Understanding platform business models

As mentioned earlier in this chapter, we have seen a tremendous shift and disruption in various industries in the last few decades. Traditionally, huge brick-and-mortar stores were synonymous with retail business, but today, the world's second-largest retailer does not have a single physical store. Companies such as Amazon, Spotify, Netflix, and so on have changed the business landscape. These companies took the very traditional concept of a platform and translated it into the digital world.

For example, Amazon is no different from the older-style marketplace where sellers display their products and buyers come to browse and buy products they are interested in. Netflix is no different from a video library where you bring home any video media with a small subscription fee. The traditional platform concept aided by technology is the secret sauce for the success of today's businesses. Imagine a marketplace where a buyer from Australia can buy goods from sellers in the US or a user from China can rent a movie from a video library in Europe.

This broader reach is possible because of platforms. It could be argued here that producers creating their own digital presence in the form of websites can still get a global reach. This is true, but this model is neither scalable nor cost-effective.

Let's look at an example here of a new designer who wants to launch their new line of clothing; if they create their own online boutique rather than leveraging an existing platform, they won’t be able to optimize it or get it right as it is not their core capability. Secondly, they will divert from their competency of designing clothes.

On the other hand, a fashion retail platform already has all the foundations in place. They are an expert in customer acquisition, Search Engine Optimization (SEO), and other digital aspects that will take years for the new designer to build, and even then, they might not get it right. This model is a win-win for all parties, in the following ways:

• Designers: Designers can reach out to consumers worldwide without spending a lot of time and effort on doing this. They can focus on creativity and design to provide more options for consumers to choose from.
• Fashion retail platform: The platform can showcase and sell the work of different creative designers. They don't have to worry about designing, manufacturing, or producing. Their job is to connect the designers to consumers. Their success depends on how well they can scale and how many designers and consumers they can connect. The more consumers they can connect to the designers, the more revenue they generate for themselves and for the designers.
• Consumers: Consumers get access to designs from multiple designers across the globe. They can search, explore, compare, and choose between different options within a single uninterrupted User Experience (UX). Getting access to a variety of options in a single uninterrupted UX is not possible in the linear business world.

This example describes how a platform business model is beneficial to all the players involved. The majority of platforms have three primary parties: producers, consumers, and the platform owner, but there are few platforms—such as payment-processing platforms—where you will find additional entities such as a bank or credit card processor, which are referred to as intermediaries.

Characteristics of a platform business model

So far, we have seen the general definition of a platform and how it applies to platform businesses in the digital world. As we go further into understanding platform business models and digital platforms, let's look at some of the characteristics that define these models. There are, for sure, lots and lots of different features and characteristics of a platform, but in my opinion, the following three are the key characteristics or the essential elements of any platform business:

• Multidimensional
• Network effect
• Plug-and-play mechanism

Multidimensional

We briefly looked at the characteristics of a platform business earlier in this chapter: the platform does not just let two entities connect linearly but allows a web of multiple entities to create and deliver value.

In a traditional linear business model, there is only one producer who delivers value to a handful of consumers. At the same time, a platform model allows multiple producers to serve and provide value to multiple consumers—for example, an author of a book has their own website selling their own books versus Amazon selling books from multiple authors. The following diagram shows the one-dimensional flow in a linear product model as compared to the multidimensional flow in a platform model:

Figure 1.1 – Linear product and multidimensional platform

The preceding diagram depicts how consumers can choose to buy from any producer on the platform, whereas the consumer is restricted to only one producer in the linear product model. In the platform model, the flow of products is coming from multiple directions.

This nonlinear and multidimensional approach is what made companies such as Amazon, Netflix, and Spotify so different and set them apart from the competition. Amazon doesn't sell products from just one manufacturer, but it allows any seller to use its platform to sell. Similarly, Netflix streams content from hundreds of production houses from dozens of countries. Spotify is not restricted to just one artist but gives listeners access to multiple artists. Creating this multidimensional connection between producers and consumers is a crucial aspect of a platform business model.

Network effect

If we extend the multidimensional characteristic of a platform business, we get something called a network effect. The ability to connect multiple producers to consumers creates a network between all the entities of the platform. A network effect is something that increases the value of one entity as the number of participants increases in another entity.

For example, when a new seller joins a marketplace, all the buyers benefit from the new seller; similarly, when a new buyer enters the marketplace, all the sellers enjoy the benefit of this. Also, the higher number of participants in one group attracts more participants from another group. For example, as the Spotify user base keeps growing, more and more artists join Spotify to provide various music choices, which in effect attracts more users. The network effect is thus the cycle that is created by the platform business model. The platform is at the center of these entities, facilitating their connection and growth, as depicted in the diagram here:

Figure 1.2 – Platform network effect

The network effect is the most crucial aspect in the success of a platform business. Platform business models cannot sustain and grow with just one entity. For example, there is no use in increasing the number of buyers when there are limited sellers on an e-commerce platform; the buyers will start dropping as they are not getting a big enough choice of products.

