Managing innovations and change HOMEWORK DUE IN 6 HOURS

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MGMT461Topic10-PlatformsandecosystemsUPDATED.pptx

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Chapter 2

Innovation & Economics

MGMT 461 Managing Change & Innovation Topic 10: Platforms and ecosystems

A/Prof Tatiana Zalan

This presentation builds on the ideas and presentations by Profs Geoffrey Parker, Marshall von Alstyne and Thomas Eisenmann

Where are we in the course?

Foundations:

Introduction to Innovation (T1)

Innovation & Economics (T2)

Developing an

innovation strategy (T3)

Creativity and idea

generation (T4)

Selecting and managing

an innovation portfolio (T5)

Implementing

innovations (T6)

Creating an

innovative culture (T7)

Boosting

innovation

performance (T8)

Funding and fostering innovation (T9)

Platforms & ecosystems (T10)

Innovation & change (T11)

Agenda and objectives

To clarify / explain:

Growth of the digital economy and platform businesses

Economics of information goods

Economics of platforms

Innovation and change enabled by platforms

“There is hardly an area of economic and, arguably, social interaction these days that is left untouched by platforms in some way”.

Martin Bailey, Leader of the European Commission, on efforts to create a single digital market, quoted in The Economist, 28 May, 2016

platform Revolution

“In 2015, Uber, the world’s largest taxi company owns no vehicles, Facebook the world’s most popular media owner creates no content, Alibaba the most valuable retailer has no inventory, and Airbnb the world’s largest hotelier owns no real estate.”

Tom Goodwin, Sr. VP of Strategy Havas Media

Source: Parker, van Alstyne & Choudary (2015)

platform Revolution

Platforms are beating products

The digital / information age – Class activity

Questions – for the entire class:

What is the difference between the digital economy and the traditional economy?

What is a “platform” (vs ‘product)?

Questions for each group:

How can you explain the success of these companies? And their dominance?

Why did they grow so fast?

Which technologies underlie their growth?

What is the downside of growth (if any)?

https://www.youtube.com/watch?v= dqdF3p9PEpU

Scott Galloway

THE BOTTOM LINE: A market warning, the big bitcoin debate and a deep dive on tech heavyweights (about 8 min start).

Task: Form 4 groups – “The gang of Four” - Amazon, Facebook, Google / Alphabet and Apple

Scott Galloway

The Four Horsemenhttps ://www.youtube.com/watch?v=XCvwCcEP74Q

Gang of Four: Apple / Amazon / Facebook /Google (Scott Galloway, Founder of L2) | DLD16‬https://www.youtube.com/watch?v=jfjg0kGQFBY

‪

Douglas Rushkoff

‪Online Companies Like Facebook Have Created a Meaningless Economy, says Douglas Rushkoff‬ https://www.youtube.com/watch?v=6_n1Dro0Uec

The Growth Trap https://www.youtube.com/watch?v=yUGzUktP7jg

the world looks different

what does the market say?

Global Internet Market Leaders = Apple / Google / Amazon / Facebook / Tencent /

Alibaba … Flush with cash …Private companies well represented

Current generation of internet leaders =

Growing faster than previous generations

Source: Galloway (2016)

New economy firms are extremely productive

Information goods are goods that have information embedded in them – books, databases, magazines, music, web pages, databases are all information goods.

Digitization has enabled the detachment of information goods from the medium of transfer, impacting the production, exchange and consumption of information.

Digital goods are real bits located on physical devices – computer software and various services ranging from Internet search engines and portals to online content.

Digital goods have unique properties:

Unique cost structure

Properties of public goods

Property of experience goods and other

Network effects

The abundance of information (information clutter) creates a paucity of attention.

Information and Digital Goods

Information goods have high fixed costs of production but near-zero or zero marginal costs (i.e., costs of reproduction).

Developmental costs of producing the first unit of an information product are generally high, but producing each additional unit costs virtually nothing.

For example, the estimated costs of developing the popular computer game Gran Turismo 5 were around $80 million (DigitalBattle, 2010); the costs of replicating additional copy range from negligible (production of DVDs) to essentially zero (downloadable files).

Cost of storing and transmitting stored information is cheap (and continues to get cheaper); there are no effective capacity constraints on the production of digital goods.

Traditional product

Digital product

Unique cost structure

MSPs (multi-sided platforms) are intermediaries that reduce search costs and transaction costs.

