Part 1: Launch and Transitions

Section 1

Introduction video

LEARNING OBJECTIVES
In Part 1 you will:

 Identify structural changes in the economy

 Show why platforms beat products – speed, innovation, resource
control, economies of scale
 Contrast how work gets done via platform firms vs product firms
 Distinguish supply economy of scale from demand economy of scale

Section 2

Video – Evidence

STRUCTURAL CHANGES IN THE ECONOMY?

Visit each of the three links below and consider which of these are “Platform”
firms and which are simply traditional product firms. Be sure you consider
platforms across a variety of nations.
• Ranking of firms by market capitalization
• Ranking of firms by global brand value
• Ranking of firms by online interactions
Now consider the composition of asset values across different corporations. In
particular, what proportion of the value of a firm derives from physical assets
and what proportion derives from intangible assets. The chart below shows
evolution over the forty-year period 1975 to 2015 for major firms in the S&P
500.

Figure 1.1: Components of S&P 500 Market Value

This chart shows that the ratio of tangible assets to intangible assets has
flipped, going from 83/17 to 16/84 over a span of 40 years. For more detail,

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take a look at Components of S&P 500 Market Value chart. There have been
two major stock market corrections over this period, one in 2001 with the
"dot.com" crash and one in 2007 with the housing bubble yet the 2005 and
2015 data suggest that these trends have survived.

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The article below raises fascinating questions about the speed and scale of
different forms of organization. As you read it, consider: Has the value
proposition of firms changed over time or is this just a difference in scale?
Has the variety of product offerings changed? Subway has only 900
employees while McDonalds has 420,000 and “without owning a single
restaurant, Subway has more fast food restaurants than McDonalds” because
it prefers a franchise model to proprietary ownership. Relative to a traditional
Taxi company, are Uber’s labor practices just another form of franchising?

Reading
Tim O’reilly (2015); networks and the nature of the firm

Intro – examples of non-Tech firms

Video: Non-tech examples

PLATFORM EXAMPLES: SHOES & SPICES

Not all platforms are high tech firms. Nike Shoes and McCormick Spice have
both introduced novel platform concepts. Nike has built communities around
self-tracking, benchmarking, and performance enhancement. McCormick
Spice has experimented with recommender systems for recipes that can be
modified by consumers and reposted. In both cases, key elements of a
platform are the addition of information and community so as to add new
value to the original value proposition.
A useful way to think about the difference in a product versus a platform
business model is: Products have features, platforms have communities.
Building these communities will be an essential ingredient going forward.

Session 3

Economies of scale - Introduction

Video: economies of scale

Reading

Next, please read Chapter 1 from "Platform Revolution: How Networked Markets are
Transforming the Economy and How to Make Them Work for You" by Geoffrey G.
Parker, Marshall W. Van Alstyne, and Sangeet Paul Choudary.

When reading consider:

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  What is a platform?
 What does a platform do and how does it create value?
 What forces might cause it to behave differently than a product firm

Make sure you understand what gets exchanges on a platform and also what the
purpose of a platform is. We will need these ideas again in Part 2 of the course.

WHY DO PLATFORMS GROW IN VALUE?

Multiple reasons explain the rapid growth in platform value. Consider these
factors:

1. External ecosystems and exchange markets give rise to "network effects"

whereby the product or service becomes more valuable as more people use
it. More Android developers lead to more Android users, and more Amazon
merchants lead to more Amazon users. This has the interesting property that
platforms appreciate in value as more people use them. By contrast, products
depreciate in value as they are used.

2. Network effects create feedback whereby value attracts users. Their usage
creates value which attracts more users. This feedback process is creating
giant Internet firms today analogous to the giant industrial firms created a
century ago.

3. Businesses typically transform from products to platforms by adding

information and community in ways that facilitate network effects. Whether
the underlying information is user generated content or algorithmic content
generated from user data, interaction with the platform creates value which
attracts further interaction. These assets typically fall into the "intangible"
category rather than the "tangible" category, illustrating the pattern observed
in the shifting composition of asset values in the S&P 500.

