Entrepreneur lesson #9: Two-sided markets are uphill battles until you win

Many of the founders I work with are interested in finding a way to become a platform company. Having customers and complementors engage with each other and taking a cut of each transaction is an incredibly attractive concept that anyone in their right mind would love to realize. It feels like a money-printing machine that just keeps going without you having to do anything.

Although the reality of running a platform company often isn’t as rosy as it may seem from the outside, it simply is true that owning a successful platform is one of the most effective moats you can have around your business. Once you’ve achieved critical mass and passed the “ignition point” where the flywheel of the ecosystem based on the platform is self-sustaining, it’s a great place to be for any enterprise.

The big elephant in the room is of course that it’s incredibly hard to build a two-sided market around a platform. Taking as an example a simple two-sided market of providers and consumers, the initial problem is that no consumer has any interest in being on your platform as you have nothing to offer. And similarly, no provider has any interest either as there are no customers to sell to.

One of the ways to establish the platform ecosystem is to buy providers and consumers. This is a matter of offering incentives to both sides to engage in the platform even if the volumes are very low. Typically, it means paying providers to create solutions that can be sold on the platform and consumers to get these solutions for free or at a very low cost. Providing these incentives can create a pull to the platform and, over time, you can reach the ignition point where the market becomes self-sustaining.

Of course, this is a very expensive and time-consuming approach that’s far from 100 percent successful. However, in some markets, there’s simply no alternative. For instance, imagine that you would want to introduce a new mobile operating system to the market to compete with iOS and Android. Here you would need device manufacturers and app developers to come on board to provide somewhat of a comparable user experience and there’s no way for consumers to even buy a phone with the new OS until there are devices that run it and apps to be installed. It can happen, but it’s an uphill battle that requires deep pockets and lots of time.

The better approach is to choose one stakeholder in the business ecosystem, typically the customers, and provide enough value for them through the platform itself. In this case, the process becomes a normal customer adoption process, which is much easier and cheaper to pursue. Once you have a sufficiently large customer base, you can decide to open up to third parties to provide complements to the platform that might be relevant to some segments of the customer base.

A challenge is that once companies are successfully building a customer base through their platform, it’s in their culture that they don’t want to leave certain functionality to complementors but rather want to own it themselves. Most businesses achieve this by creating a customer segmentation and agreeing to leave functionality relevant only to one customer segment to complementors.

Another challenge is that the boundary between the platform and the functionality provided by complementors needs to shift constantly. What starts of as relevant for only one customer segment may become more broadly adopted and the platform may need to start to incorporate that functionality. This, of course, hurts the business of the complementor, but not doing so is a sure recipe for causing the platform to commoditize and become obsolete. Riding the edge between keeping the platform relevant and the complementors in business is a difficult challenge that can easily become the point where your platform strategy fails.

Although everyone wants to run a platform business, getting there is incredibly difficult. In my experience, the best strategy is to first build a viable business with one stakeholder group and only after you’ve established some modicum of success, start to open up to other groups to platformize the business. The challenge with this strategy is that you’ll have to build a product culture in your company for the first phase and then need to replace that with a platform culture once you get big enough. But culture doesn’t really exist; incentives are what matters. So, changing incentives can go a long way to achieving your desired outcomes.

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