Disruption by “Platformization”

Disruption can also take a more subtle, but not less transformative form. Most often, traditional players become “platformed” as their markets are “platformized.” This is the process that transforms a traditional market in which supply directly meets demand into a multi-sided market, in which traditional players are “intermediated” by a digital platform. The traditional player is not substituted by the platform; it is not expelled from the market, but its status in the market is modified. The platform takes over the leadership and extracts a largest portion of the value out from the market. This is a process that evolves over different phases. These phases might take different forms, as not all platforms evolve in the same way and do not display exactly the same features, but they are common in the most mature platforms.

In the first phase, the platform starts intermediating the goods or services provided by a traditional player. The platform has no intention to substitute the traditional player in the provision of the service. Such a provision would require a substantial investment that the platform does not intend to make.

The intermediation can be the result of an agreement between the platform and the traditional player, but also a situation that the traditional player tolerates. Traditional players often perceive the platform as a new distributor that might bring them new business. This is what happened with newspapers as they started to receive traffic from Google and other platforms: such traffic increased their advertising revenue. The situation is similar with many small and medium enterprises, such as local craft shops, which, thanks to the platform, obtain access to a much larger market.

Platforms can also play the role of interloper, however, running between supply by traditional players and demand by customers, intercepting the business of the traditional player. Just like seventeenth-century traders interfering in the monopoly of the East India Company, platforms interfered in the distribution of traditional goods and services. This was certainly what happened when Napster breached music copyrights, and when Google reproduced snippets. To the surprise of no one, the motto “move fast and break things”14 was coined in Silicon Valley. The chicken-and-egg challenge requires the construction of a large pool of supply and demand, if necessary by ignoring the refusal to participate in the platform.

In the second phase, the platform aggregates the goods and services provided by a large number of competitors. Intermediating a large number of traditional players is necessary to build the large pool of supply that is required (together with a large pool of demand), so as to create relevant direct network effects. Furthermore, platforms can aggregate different products and services to create more powerful indirect network effects.

The aggregation of supply in highly fragmented markets can become a competitive advantage in itself. Amazon was popular originally because it displayed a larger catalogue of books than even the largest bookstores.15 Napster was popular not only because it was free, but also because it provided easy access to basically any recorded song; something that was just unimaginable by any other means at the beginning of the twenty-first century.

Furthermore, algorithms might identify new complementarities between traditional goods and services, which can amount to the creation of a new service. This was the case of Google News. Algorithms not only aggregated news from different newspapers, but these newspapers were automatically selected by Google’s algorithms in order to provide a personalized newspaper with only the news that is of interest for each reader. Such a proposition would be in a good position to compete with a traditional newspaper.

In the third phase, platforms displace traditional players in their relationship with the customer. The value proposition of the platforms becomes so powerful that customers prefer the direct contact with the intermediary, rather than consuming the good or service from the traditional players. This does not mean that platforms produce the good or the service. They will always only be intermediating the good and service of the traditional player.

Over time, platforms such as Google and Facebook became so efficient at making the best personalized selection of news that readers trusted platforms to feed them the daily news. The news are drafted by the traditional newspaper, and platforms merely route the reader to the specific newspaper, but readers rely on the selection made by the platform rather than on the aggregation of news made by the editor of the newspaper. This is already a reality in many markets: only a minority of readers directly access the digital edition of a newspaper to browse through the news compiled by the editor.

Such intermediation could work so smoothly that consumers might not even realize that the platform is only intermediating the service and not providing it. This was the case of Napster. Most users thought they were downloading the songs from the platform, when they were actually downloading them from a peer’s computer. Similarly, with Uber, consumers often think the platform is providing the service, when it is actually being provided by a large pool of independent drivers.

In the fourth phase, the good or service produced by the traditional player becomes a mere commodity, as customers do not differentiate between one underlying provider and another. As a result, the traditional service providers are no longer in a position to impose the economic terms for the provision of their services. Eventually, platforms evolve into a position to extract the largest portion of the value from the market.

When consumers contract directly in the platform, which they find more efficient, they might not even be aware that the platform is not the provider of the service but only an intermediary; traditional players are then no longer in a position to differentiate their service. In fact, platforms often implement an active policy to standardize supply. Standardization facilitates transactions, as consumers expect a standard quality in the service in the platform. However, standardization also makes the service undistinguishable among the different provider; Amazon is a good case in point here.

