CATALYST CODE: HOW TO IGNITE A PLATFORM BUSINESS AND RULE A PLATFORM-CENTRIC ECOSYSTEM David S. Evans Founder | Market Platform Dynamics Visiting Professor | University College London Lecturer | University of Chicago 20 April 2012 Catalyst Course 2012 2 Catalyst Panorama Platform Businesses Dominate the Economic Landscape OpenTable: Intermediary between Two Different Kinds of Customers 3 © Market Platform Dynamics Do Not Distribute Without Permission The OpenTable Business Model Restaurants Pay and Consumers Use it for Free 4 $100 million revenue in 2010 | $1.35 billion markets cap © Market Platform Dynamics Do Not Distribute Without Permission The Result: Positive Feedback Effects Fuel Open Table Growth 5 27 million reservations in 2011Q4 a month up from 19 million in 2010Q4 25k restaurants in 2011Q4 up from 20k in 2010Q4 More than 40% yoy growth in revenue © Market Platform Dynamics Do Not Distribute Without Permission Many “Multi-Sided Platform” Businesses Operate Like This Positive Feedback Effects Fuel Business Growth 6 COMPANY CUSTOMER SIDE A CUSTOMER SIDE B Windows Users Developers Google Search Searchers Advertisers Deutsche Bourse Liquidity providers Liquidity takers eHarmony Men Women Paris Match Readers Advertisers Roppongi Hills Shops Shoppers American Express Cardhodlers Merchants © Market Platform Dynamics Do Not Distribute Without Permission These Multi-Sided Platforms Include Many Massive Global Businesses 7 © Market Platform Dynamics Do Not Distribute Without Permission Catalysts Create Real Value Providing a Platform Where Customers Can Meet and Transact 8 Platforms can create tremendous value by eliminating pain points in exchange To ignite, platforms must solve extremely difficult coordination problem But if do, they can generate tremendous profits through positive feedback effects Sustaining those profits requires treacherous navigation in an n-dimensional universe of colliding platforms like Google Search (3-sided), Facebook’s Social Network (4-sided) and Microsoft Windows (3-sided) © Market Platform Dynamics Do Not Distribute Without Permission Catalysts, Platforms and Two-Sided Markets Defining Terms 9 (Economic) Catalysts are intermediaries that create value by brining two or more types of agents (businesses or people) together. (Multi-sided) Platforms are the virtual or physical places that catalysts create to enable multiple types of agents to find and transact with each other and thereby create and exchange value. Economists sometimes call these platforms Two-sided Markets a term that was introduced in the pioneering work by French economists Jean-Charles Rochet and Jean Tirole. A customer type is sometimes call a platform “side”. © Market Platform Dynamics Do Not Distribute Without Permission The Catalyst Curriculum 10 Catalyst Panorama How Platform Businesses Dominate the Economics Landscape Catalyst Defined The New Economics of Two-Sided Markets Catalyst Construction How to Use the Catalyst Toolkit to Build a Profitable Platform Business Catalyst Ignition How to Start a Platform Business and Obtain Explosive Growth Catalyst Competition How to Compete When there are Colliding Platform Ecosystems © Market Platform Dynamics Do Not Distribute Without Permission CATALYST CODE: HOW TO IGNITE A PLATFORM BUSINESS AND RULE A PLATFORM-CENTRIC ECOSYSTEM David S. Evans Founder | Market Platform Dynamics Visiting Professor | University College London Lecturer | University of Chicago 20 April 2012 Catalyst Course 2012 12 Catalyst Defined: The New Economics of Two-Sided Markets © Market Platform Dynamics Do Not Distribute Without Permission What Catalysts Do Add Value by Reducing Transaction Costs 13 Catalysts • enable two or more types of customers, who could engage in mutually valuable exchange, • to find each other © Market Platform Dynamics Do Not Distribute Without Permission to transact, • and to thereby create and exchange value. eBay Reduced Transaction Costs 14 People Who Wanted to Sell Pez Dispensers Find and Trade with People Who Wanted to Buy Pez Dispensers © Market Platform Dynamics Do Not Distribute Without Permission How Catalysts Do It 15 Catalysts provide a physical or virtual platform that enables different types of agents to find each other and transact Transact Search Platform © Market Platform Dynamics Do Not Distribute Without Permission