Characteristics of Multi-Sided Platforms (MSPs):

The platforms provides infrastructure and governance rules;

Two or more user groups participating;

Direct and indirect network effects;

Non-neutrality of fees - one side is a money side, the other a subsidy side;

Enabling direct interaction between two or more distinct sides – the sides retain control over the key terms of the interaction (e.g., pricing, bundling, marketing and delivery of goods)

Each side is affiliated with the platform – users make platform-specific investments (e.g., an opportunity cost or spending time and money on learning how to develop apps).

what is a platform?

Industry platforms are “core” to a technological system of use (essential to its function) as well as highly interdependent with other parts of the technological system. The organization of these ecosystems appears to follow a regular structure, with platform leaders acting as “keystone” members of the network of firms that are the platform complementors, with a dense set of interdependencies, both technological and strategic, between the “core” that is the platform and the other parts of the ecosystem/technological system. The complementors themselves occupy a peripheral position in the network, with fewer links between them (Gawer and Cusumano, 2008; Gawer, 2010).

2007

iPhone

2012

Coursera

2014

Apple Pay

2008

Runkeeper

Source: Mishra, Smithson, Kim, Smith & Toraty (2017), presentation at MBS, March

Apple

Positive Cross-side Network Effects

Multi-Sided Markets

CUSTOMER VALUE

Exercise / Health

iPhone

Insurance

Companies

Study

Universities

We took a closer look at a couple of the horseman starting with Apple

Apple released its iphone in 2007 and this started their network of people who use a phone to make calls go on the internet and down the track they strengthened this network with things like facetime where it paid to have an iphone… your standard network effect

They then introduced a whole bunch of apps – ive used health and well being as an example – which probably drew more users but more importantly it drew app developers creating a two sided market – the more users there were – the more it attracted developers and the more apps there were, the more it attracted users

Similarly – they create a market for peple who want to study a Mooc

And a network with financial institutions

Over time, apple has built up a huge network of customers who derive value from being “connected” and apple leveraged this customer base to launch the apple watch – for people who were willing to pay to wear this convenience!

But does the apple watch add value to the network the same way apple pay does? Or the app store does?

On the face of it – it might look like it doesn’t but it could easily provide a link to the insurance industry or even to Geoff’s point, connect to the medical community to develop something that tells you to pack your bags cos your about to have a heart attack!

What we can see here is customer value created by positive cross-side network effects.

Network effects – demand-side economies of scale

Control of user interface and user experience

Control of the ecosystem

Data and algorithms for:

Matching

Pricing

Personalisation

Trust

McAfee & Brynjolfsson (2017)

platform advantages

Network effects are demand-side economies of scale.

Note that ‘network effects’ are nothing new. What is new, however, is that the Internet has enabled network effects on a global scale.

Supply-side economies of scale (or simply economies of scale) is a function of production size, scale leads to lower costs per unit. They operate on the cost side, and while costs fall, they cannot fall indefinitely.

Demand-side economies of scale (aka network effects) is a function of users, so scale leads to higher utility for users. They operate on the customers’ willingness-to-pay side. At least theoretically, there is no upper bound to network effects.

They are both sources of competitive advantage, but network effects are thought to be stronger, as users have higher

switching costs.

Network effects

Members of each group exhibit preferences regarding the number of users in the other group (cross-side network effects) and / or regarding the number of users in their own group (same-side effects).

Network effects are demand-side economies of scale. Many large platforms also exhibit producer-side economies of scale.

Network effects create significant barriers to entry and exit in an industry.

Side 1

Side 2

Platform

A two-sided platform has FOUR network effects

Three common “laws” for estimating network Value

Zipf’s law

Metcalfe’s law is too optimistic, Zipf’s law is more accurate (according to mathematicians

Andrew Odlyzko, Benjamin Tilly & Bob Briscoe)

Facebook Values Itself Based on Metcalfe's Law, But the Market Is Using Zipf's

https://www.forbes.com/sites/anthonykosner/2012/05/31/facebook-values-itself-based-on-metcalfes-law-but-the-market-is-using-zipfs/#32d915d268f5

An example of the difference in valuation between Metcalfe's law (n2) and Zipf's law (n log (n)) is illustrated by Bob Briscoe:

Imagine a network of 100,000 members that we know brings in $1 million. We have to know this starting point in advance—none of the laws can help here, as they tell us only about growth. So if the network doubles its membership to 200,000, Metcalfe's Law says its value grows by (200,0002/100,0002) times, quadrupling to $4 million, whereas the n log( n ) law says its value grows by 200,000 log(200,000)/100,000 log(100 ,000) times to only $2.1 million."