When platforms intermediate, standardized undistinguishable services provided by different providers, they can impose pressure on traditional service providers to reduce prices (or extract larger commission). Traditional players are no longer in a position to sustain prices based on higher quality or on the customer’s perception that they are the best provider. The algorithm will privilege the service providers with a lower price, forcing a price war between the service providers.

The ultimate outcome of this situation is that the platform sets the price for the customer. Platforms have an incentive to reduce prices as a way of growing a larger pool of consumers. Prices might be temporarily below cost, but the platform takes the difference as an investment to grow the platform. Prices might actually be reduced as a result of cost reductions due to network effects. However, if the platform grows, particularly if it tips into a dominant position, pricing pressure on the services provided by traditional player can be maintained, prices for customers can be increased, and the platform can be in the position to extract most of the value from the market.

In the fifth and final phase, the platform reaches the position at which it can dictate the conditions for the provision of the services it intermediates: from exclusivity, to arbitrary and discriminatory conditions, to taking full control as coordinator of the market.

Network effects foster concentration, as a large scale is necessary to exploit direct, indirect, and algorithmic network effects. As a result, oligopoly is the most common market structure in platformed markets. Network effects might even lead to a platform reaching a tipping point and building a dominant position. This is the case of Google in search, Facebook in social networks and Amazon in marketplaces. Once a platform assumes a dominant position, it can impose conditions on the underlying service providers.

For instance, some platforms try to impose exclusivity on service providers so that they will not be able to use other platforms (multi-homing), thus creating an obstacle to competition between platforms. In the most extreme cases, platforms even try to obstruct the direct provision of services by traditional players outside the platform. See the case of payments in the Apple store in Chapter 9.

The platform dictates the terms and conditions for the use of the platform. As platforms achieve market power, the conditions become more inflexible and interpretation of the terms and conditions become more arbitrary, sometimes discriminatory. Changes in the algorithm are implemented without notice or transparency, making traditional players lose business against competitors. Traditional players can be excluded from the platform from one day to the next without a clear explanation. Complaints against the largest platforms for this kind of practices are increasingly common.

The ultimate outcome of this evolution is when the platform determines the market. The algorithms no longer select the more competitive supplier to be matched with the consumer. Rather, the algorithm simply defines the kind of service that will be provided to the consumer. Algorithms are not neutral, just as platforms are often not neutral either. They drive the ecosystem around them and are in a position to promote one type of underlying service against the other. For instance, they can promote professional content against usergenerated content if they think it will be more attractive for advertisers.

It has been identified that digital platforms sometimes vertically integrate: they no longer provide the intermediation service, but start competing with the traditional players in the provision of the product. Traditional players often complain that, under these circumstances, platforms self-preference their own service against those provided by third parties.

While the ambition of the digital platform might not be to substitute traditional players in a market, it might have the opportunity to provide some specific products in competition with the traditional service providers. We have already provided some examples: Amazon Marketplace intermediates goods sold by third-party retailers and producers, but at the same time Amazon sells a range of Amazon-produced goods. Apple has its own apps in competition with apps intermediated by Apple in the app store. Google has launched services such as Google Shopping and Google Travel that compete with price comparison and online travel agency services that are intermediated by the search service.

Digital platforms have incentives to discriminate in favor of their own services when providing the intermediation service. In fact, third parties have increasingly complained about self-preferencing and discrimination. These are practices that are considered illegal; that is, an abuse when implemented by platforms in a dominant position and if there is no objective justification. Amazon, Apple, and Google have open cases before antitrust authorities for such practices and Google was already fined for self-preferencing by the European Commission in 2017 in the Google Search (Shopping) case.

Self-preferencing is facilitated by the deep pool of data and sophisticated algorithms that platforms have regarding transactions in the markets they intermediate. As intermediaries, they have full information about all of the transactions taking place in their market - what has been termed as “God’s view.” They can process all the data they gather to identify trends in the market, popular products and effective marketing strategies, and can replicate them. They can also react to the pricing policies of the competitors thanks to the information they have about these pricing policies.

As a market is platformized and evolves into a multi-sided market coordinated by a digital platform, traditional players are not substituted; they are always relevant as the platform needs providers of the intermediated service. Nonetheless, traditional players lose their central position in the market, their ability to independently operate in the market, and their market power. They are platformed.

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