Match eBay A Platform for Agents to Search, Match, and Transact 16 © Market Platform Dynamics Do Not Distribute Without Permission Catalyst Value Creation 17 Catalysts create value by reducing pain points or what economists call “transactions costs”. Catalysts reduce transactions costs by making it easier for different types of agents to get together and exchange value. © Market Platform Dynamics Do Not Distribute Without Permission As a result agents can engage in mutually advantageous exchange that creates value. That exchange and the resulting value creation would have been more inefficient— or perhaps even impossible— without the catalyst. An eBay Example The Miracle of Value Exchange and Wealth Creation 18 Buyer values pez dispenser at $2.00 Seller values pez dispenser at -$.50 (cost of having junk around) They enter into a trade at $1.00 Buyer gets $1.00 of value (a pez dispenser worth $2.00 minus $1.00 purchase price Total Value of $2.50 created out of thin air!!!! Seller gets $1.50 of value ($1.00 plus gets rid of junk which costs $.50) A 2003 study found that eBay created $7 billion of extra value just for buyers. © Market Platform Dynamics Do Not Distribute Without Permission Common Features of Catalysts 19 Positive Network Effects Type A customers value platform more if there are more Type B customers and vice versa. Pez seller gets more value if more buyers; buyer gets better selection and deal if more sellers Critical Mass Need to be enough customers on both side to create value for either. If few buyers and sellers of Pez dispensers little incentive to join platform. Money/Subsidy Side Platforms often give one side a “break” and make their profits for the other side. Sellers pay commission plus merchant discount for PayPal. Buyers pay nothing. © Market Platform Dynamics Do Not Distribute Without Permission CATALYST CODE: HOW TO IGNITE A PLATFORM BUSINESS AND RULE A PLATFORM-CENTRIC ECOSYSTEM David S. Evans Founder | Market Platform Dynamics Visiting Professor | University College London Lecturer | University of Chicago 20 April 2012 Catalyst Course 2012 21 Catalyst Construction: How to Use the Catalyst Tool Kit to Build a Successful Platform © Market Platform Dynamics Do Not Distribute Without Permission The Catalyst Tool Kit 22 Transaction Engine Platform Concept Prices Search and Matching Engines Platform Design Product Offerings Governance Rules © Market Platform Dynamics Do Not Distribute Without Permission Three Key Questions Platform Concept for Solving Pain Points 23 1. What’s the set of problems that need to be solved for economic agents? © Market Platform Dynamics Do Not Distribute Without Permission 2. What’s the most efficient solution for solving those problems? 3. Does the solution create enough value for customers and platform? OpenTable Platform Design Solving Pain Points in Restaurant Reservations 24 © Market Platform Dynamics Do Not Distribute Without Permission Pricing Is The Key Gets Customer Sides on Board and in Right Proportion 25 Need to get both sides on board Think selling advertising with no readers Need to get right proportions Think nightclubs with few women Relative pricing (“the price structure”) is key In practice many platforms have “subsidy” side © Market Platform Dynamics Do Not Distribute Without Permission Rules of Thumb for Pricing Structure 26 Higher price (“Money side”) Economic theory shows that optimal prices may be < than MC, 0, and possibly <0. Below-cost pricing common, in fact. © Market Platform Dynamics Do Not Distribute Without Permission Lower price (“Subsidy side”) Software Platforms a Good Example of Pricing Illustrates Variety of Pricing Structures 27 PLATFORM USERS DEVELOPER COMMENT Windows Pays Subsidized App developers get API access for free and cheap or free tools Sony PlayStation Subsidized Pays Users get consoles for no more than cost and game developers pay commissions iPhone OS Pays Free for free apps Users pay for phones and Paid for paid developers pay commissions apps on sales through App Store (but not from other revenue sources) © Market Platform Dynamics Do Not Distribute Without Permission Platform Offerings 28 Offerings to Create Value for Each Side More offerings create more value and work like price (iPhone features) More distinct offerings bring in more customers (sections in newspapers) Offerings