A more robust way of estimating Network Value

Estimating Network Effects

InterBrand: 2013 Best Global Brands

These Grew Fastest

Children say “Google it”

These are platforms

Platform Examples

Desktop OS: Unix, Mac, Windows

PDAs: Palm, Psion, Newton

Game Consoles: Wii, Xbox, Playstation

Network Switches: Cisco, IBM, HP

Multimedia: Adobe/Flash, MS/Silverlight, Google-Apple/HTML5

Payment Systems: Paypal, Google Checkout, Visa, Apple, Mobile Felica

Mobile Devices: iPhone, Android, Symbian, Blackberry

Enterprise Systems: Salesforce, Oracle, i2, IBM, SAP

Social Networks: Facebook, MySpace, LinkedIn, Monster, Twitter

Batteries: Sony, Panasonic, Sanyo, A123

Web Search: Google, Bing+Yahoo!, Baidu

Ebooks: Amazon, iPad, Nook, Sony

Smart Grids: IBM etc.

Health Care: Microsoft, WebMD, IBM etc.

eBay Example: The Miracle of Value Exchange and Creation

Source: D. Evans (2012) Catalyst Code: How to ignite a platform business and rule a platform-centred ecosystem

In a traditional value chain, on the left is cost, on the right is revenue

Price consumers are Willing

To Pay for a product

Retail Price

Wholesale Price

Price to wholesaler

Price to manufacturer

Price of farming inputs

Consumer surplus

Cost - including risk-adjusted cost of capital

Producer profit

Consumer

Retailer

Wholesaler

Manufacturer

Primary

Value added

Traditional Value Chain

Apple as a standard linear value chain business

User matches MP3 player to library (Apple pre-iTunes)

Apple as a two-sided market

Apple matches users to content

In these markets, value / cost can be on the left or right

Source: Parker & Van Alstyne (2011)

Platform businesses are different

Source: Hagiu & Wright (2015)

Note: becoming an MSP is a strategic choice, not an inherent characteristic of an industry!

MSPs vs alternative businesses

Innovation and change in platforms

Marketing and prices

Winner-take-all (WTA) dynamics

Openness (vs control)

Valuation and finance

Unlocking new value from spare resources

New forms of organization

The platform may charge a side….

Example: Microsoft makes consumers pay for video games

…or subsidise a side

Example: YouTube finances video content providers

Who should you charge?

Who should be subsidised?

The answer depends on three considerations:

Ability to capture cross-side effects => if your network’s subsidy side can transact with a rival platform provider’s money side, your ‘giveaway’ will be wasted (e.g., Netscape)

User sensitivity to price => subsidise the price-sensitive side

User sensitivity to quality = > subsidise the quality-sensitive side

Source: Eisenmann et al. (2006)

The allocation of fees on one side of the platform will affect the total volume of transactions, hence many MSPs have a money side and a subsidy side [see next slide]

The most important decision is the pricing structure

Price

Quantity

Market One

Price

Quantity

Market Two

Price

Market One

Quantity

Price

Market Two

Quantity

If markets are separate, collect profits in both

But if markets are interdependent, discounting one builds demand in the other

See "Two Sided Network Effects” (2006) Management Science, Parker & Van Alstyne

The economics of pricing in two-sided markets

Cross-side effects are positive and strong.

User groups do not require differentiated features.

Switching costs (from one offering to another) and multi-homing costs (costs of affiliation with multiple platforms) are high.

Winner

takes all!

Three conditions lead to a WTA dynamic:

Source: Eisenmann et al. (2006)

}

… this is what underlies the success of Amazon, Microsoft, Uber, Google, Facebook…

Firms strive to be MSPs because they can become winners-take-all

(or most) in their respective industries

Research shows that MSPs (“ecosystems”) have higher revenue growth (32%) and higher profit margins (27%) than industry average. Smaller companies are better at seizing disruption opportunities (Weill & Woerner, 2015).

There is evidence that MSPs outperform other types of firms

Corporate valuation models that underestimate market expansion due to network effects fail to invest

Platforms encourage openness in organizations

Platforms Open Themselves to Third Party Contributions

Openness vs. Control

Your Share

Industry Value Added

Open

Proprietary

Your reward = (Value added to industry) x (Your share)

Based on: Shapiro & Varian ‘99

Maximum protection ≠ Maximum Value

Openness vs. Control

Your Share

Industry Value Added

Open

Proprietary

Linux is so open (viral GPL) it’s difficult to control and make money.

Maximum protection ≠ Maximum Value

Why platforms beat products

Consider product innovation alone

- Harnessing 3rd party resources, innovation occurs at a higher combined rate.

