Understand the Obsession with Platforms in Silicon Valley

This is the Chapter 22 of my e-book Silicon Valley for Foreigners, that can be downloaded for free on www.siliconvalleybook.com or purchased for $2.99 on the iBookStore and Kindle. A new chapter will be posted on this blog every week.

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The best products work when they are able to solve real problems, create new needs or connect with customers emotionally. Sometimes, as in the case of fast food chains and Hollywood movies, they appeal to the basic instincts that make all of us humans.

In the digital world, things are a little bit more complicated. The majority of startups have no money to invest in traditional marketing channels such as TV ads or billboards to advertise their products. Moreover, the conversion rate from offline channels to online products has always been very poor.

In the beginning, the Internet had no digital distribution channels to have been taken advantage of, so the smartest entrepreneurs decided to create their own to reach online users without spending money on customer acquisition.

Yahoo!, for instance, was the Internet version of the Yellow Pages. Amazon wanted to be the digital version of Wal-Mart, and Craigslist replaced classifieds ads on newspapers with online ads. These startups had been growing so fast that they began thinking about what they could do to keep their millions of users coming back. They were the precursors of what we call, today, digital platforms.

A digital platform is a technology enabled business model that facilities exchanges between multiple groups — for example, end users and producers — and offers enormous value to the community such as the generation of trust, revenue or knowledge. The larger a platform is the faster are its network effects. There are many examples of successful platforms.

The top tech companies learned that having a direct relationship with their customers, over the Internet, was the best way to achieve high margins, maintain loyalty, and lower their acquisitions costs. Those who control distribution tend to become monopolies, as the cases of Microsoft Windows and Internet Explorer taught us two decades ago.

Apple and Google, for instance, masterfully diverted resources from their main businesses in order to create their own operating systems and mobile stores. The idea was to allow developers to launch and monetize their applications more easily while maintaining control of the distribution channel and undercutting traditional middlemen such as retailers, movie theaters, cable TV companies, and wireless carriers.

The best part of this model is that the tech giants do not necessarily need to enter into the content business, which is high risk and require lots of capital. The platform holders take a 30 percent cut, so the more successful developers are, the more money Google and Apple make. The iOS App Store generated, alone, $28 billion in 2016, in which more than $20 billion went to app developers, fomenting a powerful ecosystem.

Owning the operating system and the distribution platforms, as Apple and Google do, is the ultimate goal for any startup. These are considered to be tier one platforms, which are a hundred percent controlled by the companies that created them.

But there are other ways to be extremely successful on the Internet. Facebook, as we know, created a powerful platform based on people. More than 2 billion people come back to Facebook properties every day. They can watch videos, read news, play games, participate in discussions, buy stuff or chat with their friends. Facebook adds new services constantly to keep customers engaged on its platform so it can monetize them using ads.

Interestingly enough, Facebook is a tier two platform. On the web, where there is no owner, they can control their destiny. But on iOS and Android, which generate 85 percent of their revenues, Facebook relies entirely on the platforms maintained by Apple and Google. If either company decides, one day, to shut down the Facebook app from their stores, they can bankrupt the company instantly. This is not likely to happen, but it can happen.

There is an enormous variety of tier two platforms built on top of tier one platforms. Uber connects drivers with riders; Airbnb, guests with hosts; Quora, experts with laymen; Fiverr, service providers with customers; Netflix, content makers with viewers. Each of these platforms relies on a different business model, but they add enormous value to both sides of their marketplaces.

Then, there are the tier three platforms such as the stores inside instant messaging apps such as Viber, Line, WeChat or Kakao, where these guys can sell and promote other apps. In the end, an app sold through their stores would have to pay a cut for two layers of middlemen, but mobile got so big that there is money for everyone. While the majority of the ecosystem still focuses on mobile, startups and large tech companies in Silicon Valley began looking for the next big tier one platform.

That is why, after the success of PCs, the Internet and smartphones, there is so much investment right now in virtual reality, augmented reality, and autonomous cars. Each of them, on their own, could one day supplant or complement the current one tier one platforms, creating other huge platforms from scratch.

The fact is that Silicon Valley went surprisingly full circle as it was able to dominate digital distribution (iOS, Android, Facebook, WordPress, Google, Chrome, Gmail, GitHub) and online revenue models while fomenting the creation of enormous foreign companies using its platforms such as Didi Chuxing, Supercell, Spotify, Line, and Tencent.

The lesson I have learned from Silicon Valley is that, the majority of value in a digital business relies on the distribution platforms, which are scalable, have a repeatable business model, and may last for decades. If you are a tech startup, you should strive to become a platform and not a content player.