to Promote Interactions and Transactions Search and matching (eHarmony) Information (depth of book data for exchanges) Transactions (Google AdWords) © Market Platform Dynamics Do Not Distribute Without Permission Design for Positive Network Externalities Platform Design/Rules Promote Positive Externalities 29 Sorting Devices to Get Right Customers “Exclusionary vibe” (JDate discourages Gentiles) “Exclusionary amenity” (Upscale anchor stores discourage low-end shoppers) Search Diversion Design rules encourage one type of agent to meet another type of agent who really values them but may not seek out by themselves Shopping malls with anchor stores at either end © Market Platform Dynamics Do Not Distribute Without Permission Design to Mitigate Negative Externalities Reducing Bad Behavior that Reduces Platform Value 30 Rules Prohibitions on actions that could harm other agents (usually those on other side of match/transaction) eBay has detailed rules for buyer and seller behavior No misleading ads (sellers) and no multiple auctions for same good (buyers) Detection and Monitoring Systems to determine if rules are being broken Facebook has hundreds of employees looking for bad pictures and bad language Enforcement Platforms have and use “Bouncers Rights” to exclude violators Google manually reduces ranks of websites that violate rules for 90 days and sometimes delists © Market Platform Dynamics Do Not Distribute Without Permission CATALYST CODE: HOW TO IGNITE A PLATFORM BUSINESS AND RULE A PLATFORM-CENTRIC ECOSYSTEM David S. Evans Founder | Market Platform Dynamics Visiting Professor | University College London Lecturer | University of Chicago 20 April 2012 Catalyst Course 2012 32 Catalyst Ignition: How to Ignite a Platform Business and Obtain Explosive Growth © Market Platform Dynamics Do Not Distribute Without Permission YouTube Ignited in Late 2005 33 TABLE 1 -- YOUTUBE UNIQUE VISITORS ('000) 70,000.000 Get both sides on board 60,000.000 YouTube needed content creators and content viewers 50,000.000 Block and tackle 40,000.000 30,000.000 YouTube tried multiple strategies to increase uploading and viewing of videos 20,000.000 Ignite YOUTUBE 10,000.000 0.000 05 05 l 05 05 05 t 05 05 05 06 06 06 06 06 06 l 06 06 06 t 06 06 06 07 07 07 07 07 07 l 07 07 07 t 07 07 07 08 08 r r r r ay jun ju ug ep oc ov ec jan feb a ap ay jun ju ug ep oc ov ec jan feb a ap ay jun ju ug ep oc ov ec jan feb n d n d n d a s a s a s m m m m m © Market Platform Dynamics Do Not Distribute Without Permission Slow growth from February to December 2005 when YouTube shows an inflection point Platforms Need Critical Mass to Ignite 34 Critical mass Critical mass refers to the minimal set of customers on each side that is large enough to attract more customers and result in sustainable positive feedback Critical mass depends on scale and balance Probability of customers from two sets getting together and exchanging value increases with the number of customers on each side Platforms implode if they can’t reach critical mass If there aren’t enough customers on the other side the probability of advantageous exchange falls and the customer doesn’t join and eventually leaves © Market Platform Dynamics Do Not Distribute Without Permission Successful Platform Launch Depends on Critical Mass 35 Critical mass corresponds to a combination of scale and balance that is minimally sufficient to ignite the platform 1200 1000 800 600 400 200 Each point reflects a combination of scale (how many customers) and balance (proportion of customer types) 0 0 200 © Market Platform Dynamics Do Not Distribute Without Permission 400 600 800 1000 Platform Ignition Requirements Reaching One of Possibly Many Combinations of Scale and Balance Based Critical Mass Points 36 Figure 1. Catalytic Ignition and Critical Mass In this example the critical mass points are between C’ and C”. Ignition D*- Long-run equilibrium C` Points of critical mass Movements at starting to achieve critical mass C* C`` O Side B © Market Platform Dynamics Do Not Distribute Without Permission C* is the point that would lead to optimal platform launch. Points to the NW of the vector 0-C’ and to the SW of vector 0C” would result result in platform implosion. B2Bs Died Because They Didn’t Get to Critical Mass No Model to Get the Right Scale and Proportion of Suppliers 37 Points