Similarly, if there are fewer buyers on the platform, this will not be profitable for the sellers, and hence they will move out of the platform. None of the entities can exist without the other. Growth and increase in one entity will lead to the development and growth of another, leading to the platform's growth. Therefore, a strong network effect is key in the success of any platform business.

Plug-and-play mechanism

As we saw earlier, a platform's success depends on how well it can connect and not on how well it can sell. One thing that facilitates the seamless connection between producers and consumers at a massive scale is the plug-and-play nature of platforms. The success of a platform depends on how easy it is for producers and consumers to join the platform. A linear business focuses on making consumer onboarding easier, but in the case of a platform, it is equally—or maybe more—essential to make producer onboarding easier and seamless so that they can launch and test their ideas or products quickly. The easier and quicker it is for producers to join, the more and more they will be attracted to the platform, bringing in more consumers and creating a strong network effect.

The plug-and-play mechanism is what disrupted the smartphone market a decade ago. Android and iOS were not significantly different in offering feature sets than some of their competitors, but their App Store/Play Store revolutionized the market. Any external developer can develop an app and create value using these platforms, and this plug-and-play mechanism is what differentiated them from their competitors.

The plug-and-play nature of a platform business enables its scalability and extensibility—for example, an e-commerce platform can quickly onboard new sellers and easily introduce new categories, and expand into new services. If the foundation of the platform is designed right, the possibilities are endless. If the producer onboarding to the platform is tedious and has lots of steps, or deals with complex configurations, producers might create something of their own. One of the crucial benefits of a platform for producers is to launch and test quickly. If producers cannot do that, they are unlikely to join the platform, reducing the number of choices to consumers and leading to a reduced number of consumers, hence hampering the platform's growth and sustainability.

To summarize, these three characteristics are the key to defining a platform business model's success. To be successful, a platform should connect entities in a multidimensional way to deliver value, scale to create a strong network effect, and enable easy onboarding via a plug-and-play mechanism.

Types of platforms

Different entities that a platform connects to deliver value are producers and consumers of products or services; as in our previous example, the designer launching the new clothing is a producer, and the person buying the clothes is a consumer. Hence, when building a platform strategy or creating a platform, it is essential to understand that there are two types of users: consumers and producers.

Designing a platform with both types of users in mind is necessary. However, there are specific platforms where the producers are also the consumers. The approach and design of these kinds of platforms where producers and consumers are the same will be different from that of a platform where producers and consumers have two separate personas. To understand this concept in detail, let's look at some common types of platforms, as follows:

