public in May 2019 and has
since seen its stock price drop sharply,
even though Uber remains a compelling
and convenient service. Uber users can
summon a ride, usually within minutes,
track the driver’s progress, and then pay,
all via a smartphone app. Uber and other ride-sharing companies also usually
charge less than taxis to attract riders.
Each additional driver adds value because transportation options for riders
increase. Uber also owns no cars, so its
capital costs are minimal. Nevertheless,
Uber lost $4.5 billion in 2017 and $1.8
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COMM UNICATIO NS O F THE ACM
billion in 2018 (with income boosted
from selling some overseas operations).
For the first six months of 2019, Uber
reported sales of $6.2 billion and operating losses of $6.5 billion, including costs
related to the IPO.12 Uber has been raising prices and cutting staff, yet operating
losses in the billions are expected to continue.3 Why does a company with such a
valuable service lose so much money?
First, Uber (like Lyft and WeWork)
is not really a digital business. Only the
transaction process is digital. Transporting people or goods is a physical service
with potentially high costs. In this case,
Uber must pay a lot of money to find
drivers, and it keeps prices low to attract
riders. In addition, Uber’s economies of
scale and scope are primarily local since
each area needs its own drivers.
Second, a platform rather than a
traditional product or service company should bring together two or more
market sides, rely on network effects to
grow, and then charge for a product or
transaction fee without the expense of
having the same number of employees
or large capital investments as a conventional business. Uber’s platform
works best if the driver side is heavily
populated so that customers can always
get a ride quickly when they need one.
However, Uber drivers frequently quit
because of long hours and low compensation, with no employee benefits since
they are independent contractors.
According to data released prior to its
IPO, Uber drivers were quitting at a rate
of 12.5% per month and the company
had to pay approximately $650 to hire
each new driver. With at least three mil-
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lion drivers, this meant Uber had to find
375,000 new drivers every month and replace all its drivers every eight months.
Driver costs before commissions on rides
were almost $250 million per month or
nearly $3 billion per year.2 In short, Uber
has been massively subsidizing both
sides of its platform—large payments to
drivers as well as low fares to riders. This
is a great way to lose a lot of money.
Lyft loses less money ($911 million
in 2018 on sales of $2.2 billion, and
$1.14 billion on sales of $776 million in
the first quarter of 2019, including IPOrelated stock-compensation charges)
mainly because it is smaller.4 WeWork
lost $1.9 billion in 2018 on $1.8 billion
in revenues and postponed its IPO after losses of $690 million on revenues
of $1.5 billion in the first six months of
2019.6 By contrast, Airbnb, which plans
to go public in 2020, consistently reports profits or at least a positive cash
flow.9 Why? Because Airbnb can charge
both sides of its platform. It does not pay
people to list rooms or to rent real estate
on its supply side, and it allows renters
to charge market prices. Uber pays drivers even when they do not have riders.
WeWork pays for real estate even when
it does not have renters (and, like Uber,
it generally has charged well below the
market price in order to grow quickly).
Why would investors put their money
into businesses that consistently lose
money? In the case of Uber, investors
must be hoping for a “winner take all
or most” outcome. Once competitors
have disappeared, then Uber can raise
prices to riders and reduce payments
to drivers. But Uber already has 70% of
the U.S. ride-sharing market and it still
does not have enough market power or
operating efficiencies to turn a profit.
At least in part this is because of high
driver turnover and the fact that, in
most cities, there are still too many
transportation options (including
people using their own vehicles). Uber
makes a profit mainly in a few cities
where taxis and other transport options
are limited and expensive.
Uber has also attracted investors with
the promise it will become the “Amazon
of transportation” and move into nearly
every transportation segment.1 But expansion into more “bad” businesses
simply means the bigger the platform
gets, the more money it will lose. Amazon took many years to make a profit and
viewpoints
funded much of its growth through cash
flow from its global online store and then
a marketplace matching buyers and
sellers, with high fees for fulfillment services and advertising. Still, most of Amazon’s profit (nearly 60% in 2019) comes
from a highly profitable digital service
and innovation platform: Amazon Web
Services (see “The Cloud as an Innovation Platform for Software Development,” Communications, October 2019).