Show Supplier (X) and Buyer (Y) Combinations for B2B Exchanges (Illustrative Example) 250 200 Critical mass points that could lead to ignition 150 100 Most B2Bs ended up with Too few suppliers and imploded 50 0 0 200 © Market Platform Dynamics Do Not Distribute Without Permission 400 600 800 1000 1200 Platform Ignition Has a Stopwatch 38 Limited Time for Reaching Critical Mass Early adopters have limited patience Diffusion must be rapid enough for momentum Competitors, new technology, and market changes can dose ignition Critical Time Period Depends on Type of Platform More time if sides can be sequenced (e.g. build up advertisers then gets readers) Less time if sides much show up simultaneously (dating clubs, exchanges, payments systems) Evans’s Law of Ignition Timing Platforms that can’t be sequenced have two years or their toast Completely unscientific law but can’t think of many that were successful with longer fuse and lots died who didn’t ignite in that time © Market Platform Dynamics Do Not Distribute Without Permission Platform Failures: Video Sharing Sites That Imploded (13 Largest as of February 2008) 39 Video Sharing Company Feb 04 May-04 Aug-04 Nov-04 Feb-05 May-05 Aug-05 YOUTUBE.COM MSN Video 5,830 5,003 8,211 9,760 10,921 9,971 14,762 Internet Broadcasting, Internet Broadcasting Systems CSTV: College Sports TV 3,747 5,277 Nov-05 Feb-06 May-06 3,654 3,086 Nov-06 Feb-07 May-07 Aug-07 Nov-07 Feb-08 900 4,230 12,669 19,089 25,471 34,413 41,035 44,894 53,521 63,921 11,738 12,453 16,350 15,414 13,250 15,769 14,488 14,987 13,606 13,543 11,620 9,257 9,573 9,393 10,329 12,302 10,709 12,658 12,742 10,898 7,383 5,504 4,724 5,797 7,373 5,433 4,370 5,943 8,318 4,804 21,141 22,059 19,802 20,855 23,571 6,467 3,982 Yahoo! Video EBAUMSWORLD.COM Aug-06 2,947 3,166 3,926 4,365 4,394 5,047 4,453 5,316 5,069 4,280 3,363 3,408 4,894 5,224 3,489 490 759 1,927 2,087 2,970 5,589 5,480 6,208 7,518 6,840 3,391 5,241 5,758 4,349 5,092 DAILYMOTION.COM 436 691 1,298 1,952 3,196 2,751 3,729 3,747 VEOH.COM 207 667 293 784 1,857 3,537 3,457 3,196 3,065 1,213 2,057 1,534 2,233 2,576 1,847 2,374 1,870 2,101 1,815 2,106 HEAVY.COM ATOMFILMS.COM 732 329 1,359 1,845 1,132 1,371 1,154 1,178 1,257 NICK.COM TurboNick IFILM.COM 2,522 2,757 2,731 BRIGHTCOVE.COM 2,873 2,241 2,467 2,876 2,846 3,594 3,275 2,979 3,443 3,484 2,124 2,272 1,753 1,115 181 334 2,016 1,418 1,578 1,641 2,736 No separate data available on Google Video which also imploded. © Market Platform Dynamics Do Not Distribute Without Permission Foundations of an Ignition Strategy Determining Relative Prices and Value Propositions 40 Who’s Needed Most and Why? What value is being provided to each side? © Market Platform Dynamics Do Not Distribute Without Permission What alternatives does each side have and what is demand elasticity? How much is each side valued by the other side? MPD’s Strategic Framework for IgnitionTM These are methods that platforms have used successfully in solving coordination problems and reaching critical mass. The appropriate method depends on the economic situation of the particular platform. Business Model Getting to Ignition Sequential entry Get one side on board first, then use it to get the other side on board. SImultaneous entry The platform is opened up right away with both sides on board, usually done when there is an obvious problem to be solved and it is simply making both sides aware of the business proposition that gets both sides to show up at the same time. Static precommittment strategy Make credible commitment to each side that the other side will show up Dynamic precommittment strategy Have both sides in play by approaching one side and getting them to agree to show up if there is evidence that the other side is on board. Then, go to the other side and promise that the side they are most interested in is on board. Xbox Basic zigzag Incremental growth. Engage in a variety of strategies to get one side and then the other to join the platform over a space of time YouTube Marquee strategy Secure a small number of really influential players on one side or both. Zig zag with self supply Launch platform by initially providing one side yourself. Partner with another platform Partner with a platform that has the most critical side of your platform already on board. Android Developer strategy Create APIs and give