• Marketplace: This is the most common and easy-to-understand platform type. Here, buyers and sellers (producers and consumers) are two different entities and they connect using the platform. Buyers get to explore various products, compare them, and make an informed decision about the purchase. Sellers can demonstrate their products to all potential and interested buyers. Amazon, eBay, Alibaba, Walmart Marketplace, and so on are some of the well-known platforms in this space.
• Social media: Everyone is familiar with social media platforms nowadays. They are where people connect, share ideas, and socialize virtually. Facebook, Twitter, and LinkedIn are some examples of popular social media platforms. Social media platforms are one type of platform where producers and consumers are the same. On these platforms, a user shifts between being a producer and a consumer within the same session and in a few minutes. For example, when a user is writing a tweet, they are the producer, but they are the consumer when they are reading someone else's tweet.
• Search engines: When I say search engine platforms, it is not just the Googles and Bings of the world, but it could be a search engine for a very specific category. For example, Zillow is a real-estate search engine where buyers/renters can search for properties, and Indeed is a search engine where candidates search for job openings. There are two entities in the specific search-platform category—on Zillow, there are homeowners and renters, and on Indeed, there are recruiters and job seekers. But information search engines that are category-agnostic, such as Google and Bing, only have consumers; there are no specific producers of that information.
• Content and entertainment: For entertainment and content platforms, content creators are producers, and users streaming and watching the content are consumers. On some of these platforms, content creation is restricted to artists and experts and is controlled by the platform owners—for example, Netflix or Spotify. But there are platforms where content creation is open to everyone and anyone—for example, on YouTube, which can also be categorized as a social media platform.
• Knowledge and information sharing: Knowledge and information sharing platforms are similar to social media platforms in that the producers and consumers are the same. Some common examples of such knowledge and information sharing platforms are Stack Overflow, Coursera, Quora, and Yelp. When a user asks a question or replies to a question on Stack Overflow, they are a producer, but when they are browsing and reading solutions, they are a consumer. Similarly, on Yelp, when a user is adding a review, they are a producer, but when they are browsing and reading reviews, they are a consumer.
• Service-oriented: Service-oriented platforms are the ones where a platform enables the aggregation of Service Providers (SPs) and connects them to the consumers. SPs are the producers in this scenario. Classic examples of this type of platform are Uber, Airbnb, DoorDash, and so on. These platforms crowdsource the SPs and connect them to the right consumers. Platforms such as DoorDash have an additional layer; they connect three entities instead of two, as seen in most platform types. They connect restaurants, dashers (drivers), and consumers for the seamless completion of food delivery.
• Transaction and payments: All financial platforms such as PayPal fall under this category. They facilitate the completion of a transaction by processing the payment. Most of them operate at a commission or transaction fee; we will cover this in the Platform revenue models section. Similar to DoorDash, transaction platforms have three layers or connect three entities—buyers, merchants, and banks.
• Communication: Direct messaging and chatting platforms such as WhatsApp, Slack, Skype, and so on are popular and familiar examples of communication platforms. Producer and consumer roles and responsibilities in communication platforms are similar to those of social media platforms. The same user acts as a producer or a consumer, depending on their action.
• Infrastructure: Infrastructure platforms provide hardware and computing resources to organizations. Infrastructure platforms take care of hosting, storage, networking, and other essential hardware and software needed to create and deploy any application. Cloud computing platforms such as Amazon Web Services (AWS) and Azure are the most popular and dominant players in this space.
• Development: All the operating systems are categorized as development platforms; some are controlled and closed, such as Windows and Apple App Store, whereas some are open source, such as Android and Linux.

Apart from the operating systems, platforms built to access data via Application Programming Interfaces (APIs) or platforms that enable different software development aspects are also classified as development platforms.

Platform revenue models

As we have seen, there are multiple entities involved in the platform ecosystem: producers, consumers, platform owners, and, in some cases such as payment platforms, intermediaries such as banks. The platform ecosystem must be beneficial to all parties, hence picking a suitable revenue model for the platform business is crucial.

A platform ecosystem is like a network of these entities, and it only works when all the entities are present in the ecosystem and are doing what they are supposed to do. Therefore, for any platform's success, all the entities must benefit from it, which is only possible if the platform is operating with a suitable revenue model. Hence, choosing the optimized revenue model for all the entities is key in a platform business model's success.

Types of revenue models

Understanding different revenue models is essential before deciding which is the best revenue model for enabling all the entities involved in the platform ecosystem to function at an optimal level. The following are some standard and popular revenue models for platform businesses; let's look at them in detail:

• Subscription: A subscription model is where consumers pay a fixed amount of a monthly or yearly subscription fee and can access all the products and services offered by the business. This model is prevalent for content and entertainment platforms such as Netflix and Spotify. Consumers get access to all the content on the platform by paying a subscription fee. This model also works for knowledge and information sharing platforms.

Producers on these platforms are usually paid a royalty on how much their content is consumed or a fixed amount for each piece of content that they create. A subscription model works best on content platforms as the content, once created, does not incur any additional cost based on its consumption. For example, the production costs of a movie that streams on Netflix do not increase as the number of viewers keeps increasing exponentially. Hence, a subscription model is the most suitable model for content platforms, but this model is not advisable and is not suitable for marketplaces or service-oriented platforms.

• Advertising: An advertising model is the reverse of a subscription model. In a subscription model, consumers pay a fee and producers get royalties, while in an advertising model, consumers do not have to pay anything but the platform charges producers to promote and provide featured placement of their content, products, and services. This model is suitable for and works best with social media and communication platforms such as Facebook, Twitter, LinkedIn, Skype, and so on. Some information-sharing platforms such as Stack Overflow also run on an advertising business model.

This model works when the content is not premium and the content creator is not charging anything—for example, people tweeting on Twitter don't get paid for tweets, or people replying to Stack Overflow questions do not charge anything. When content is free, consumers don't have to pay, but the platform's cost and the profit for the platform owner are derived by promoting and sponsoring certain content, products, and services.

• Pay-as-you-go: Pay-as-you-go revenue models charge the consumer for the goods and services they are using. The price will depend on the size and cost of the goods or services consumed. A major part of the price goes to the producer, and the platform owner charges some service fee, transaction fee, or commission. These fees are sometimes a fixed amount but can also be a percentage of the total price or a combination of the two.