4. More and better matching creates wealth by facilitating new transactions

that would never have occurred. It also creates wealth by facilitating better
transactions than those already occurring.
Economists have another name for "network effects." They call this
phenomenon a "demand economy of scale" since the value of and demand
for a good or service rises in consumption. This has the unusual property that
demand can become self-sustaining.
The mechanism by which platforms create value is typically via more and
better matching. Platforms connect people to other people or they connect
people to content and services that they value. Examples include people
connected to friends on Facebook, riders connected to drivers in Uber, users
connected to apps on Android, and buyers connected to products on Alibaba.

WINNER TAKE ALL MARKETS

Two main drivers of winner take all markets are supply side economies of
scale and demand side economies of scale. Industrial giants tend to be driven
by supply economies of scale. Internet giants tend to be driven by demand
economies of scale. Under a supply economy of scale, with high fixed costs

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 and low marginal costs, a rise in volume allows the firm to lower price, which
increases volume, which allows the firm to lower price. Under a demand
economy of scale, with network effects, a rise in the user base increases
value, which attracts users, which increases value. Both types of economy of
scale give a firm substantial advantage relative to firms with lower volume.

Economies of scale – math model

Video: economies of scale Math model

IN WHAT SENSE ARE THE CAUSES OF GIANT FIRMS TODAY THE

OPPOSITE OF THE CAUSES OF GIANT FIRMS IN THE INDUSTRIAL
ERA?
Industrial era giants were driven by supply side economies of scale, high fixed
costs with low marginal costs. A supply side economy of scale means that
average cost is declining in volume so that more sales implies the ability to
lower prices. This leads to more sales, which allows even lower prices. The
supply curve shifts down.
Internet era giants are driven by demand side economies of scale, network
effects that improve the value of a product or service the more it is used. A
demand economy of scale means that average value is rising in volume so
that more users implies more value, which attracts more users. The demand
curve shifts up.
These forces act on opposite sides of the profit equation, one on costs and
one on value. This is depicted graphically in the figures below.

• Falling average costs • Rising average value

• Monopoly production • Monopoly consumption
• Utilities, Semiconductors • Operating Systems, IM, Social Networks

Figure 1.2: Two plots show the price-quantity curves for supply economy of
scale and demand economy of scale. Initially, the demand curve is downward

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sloping and supply curve is upward sloping when x-axis is quantity and y-axis
is price. When the supply economy of scale takes place, the slope of supply
curve decreases thereby, in the new equilibrium, price decreases and quantity
increases. When the demand economy of scale happens, the demand curve
shifts upward thereby both price and quantity increase in the new equilibrium.

Later entrants in the market have fewer consumers so they have either a
significant cost disadvantage (supply diseconomy) or a significant value
disadvantage (demand diseconomy). Both forces can be present in the
market at the same time. For example, a fully compatible completely new
desktop operating system would cost about $1 Billion to develop. Each
incremental copy, however, is very cheap to produce. This provides a supply
economy of scale. Operating systems also have network effects since users
attract developers, who attract users. So, operating systems also illustrate a
demand economy of scale.

Section 4
Firm inversion
Network effects cause the firm to "invert," that is to shift value creating
activities from inside the firm to outside the firm. The reason is simply that one
cannot scale network effects inside the firm as easily as outside. There are
more people outside. This implies that executives must shift their attention
from inside to outside. The old business practices still matter. Supply
economies of scale, for example, will always matter. But the new business
practices must take account of community resources and networks of
interactions as new sources of business value. This shift in focus moves
attention from production to orchestration.
This is the underlying cause of what others have observed about platforms:
Facebook, the largest social network doesn't make it's own content. Alibaba,
the largest retailer, doesn't own inventory. Uber, the largest ride service,
doesn't own cars. And, Airbnb the fastest growing accommodations firm,
doesn't own real estate. These resources are provided by an external
community. Again, these forces are consistent with a business model that
represents a shift away from tangible assets as the core source of value for a
firm.
The videos below provide illustrations of the "firm inversion hypothesis."
Mathematically inclined students might wish to explore a model that shows
how network effects invert the firm in the optional MISQ reading at the end of
this section, but this material is not in any way required to complete this
course. Bonus material is simply available to show the rigor underlying ideas
presented here. Everyone else can simply enjoy the videos.