a let developers access the platform to create value for the platform’s customers PayPalX © Market Platform Dynamics Do Not Distribute Without Permission Whose Done It OpenTable Facebook Diners Club Mall of America Palm Pilot 42 Catalyst Competition: How to Dominate and Survive With Colliding Platform Ecosystems © Market Platform Dynamics Do Not Distribute Without Permission THIS SECTION NEEDS MORE WORK. 43 1. OFFENSIVE STRATEGIES 1. CREATING BARRIERS TO ENTRY 2. FEATURE COMPETITION 3. PRICING 2. DEFENSIVE STRATEGIES FIND WEAKNESS (SQUARE) PRICING SIDEWAYS ENTRY (QIHOO VS TENCENT) Platform Competition “How To” When There Are Positive Feedback and Scale Effects 44 Success Factors Positive feedback effects and scale can propel catalysts to dominant positions Windows has had more than a 90% share of PC operating systems since the late 1980s Offensive Implications First mover advantages create value in being first to ignite and achieving rapid positive feedback effects and deters others Captures sources of liquidity and creates expectations of invincibility that deter investment by complementary businesses Defensive Implications Most platform industries have multiple successful firms Differentiation on either/both sides key to countering positive feedback/scale effects. Amex leapfrogged first igniter Diners Club by moving high-end © Market Platform Dynamics Do Not Distribute Without Permission Asymmetric Competition Introduction 45 Asymmetric Competition Occurs when a Platform Competes with: A platform THAT has made a different money/subsidy choice than a competitor (e.g. media properties that charge both sides vs. those that only charge advertisers) A platform THAT has an additional non-intersecting side that enables it to price an intersecting side lower (Google prices Android OS at zero because it expects ad income; Microsoft prices Windows Mobile OS positively because it lacks offsetting income © Market Platform Dynamics Do Not Distribute Without Permission Asymmetric Competition Response 46 Differentiation Create value prop so strong that lower price of rival doesn’t matter (WSJ creates unique value so it can charge subscribers) Price discrimination—lower price to customers most at risk Expand Platform to Achieve Symmetry Integrate into additional side to compete directly (e.g. Apple into ads, Google into hardware) Expand Platform to Achieve Another Revenue Stream Integrate into an new side that rival lacks but than can provide similar offsetting revenue © Market Platform Dynamics Do Not Distribute Without Permission More Material and Case Studies 47 CATALYST CODE: HOW TO IGNITE A PLATFORM BUSINESS AND RULE A PLATFORM-CENTRIC ECOSYSTEM David S. Evans Founder | Market Platform Dynamics Visiting Professor | University College London Lecturer | University of Chicago 20 April 2012 Catalyst Course 2012 49 Catalyst Conclusion © Market Platform Dynamics Do Not Distribute Without Permission The Catalyst FrameworkTM © Market Platform Dynamics & Evans & Schmalensee, The Catalyst Code (HBS Press, 2007) © Market Platform Dynamics Do Not Distribute Without Permission Concluding Thoughts 51 Catalysts can create tremendous value for themselves and their customers • • • • All about solving pain points between agents Can have explosive growth through positive feedback Hard to design because solving many masters Hard to ignite because coordination makes it difficult to achieve critical mass © Market Platform Dynamics Do Not Distribute Without Permission For More Detail and Background Catalyst Reading List 52 Evans and Schmalensee, Catalyst Code: The Secrets of the World’s Most Dynamic Companies. Harvard Business School Press, 2007. Evans, Hagiu and Schmalensee, Invisible Engines: How Software Platforms Drive Innovation and Transform Industries. MIT Press, 2006 Evans, “How Catalysts Ignite: The Economics of Platform-Based Startups,” in Gawer, Platforms, Markets, and Innovation, Elgar Publishing, 2009. Evans, Launching New Payments Businesses: The Role of Critical Mass and Ignition Strategies, PYMNTS.com, 2010. www.catalystcode.com © Market Platform Dynamics Do Not Distribute Without Permission Thank You! 53 DAVID S. EVANS Market Platform Dynamics | Founder david.evans@marketplatforms.com Mobile: +1 617 320 8933 Skype: david.s.evans © Market Platform Dynamics Do Not Distribute Without Permission