This revenue model is suitable for marketplaces and service-oriented platforms such as Amazon, eBay, Uber, Airbnb, and so on. Most of the development and infrastructure platforms such as AWS also follow the same model; consumers pay for the services and resources they are using. This model is suitable when the cost of goods and services varies hugely and depends on its value. For example, one consumer buying a book and another purchasing a TV set on Amazon cannot pay the same subscription fee; they will have to pay differently for different products. Similarly, an Uber ride for a 3-mile journey will have a different cost from a 15-mile trip. Hence, in a pay-as-you-go model, consumers are paying as they are consuming.

• Pay-per-listing: A pay-per-listing model also charges the producers instead of consumers, as we saw with an advertising model. This model is quite prevalent on search engines, especially search engines of a specific category—for example, a job site will charge recruiters for job listings but won't charge anything to job seekers. Some search engines also offer free listings in the general search results but only charge for premium placements, such as at the top of search results or strategic locations where the listing is very prominent and users tend to click more. Some search engines extend a pay-per-listing model to a pay-per-click model, where producers are only charged when users click on their listing.
• Hybrid: Most platforms nowadays follow a hybrid revenue model where they combine two or three revenue models, such as advertising and subscription or advertising and pay-as-you-go. Search engines such as Google display advertisements and charge for a premium or sponsored listing. LinkedIn has a premium membership model but also earns revenue from advertisements.

Amazon operates with a majority of or almost all revenue models; for example, it offers Prime membership at a subscription fee, earns a commission/fee on every purchase, offers sponsored products, and displays other advertisements and promotions. In most hybrid revenue models, the advertising model is usually combined with one other model. It does not directly impact the consumer but provides an additional revenue stream for platform owners from producers who are ready to pay a little extra.

We looked at the different types of platforms and the role of different entities such as producers, consumers, and platform owners in each of those platform types. We also looked at the different revenue models. This combination of platform types and various revenue models will help us understand how to choose a suitable model for any platform business.

Choosing the right revenue model

Selecting the right revenue model depends on two key factors, as outlined here:

• Direct cost of product/service/content: While deciding on a platform revenue model, it is essential to understand the cost structure of the product/service or content that the platform is offering. Is the cost of production one-time, irrespective of quantities consumed, or does it multiply with the number of quantities? When the production cost is one-time and does not increase exponentially with the consumption, a subscription revenue model is best suited. For example, songs produced once can be streamed millions of times on Spotify without incurring additional cost, or the cost of content created for Netflix does not increase with the number of times it is streamed. Hence, charging a subscription fee in exchange for access to the content is feasible for the platform owner. Consumers get unlimited access to the content on the platform for a fixed fee irrespective of how many hours' worth of content they are streaming.

Imagine a pay-as-you-go model here, where consumers had to pay for every video they watched. They would be very selective on what they watched, which would create very stiff competition between content creators. Netflix would have been even more selective in choosing the content they provided, but with a subscription model, Netflix can take a risk and give a chance to new content creators. Today, Netflix can afford to have a few average shows in their pile.

Similarly, when the cost of the goods or service or content increases exponentially with the quantity consumed, a pay-as-you-go model is most sustainable. For example, there is a cost associated with every ride on Uber, and there is a cost price for each Stock-Keeping Unit (SKU) of every product sold on Amazon. Hence, to cover the cost and generate profit for the producer and the platform owner, a subscription business model would not be feasible or sustainable in the long run. The price will depend on the goods or services that consumers are buying. The price will cover the product's cost, profit for the producer, and a fee for the platform owner. There are different options for platform owners to charge a fee such as a fixed amount per transaction, percentage of the transaction amount, or a combination of the two.

• Charge from the producer: Another factor to consider while deciding a platform's revenue model is how much the producer of the goods or services is charging. If the producer provides the goods or services or content for free, it is advisable to offer them for free to consumers. The cost of running the platform and the platform owner's profit can be generated through advertisement revenue.

Most platforms falling into this category are social media or knowledge and information sharing platforms. If a producer provides content for free or at a meager cost, such as Stack Overflow or Twitter, platform owners do not charge the consumers but earn their revenue from advertisement. But if the content provider is charging a fee, the content becomes premium and a subscription model is best suited for such platforms, such as LinkedIn Learning.

Apart from the two critical factors mentioned here, there are few other things such as access cost of the goods and service, market demand, the operating cost of the platform, and so on that will play a minor role in selecting the platform's revenue model, but most of these factors are more relevant in choosing a price point rather than the revenue model itself. These factors will decide how much to charge rather than what structure should be used to charge.

