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Not all platforms are created equal

071220147 platforms

Not all platforms are created equal

Earlier in the year Andrew Macken wrote a whitepaper on what we believe will be the business model of the future – the Online Technology Platform. Many of the largest businesses in today’s world, such as Apple (Nasdaq: AAPL), Amazon NASDAQ: AMZN), Alibaba (NSYE: BABA), Facebook (NASDAQ: FB) and Tencent (HKEx: 700 HK) are technology platforms.

However, not all platforms are created equal, and it would serve investors well to distinguish between different types of platform businesses.

We can broadly classify technology platforms into two categories: exchange platforms and creator platforms. The distinction is made based on the matching intention of the transactions that take place on the platform. For exchange platforms, the matching intention is discrete and typically low. Consider an Uber driver, eBay seller or a WhatsApp conversation – concurrent transactions with other platform users is limited to 1:1 (1 passenger, chat or auction item) or 1:few (carpool or group chat) at best. For creator platforms, the matching intention can be 1:many. Apple’s App Store, for example, is a platform for iOS developers and users with high matching intention, as each app can be downloaded by many users, and the hundreds of millions of iPhone users have encouraged thousands of developers to create millions of apps.

Let’s consider several examples of exchange and creator platforms that highlight the importance of investing in the right type of platform.

Uber and Airbnb

Uber and Airbnb are the two most valuable (on paper) US tech unicorns and are posterchildren for the exchange platform model. Both platforms have low matching intention – an Uber driver can only serve one rider at a time, just as an Airbnb listing can only accommodate one group of guests at a time. For a given number of additional riders or guests, Uber and Airbnb must source more supply of drivers and listings. Because chauffeuring or hosting strangers is not the “usual” thing for people to do with their cars and homes, it becomes expensive for Uber and Airbnb to fulfil the incremental supply side of these transactions. When network effects are maintained through subsidies/payments to both buyers and sellers on a platform, those platform businesses tend to be low margin or unprofitable (though Airbnb has reportedly turned a profit in recent times).

Alibaba and Tencent

Alibaba and Tencent are two excellent examples of creator platforms. Alibaba is usually regarded as the world’s largest e-commerce business (an exchange platform), but it is first and foremost a marketing machine – nearly 60 per cent of the company’s commerce-related revenue comes from online marketing services. Instead of simply confining itself to a marketplace through which goods are exchanged, Alibaba shaped itself into the epicentre of Chinese consumerism, and made it fit in the consumer’s pocket. Marketers on Alibaba’s platform derive value from creating ad content and engaging with users, while users both consume and create content by engaging with brands and each other through reviews and discussions, all of which is designed to encourage greater consumption, whether it takes place on Alibaba or offline. Alibaba’s CEO recently said that its Taobao app is transitioning from satisfying demand to creating demand.

Likewise, Tencent’s WeChat app has become the epicentre of all thing social in China. The app extends far beyond messaging – it can be used to play games, shop online, call a taxi, book a hotel, book a restaurant, split the bill with friends and et cetera. In fact, WeChat’s recently-launched apps-within-an-app (“mini programs”) promises to become the one and only app that users need.

Facebook vs Twitter

Both Facebook and Twitter are creator platforms, but their financial fortunes differ vastly. Facebook’s consumers and creators are one and the same. As a user’s connections increase, the user-created content in their newsfeed increases exponentially, and matching intention rises from 1:few to 1:many. This in turn generates more ad inventory for Facebook to sell to marketers. The transactions remain personal enough to keep users engaged, but not so personal that native ads become a nuisance (try monetising WhatsApp conversations with ads). Twitter, on the other hand, has struggled with low engagement (both time in app and number of active tweeters), which suggests that the transactions enabled by the platform provide limited value to both creators and consumers, and this limits the value that Twitter can extract from the high matching intention.

eBay vs Amazon

Finally, we consider two exchange platform stalwarts in the form of eBay and Amazon. eBay pioneered the online marketplace model when it launched its first auction website two decades ago. Unfortunately for investors, eBay failed to expand beyond a simple 1:1 or 1:few exchange platform and was left in the dust by Amazon. Amazon’s explosive growth has been underpinned by its famous “flywheel”, which allowed it to scale up the number of 1:1 and 1:few transactions as cost efficiently as possible. Amazon’s investments are entirely targeted at removing all friction from transactions on its platform, which in turn encourage a greater and greater number of users to transact. Amazon Prime was launched to make transactions as quick as possible for buyers, while Fulfilment By Amazon was launched to make sellers’ products as widely accessible as possible. When buyers can buy an ever-expanding selection of items for 2-day delivery, more sellers will sell on the platform, and more buyers will follow. Compare Amazon’s investments in its platform infrastructure to Uber’s payment of subsidies per ride, and it is easy to see which exchange platform is more scalable and which network effect more valuable.

As the above examples demonstrate, platform businesses are valuable because their growth enhances the value of the platform to all users on the platform. However, investors must not forget to check whether the value of the platform accrues entirely to its users, or is shared between the users and the platform operator. This is no trivial task, so understanding the matching intention of a platform is an important first step to determining the platform operator’s prospects.

The Montgomery Global Funds own shares in Alibaba, Amazon, Apple, Facebook, and indirectly in Tencent through Naspers

Are you looking for a simple way to invest in high quality global businesses? Applications to the new Montgomery Global Equities Fund are now open. To access the PDS and find out more, please visit the MOGL website.

Daniel Wu is a Research Analyst at Montgomery Global Investment Management. Prior to joining Montgomery in June 2016, Daniel was an analyst in the investment banking divisions of UBS and Goldman Sachs, where he covered the Infrastructure, Utilities, Technology and Media sectors.

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This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564) and may contain general financial advice that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking advice from a financial advisor if necessary.

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