Video - Firm Inversion: Marketing

Video - Firm Inversion: Human resources
Video - Firm Inversion: Operations and logistics

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Video - Firm Inversion: Finance
Video - Firm Inversion: Innovation and R&D
Video - Firm Inversion: Information technology
Video - Firm Inversion: Strategy
Video - Firm Inversion:
Video - Firm Inversion:

TYPICAL DIFFERENCES

Industrial Firms Business Function

Supply economies of scale Strategy

Product/Service Promotion Marketing

Linear Supply Chain Operations

Internal R&D R&D

Value driven by firm assets Finance

Employees Human Resources

Back Office (ERP) / Front Office (CRM) Systems Information Technology

Table 1. 1: Typical Difference of Properties of Platform

The first and third columns represent typical differences. These can be
extremes and should be taken as end points not as definitions. Clearly a
range of possibilities exist along a continuum of choices for different business
functions.
SCALABILITY

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Note how external value creating activities allow the platform to scale rapidly.
Elastic production and consumption simply expands as needed. As noted in
the video on operations, platform businesses can often exhibit zero marginal
costs. This allows for extremely rapid expansion.
Caution: Such rapid expansion via 3rd party production also implies that
quality controls must scale rapidly. Uber needs ways to keep bad drivers off
the platform. Airbnb needs ways to keep bad hosts off the platform. Google
Android needs ways to keep malware off the platform. These methods must
scale, either via algorithms or crowds, in order that a centralized quality
control point does not become a bottleneck.
The operational components that support a platform determine the platform’s
scalability. As the level of incremental resources that must be invested into a
platform falls for each new user, the more “scalable” a platform becomes.
Platforms that do scale have less difficulty maintaining the quality of their user
experiences as their user base grows than platforms that don't scale.
Section 5

Question 1
The main activity of a platform is to…

A. Make money
B. Dominate a market
C. Boost sales
D. Facilitate Interactions
E. Change strategy

Question 2

Every interaction on a platform involves an exchange of…

A. Information
B. Goods or services
C. Social Currency
D. All of the above

Question 3

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A duplicate car key costs $.75 to manufacture. The first buyer and 100th
buyer pay the same price. This is an example of ...

A. A supply economy of scale

B. A demand economy of scale
C. Both A and B
D. Neither A nor B
E. An industrial good

Question 4

As you add friends on Facebook or Snapchat the value of your interactions

increases. This is an example of ...

A. A supply economy of scale

B. A demand economy of scale
C. Both A and B
D. Neither A nor B
E. A Network Effect
F. B and E

Question 6.
A table divided between industrial and platform firms
Two columns; Industrial Firms (left) and platform firms (right) and 5 rows

Linear Supply Chain,

Valuation driven by firm assets,
Innovation via internal R&D
Supply economies of scale
Product/Service Focused
Demand economies of scale
Open 3rd Party Innovation
Value Ecosystems

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Valuation driven by community assets
Interaction Focused

OPTIONAL READINGS
 Andreessen, M. (2011). "Why Software Is Eating The World". Wall
Street Journal, p.20.
 Evans, P. & Gawer, A. (2016) "The Rise of the Platform Enterprise: A
Global Survey." Center for Global Enterprise research paper.
 Parker, G., Van Alstyne, M. & Jiang, X. (2017). “Platform Ecosystems:
How Developers Invert the Firm” MISQ 41(1). pp 255-266.