Many investment decks I receive every day are from startups that aims to create multi-sided platforms. This kind of venture is especially difficult because the founders have to struggle with the well-known chicken and egg problem typical of these platforms. Entrepreneurs need what is called critical mass: a sufficient number of customers on both sides, and in the right proportions, in order to guarantee satisfactory value for both clusters of users and to achieve sustainable growth of the platform. If the critical mass is not reached in acceptable time the platform will implode.
So the main question when starting a multi-sided platform is how and when to gather the various groups of users that the platform aims to bring together. When I collaborated with Prof. Cellini of LUISS University in the writing of the book Internet Economics, we analyzed the multi-sided platforms as a distinctive case of internet economy and some useful insights for startups can be extrapolated.
First of all we can distinguish three cases of users entry in multi-sided platform:
#1 Sequential entry – in some cases it is possible to get one group of customers on board over time and then make this group available to the other group of customers at a later stage. This is the situation with multi-sided platforms in an advertising environment. Content can be used to attract viewers and advertisers can be brought on board later. This dynamic works because there are non-positive indirect network effects between the two sides: viewers do not care about advertisers (and may dislike advertising) but come to platform for the content.
#2 Entry with significant pre-commitment investment – in other cases, one group of customers needs to make investments over time to participate in the platform. This is the case with software-based platforms such as operating systems. Developers of games and applications have to invest in the creation of software for the next release of an operating system without knowing how many consumers will be interested in using the platform when it is available. The platform must either convince developers that buyers will show up, provide them with some financial guarantees that buyers will show up, or self-produce games until the platform has proven itself.
#3 Simultaneous entry – finally, there are cases in which groups of customers make the decision to join the platform at the same time and have to join at the same time for the platform to provide them with value. Some platforms require almost perfect simultaneity. Heterosexual men would quickly leave a new dating platform that had no women, and vice versa. Similarly, women would not register with an online dating platform if no men had yet signed up, and vice versa. Other platforms can provide more latitude. Buyers may not desert an exchange platform right away if there are no sellers but they will arrive soon.
In all cases, however, platform growth is not sustainable until the platform reaches critical mass. Therefore the key challenge for new platforms is figuring out ways to reach critical mass quickly. We shall now illustrate the main strategies for achieving critical mass:
#1 Zig-zag – a basic strategy for reaching critical mass is to build participation on the two sides incrementally. The platform starts with a small number of economic agents on both sides. It then persuades agents on either side to join. It also relies on the natural processes of product diffusion. Because of indirect network effects, the platform is more valuable to each successive group of prospective customers. eBillMe provides an example of this strategy. Consumers who click on the eBillMe sign at the checkout for an e-tailer can pay with their online banking account. They then receive an email containing the payment details and after entering this information in their online banking account they receive a receipt and the product is shipped. This payment alternative is attractive to people who are concerned about the security of paying with cards online. To get started, eBillMe persuaded ToolKing to offer eBillMe as one of the methods of payment on the site. A small percentage of customers used this payment alternative. eBillMe then went to other online retailers. Each led to eBillMe having more people who were accustomed to using its service. For each subsequent merchant it went to it offered an increasingly valuable offer since it had more users who were predisposed to use this payment alternative. At the same time it let its users know that they could pay at more places thereby increasing the value to the merchants. eBillMe grew from 1 merchant and hundreds of users during its first year of entry in 2005 to hundreds of online stores, with 2% to 10% of their transaction volume intermediated by this payment system in 2008.
#2 Pre-commitment to both sides – some platforms such as eBillMe are able to start with one member on one side that it uses to attract members on the other side. More commonly, platforms need to have multiple members on both sides to begin the zig-zag process described above. They therefore need to persuade a minimum number of early adopters on both sides to show up at the start of the platform to make it credible. This requires getting both sides to believe that when the platform opens for business there will be members of the other side present. Operating systems are a good example of this strategy. These are platforms that connect application developers with users. The user will not purchase the hardware and operating system without enough applications and games, and developers will not invest their time if they are not sure that people will buy their applications. This is because the creation of an application is a long process, and the platform has to ensure that there are enough applications and games at launch.
#3 Single and double-marquee strategies – a single-sided marquee strategy is aimed at acquiring an influential or prestigious member on one side. Announcement of this may attract enough members of the other side at the beginning. The shopping mall strategy is the classic: the mall gets an anchor tenant which many shoppers want to connect to.
#4 The two steps – the two-step strategy involves getting enough members of one side on board first and then getting members of the other side on board. As mentioned earlier this works when the first side does not value access to the second side which is often the case for advertising-supported media. Search engines have followed this strategy. They attracted users who did searches of the world-wide-web. The search results were displayed on a series of pages. Once they obtained enough page views they sold access to those pages to advertisers. Google, for example, operated its search engine for 23 months before it opened its search results pages to advertisers. At that time it had more than a billion pages indexed and 18 million user queries per day.
#5 Ziz-zag with self-supply – founders may be able to jump start their platforms by providing one of the sides themselves, at least initially. Consider YouTube, which is a three-sided platform: user-generated content attracts viewers, viewers attract content providers who want an audience, and access to the viewers can then be sold to advertisers. YouTube started by focusing on users and viewers. Its founders seeded the site with content they generated themselves and started the process of diffusion by suggesting that members of their personal social networks check out the content. They also used various marketing strategies to attract viewers: they posted an ad on craigslist to reward attractive women who posted on the site and promised to give an iPod to a random user every day till the end of the year.
From a mathematical perspective, critical mass would have to be reached instantaneously to ignite the creation of value. In practice it appears that platforms have a limited period of time to get to critical mass. Early adopters are the first to use a platform. If they come back and if later adopters also find value then it is possible to reach critical mass. If the platform does not grow quickly enough to reach critical mass, early adopters lose interest, fewer later adopters come and word-of-mouth referrals stop or turn negative, leading to the eventual implosion of the platform.
This post was originally published on cirospedaliere.it