- Even if a platform starts behind, its value will overtake the product leader.

Time

Value Added

Platforms, innovation and change - summary

‘Free’ pricing is profitable

Who is the money side, and who is the subsidy side?

Platforms unlock new value from spare resources and user generated content

Instagram sold for $1B not because of contributions of 13 employees, but from 30M users (premium on the value of personal data?)

Platforms enable collaboration between teams across the organization and organizational boundaries

Amazon’s motto – all teams expose their data

Platforms promote Open Innovation – they open themselves to third party contributions

Innovation takes place at a higher rate

Uber live case study

Task 1:

Compare Uber with BMW

Consider: (1) year founded; (2) employees and (3) market cap

What conclusions do you make?

Task 2:

What is innovative about Uber?

What is the pain point they are addressing? What problem are they trying to solve?

How did they build the platform? How did they start? How did they overcome the chicken-and-egg problem?

How does Uber make money? And how much?

Is Uber vulnerable? What could go wrong?

Side A DIRECT INTERACTIOINS

MSPs vs. Alternative Business Models

Side B

Side A Side B

MSP

RE-SELLER

AFFILIA TION AFFILIATION

SALES OF GOODS OR SERVICES

V.I. FIRM

SALES OF GOODS OR SERVICES

OWNERSHIP OF SIDE A (VERTICAL INTEGRATION)

INPUT SUPPLIER

SALES OF GOODS OR SERVICES SALE OF INPUT

Side A

DIRECT INTERACTIOINS

MSPs vs. Alternative Business Models

Side B

Side A Side B

MSP

RE-SELLER

SALES OF GOODS

OR SERVICES

SALES OF GOODS

OR SERVICES

V.I. FIRM

SALES OF GOODS

OR SERVICES

OWNERSHIP OF SIDE A

(VERTICAL INTEGRATION)

INPUT

SUPPLIER

SALES OF GOODS

OR SERVICES

SALE OF INPUT

•  Estimate global taxi market •  Estimate market share

•  Est. risk adjusted cash flow •  Consider proprietary

methods, barriers to competition

•  Value: $5.9 Billion

Aswath Damodaran: NYU Finance professor, Corporate Valuation author, Herb Simon Prize.

• Estimate global taxi market

• Estimate market share

• Est. risk adjusted cash flow

• Consider proprietary

methods, barriers to

competition

• Value: $5.9 Billion

Aswath Damodaran: NYU Finance professor, Corporate

Valuation author, Herb Simon Prize.

Bill Gurley: Venture Capitalist, OpenTable, Zillow, Uber

•  All true but overlooking network effects.

•  Prices decline expanding to rental car market and car replacement market and delivery market.

•  Oh, BTW, already 3x size in 2009 when Uber started.

•  Value: $17 Billion

Source: David Sacks, COO PayPal, CEO Yammer

Bill Gurley: Venture Capitalist, OpenTable, Zillow, Uber

• All true but overlooking

network effects.

• Prices decline expanding to

rental car market and car

replacement market and

delivery market.

• Oh, BTW, already 3x size in

2009 when Uber started.

• Value: $17 Billion

Source: David Sacks, COO PayPal, CEO Yammer

1.  All teams will expose their data… 2.  Teams must communicate

through interfaces. 3.  … no other form of interprocess

communication allowed 4.  Interfaces, without exception,

must be externalizable. 5.  Anyone who doesn’t do this will

be fired.

Bezos Platform Mandate

Source: Yegge Rant

1. All teams will expose their data…

2. Teams must communicate

through interfaces.

3. … no other form of interprocess

communication allowed

4. Interfaces, without exception,

must be externalizable.

5. Anyone who doesn’t do this will

be fired.

Bezos Platform Mandate

Source: Yegge Rant

A platform is a system that can be… adapted to countless needs and niches that the platform’s original developers could not possibly have contemplated…”

Source: “The 3 kinds of Platform you Meet on the Internet” – Sept 16, 2007.

A platform is a system that

can be… adapted to

countless needs and

niches that the platform’s

original developers could

not possibly have

contemplated…”

Mark Andreessen: Venture Capitalist, Netscape

Founder, Board HP, eBay

Source: “The 3 kinds of Platform you Meet on the Internet” – Sept 16, 2007.

− Open to .com”

Open to developers −

The Rise & Ignominius Fall of MySpace – Business Week 2011

Does Openness Work?

− Open to .com”

Open to developers −

The Rise & Ignominius Fall of MySpace – Business Week 2011

Does Openness W ork?