The following table summarizes the preceding discussion on revenue-model selection:

Important note:

Please note that a hybrid revenue model is not mentioned in the preceding table as a combination of any two or more models will be applicable for some of the platforms. Combining an advertising model with any other model is particularly common and widespread.

Benefits of a platform business model

We have discussed the different types of platforms and their revenue models, but why we should have a platform business or move from a linear business to a platform model is an important point to address.

Here are some benefits having a platform business model brings to consumers, producers, and platform owners, which will help you understand why platform businesses are disrupting the market and why small businesses want to leverage the platforms to grow their businesses. These benefits explain how a platform business model is advantageous for all the parties involved:

• Reduced cost: A platform business model benefits from economies of scale. Imagine a scenario where each seller is creating their own website and building an e-commerce foundation; the cost of everything will multiply. But that is not the case for platforms. Even with an increase in the number of sellers on the platform, the cost to build the foundation remains the same, distributing and reducing the overall cost of the products or services. Whereas, in a case where each seller has their own e-commerce presence, the cost of building and maintaining the website increases the overall cost of the product or service that they are offering.
• Increased customer base: It is easy for platforms to scale and grow their reach compared to individual producers. They have a robust foundation that helps them to expand into new categories, new geographies, and so on. More scale and better reach mean an increased customer base. As platforms offer various categories under a single experience, the traffic on the platforms is exponentially higher than on the website of an individual seller.

This is like a mall versus a small showroom on the corner of a street. As malls offer everything from dresses to washing machines under one roof, the number of people visiting malls is way higher than for a small showroom, and all the sellers in the mall benefit from the higher footfall. There is always a correlation between the number of people visiting and the number of people buying.

• Increased revenue: Increased revenue is the result of an increased customer base. As the platform has already acquired many customers and is constantly acquiring more due to extensive choices and low cost, the producers' revenue increases with the increased customer base. As mentioned earlier, increased traffic always leads to increased revenue, be it a physical store or a digital platform.
• Increased profit for producers: Reduced cost and increased revenue means increased profit for producers. The cost of building and maintaining a digital presence is relatively high, but in the case of a platform model, this cost is distributed among thousands of different producers, in the form of commission or fees. This significantly brings down the operating cost for the producers, increasing their profit margins. Reduced costs and increased revenue due to an increased user base lead to higher profit margins.
• Distribution of ownership and responsibility: In a platform model, each entity is responsible for its own areas of expertise. Platform owners are experts in building a digital presence, customer acquisition, SEO, and so on. Hence, they focus on and build a robust foundation that can be easily maintained and expanded.

Producers are more creative heads; they focus on offering different and specialized varieties to consumers. In some cases, intermediaries such as banks or drivers/dashers (DoorDash) own their specialized job. This distribution of ownership and responsibilities makes platform models highly scalable and guarantees quality, as different parties undertaking different tasks are experts in their respective fields.

• Lower risk: Distribution of ownership reduces business risk—the risk of failure and risk of investment. As we have seen, the distribution of ownership guarantees quality; it also distributes the risk and reduces the chances of failure. As each entity is an expert in its respective area, the chances of failure are fewer.

I am not saying that there are zero chances of failure, but they are low for sure. This distribution also reduces the risk of investment. Let's look at the same designer example that we saw earlier: if our designer has to launch a new clothing line and build an e-commerce website, their investment will be enormous. If their clothing line doesn't work, the loss is considerable. But with a platform model, they can avoid investing large amounts in building a website. Hence, this targeted ownership and distribution of responsibilities leads to lower risks.

• Variety of choices for consumers: As the number of producers is significantly higher on platforms, consumers have ample options. The increased number of producers on platforms also leads to increased competition, indirectly bringing in more—and better—choices for consumers. Due to platform models, the options within a category have increased, and the number of offered categories has also multiplied. Several products, a variety of services, and a wide range of content are at users' disposal today, all thanks to platforms.
• Lower prices for consumers: Reduced costs, increased revenue, and stiff competition have brought down prices significantly. It is challenging—and almost impossible—to create a monopoly. Because of the choices and the variety that the platforms are offering, consumers can compare and find the best prices not just by sitting on their couch but without even visiting another website.
• Faster and reduced time to market: Platform models are best for experimenting with a new idea or a product. Let's again look at the same example of a designer who wants to launch a new clothing line. It will be swift to launch it via an existing platform and test the waters. The designer can get faster feedback if their designs are working or if they need minor modification or to scrap a particular design. If they were building an e-commerce website themself, this would have taken way more time to launch, but the feedback cycle post-launch would also have been slower because of low traffic generation.