The platform business model: An introduction

Airbnb does it; Uber does it. What about your organization? Sangeet Paul Choudary lays out the fundamentals of the platform business model.

CAMBRIDGE, Mass. -- If your organization hasn't taken a long, ruthless look at how it does business, your organization hasn't heard Sangeet Paul Choudary expound on platform economics.

Choudary is founder and CEO of Platform Thinking Labs, a C-level and board advisory firm that helps companies adapt their business models to a marketplace in which value is increasingly generated through digital technologies: the Internet, social media, mobile smart devices, 3D printing and the Internet of Things.

Digitization, Choudary contends, has rewritten the rules of business competition, giving rise to a new form of business design he calls the platform business model. The traditional "pipe," or linear model of doing business, dates from the Industrial Age and, according to Choudary, relies heavily on two components for success: unique access to resources and/or labor, and the efficient delivery of a product or service to customers. Technology was and remains a key element. Amazon's initial success was based on using the Internet as an extremely efficient distribution pipe.

The platform business model -- used by companies like YouTube, Airbnb Inc. and Twitter -- also demands efficiency, but its path to the customer is not linear and value is not a one-way street.

Sangeet Paul ChoudarySangeet Paul Choudary

"Instead, it creates an infrastructure on top of which external producers can come and create value, and on top of which consumers can come in and consume the value," said Choudary at the recent MIT Platform Strategy Summit where he was a featured speaker. "Platforms no longer compete on the basis of resources, but on the basis of this ecosystem that coalesces around the platform." Value in platform business models lies not in the aggregation of resources, but in the filter.

Heady stuff? You bet. Here is an introduction to some of the tenets of platform economics laid out by Choudary in his talk. 

Start with the interaction 

The platform business model is essentially interactions enabled by infrastructure, Choudary said. When companies resolve to go digital, they often focus on the technology infrastructure rather than on the interactions that would help them get there. That is akin to building a factory first and hoping some product comes out. Companies looking to adopt a platform business model need to design the interaction first and use the interaction to design the infrastructure. Form follows function.

In a pipe model, the business goal is to improve the quality and quantity of the product -- to scale it -- by designing a process that is highly efficient and highly repeatable.

The goal of a platform business is to ensure the efficiency and repeatability of the interaction it enables. Once a business figures out how to do that, it can achieve a new kind of scale, according to Choudary. Ease and consistency spur people to increase their participation on the platform. As people participate more, more people come to the platform, creating a network effect, which then has to be managed.

"The network effect is no longer about producing huge bases of producers and consumers," Choudary said, but about identifying points of failure in the interaction the platform is enabling.  "Platforms focus on the interactions and remove all kinds of friction."

How platforms create and capture value

Interactions involve three exchanges, and platforms must successfully enable and manage all three to create value. "There is an exchange of information on the basis of which supply and demand meet and decide to interact with each other, followed by an exchange of goods and services, and an exchange of currency," Choudary said.

Sometimes value lies in the platform itself. Airbnb produces availability of accommodation on top of a platform. "If the platform did not exist, the accommodation would not exist, so they are actually building something of value because of the platform," he said.

But platform businesses create value through many means. If a company is exchanging virtual goods, content is created on top of the platform. If the exchange involves physical goods, availability and information about the goods that enable supply and demand to meet (e.g., a product listing) is created on top of the platform. Certain services enabled by the platform are highly standardized -- an Uber ride or an Airbnb listing -- and others are not, as is the case with TaskRabbit Inc., a digital marketplace that enables users to outsource all kinds of small jobs and tasks to others in their neighborhood. Google-owned Nest Labs Inc., the maker of smart thermostats and other security systems, creates value from the data generated by its connected products; the network effect stems from every thermostat learning from every other thermostat.

Metrics depend upon the type of value the platform creates, Choudary said. If content represents value, then the ability to scale content production, as well as the liquidity of content (how fast it is consumed) are important metrics. With nonstandardized services, the availability of the service producer, not just the number of providers, is important.

Platforms focus on the interactions and remove all kinds of friction.
Sangeet Paul Choudaryfounder and CEO of Platform Thinking Labs

In addition to creating value, platforms need to capture value by ensuring that some form of currency is fed from consumers to producers -- a design feature many companies gloss over. "If that feedback loop … breaks at any point, the platform fails," Choudary said.

Value capture has traditionally meant dollar capture. On a platform, however, value can also mean data capture. For example, a company can use the data captured on its platform to sell more of the product in its pipe; or the data captured from one platform-enabled interaction can be used to strengthen another interaction that the company makes money from.

To ensure repeat interactions, producers also need to feel "they are progressing on the platform," said Choudary, who recommended platform designers study game theory. "Games are addictive because they encourage progression. They make it just easy enough to get to the next level. A similar dynamic is important in designing platforms."

Platform infrastructure needs to balance conflicting priorities

The infrastructure to enable platform interactions must provide both easy access and access control. The platform needs to be "plug and play," Choudary stressed. Producers and consumers should be able to get on the platform easily and easily interact with each other. Easy access, however, will bring on both good and undesirable interactions. In addition, an open and participatory environment invites "the problem of abundance," driving up the cost of search. If consumers have a hard time finding what they want, the platform-enabled interaction is longer and less efficient.

Want to learn more about the IT infrastructure behind successful platform companies? Read John Moore's case study on how the Etsy technology team uses open source and adaptable  infrastructure to efficiently meet the needs of the online craft exchange's buyers and sellers.

"Platforms need to balance these conflicting priorities by building an environment that is open and highly participatory, but also curated and governed," Choudary said.

Platforms need to have access controls for producers to determine what kinds of producers are allowed and what kinds of actions they are allowed to do. 

On the consumer side, platforms need a filter that determines what is served to customers. "Platforms are gatekeepers at the end of the day," Choudary said.

Of course, that assumes that once the platform is built, throngs will come.

Email Linda Tucci, executive editor, or find her on Twitter @ltucci.

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