Transporting food is slightly more profitable than transporting people.2 But
Amazon tried and failed to make money
in food transport and recently closed
down Amazon Restaurants.11 Deliveroo
is the market leader in the U.K. and Europe but it also has failed to earn a profit
in food transport.10
Another option for Uber is to get rid
of drivers (its main cost) by investing in
driverless vehicles. This strategy may
work someday in some locations. But
Uber will most likely run out of cash long
before driverless vehicles become safe
and commonplace. Moreover, someone
still has to own the vehicles. Let’s say
Uber buys two million vehicles to replace
its three to four million drivers. Even at
$50,000 per vehicle, that would be a massive expense of $100 billion. Then there
are maintenance, recharging, replacement, or leasing costs. The economics
may still be better than constantly subsidizing drivers and riders. However, there
will also likely be more competition.
Every major automaker in the world, as
well as Lyft and Google Waymo, are in or
planning to enter the markets for ridesharing and driverless vehicles, with the
goal of “selling miles, not cars.”7
Uber and Lyft should stay with the
platform strategy rather than own or
lease their vehicles, but their ongoing
losses may force them to get smaller
before they can get bigger again. Ridesharing platforms should focus on the
few cities where taxis and transportation options are expensive and in short
supply, and then expand gradually into
other geographies and transportation
segments, such as partnerships with
public transportation authorities to
bring people from their homes to masstransit facilities. Uber already is exploring such partnerships, and it has sold
several unprofitable overseas subsidiaries. It also seems to be making some
money matching shippers with truckers
in a new marketplace venture. However,
Expansion into more
“bad” businesses
simply means the
bigger the platform
gets, the more money
it will lose.
there is nothing to stop more companies and entrepreneurs from entering the transportation business. Taxi
companies can also develop their own
smartphone apps and expand their operations and partnerships (see “How
Traditional Firms Must Compete in
the Sharing Economy,” Communications, January 2015). As for WeWork, it
must raise prices much more to cover
its costs, and that will depress demand.
Landlords are also now hesitant to lease
properties to WeWork, putting the whole
business at risk.8 Meanwhile, Airbnb
is likely to continue its strong business
model, although there is nothing to stop
traditional hotel companies from aggressively entering roomsharing—if it is
a “good” (that is, profitable) business.13
References
1. Bond, S. Uber aims to be the ‘Amazon of
transportation.’ Financial Times (Oct. 25, 2018).
2. CB Insights. How Uber makes money. (2018), 6–23.
3. Clark, K. Uber lost more than $5B last quarter.
Techcrunch (Aug. 8, 2019).
4. Conger, K. Lyft’s first results after I.P.O. show $1.14
billion loss. New York Times (May 7, 2019).
5. Cusumano, M.A., Gawer, A., and Yoffie, D.B. The
Business of Platforms: Strategy in the Age of Digital
Competition, Innovation, and Power (2019), 18–20.
6. Farrell, M. WeWork IPO filing reveals huge revenue
and losses. Wall Street Journal (Aug. 14, 2019).
7. Gindrat, R. Automakers envision a business model for
AVs: Selling miles, not cars. Axios.com (Apr. 17, 2019).
8. Grant, P. and Morris, K. Virtually no one will lease to
WeWork. That’s a drag on NYC’s office market. Wall
Street Journal (Sept. 29, 2019).
9. Prang, A. Airbnb plans to go public next year. Wall
Street Journal (Sept. 19, 2019).
10. Satariano, A. Deliveroo takes a kitchen sink approach
to food apps. Bloomberg.com (Jan. 15, 2018).
11. Soper, T. Amazon to shut down its Amazon restaurants
business in the U.S. Geekwire (June 10, 2019).
12. Uber Technologies, Inc. Form 10-Q (June 30, 2019).
13. Weed, J. Blurring lines, hotels get into the homesharing business. New York Times (July 2, 2018).
Michael A. Cusumano (cusumano@mit.edu) is a
professor at the MIT Sloan School of Management
doing research on computing platforms for business and
coauthor of The Business of Platforms: Strategy in the
Age of Digital Competition, Innovation, and Power (Harper
Business, 2019).
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