Deep Dive: Platforms, networks, and the future of distribution
Can these modern-day disruptors displace the value chain, or do all three have more in common than we think?
Network-based platforms are disrupting, displacing, unraveling, and augmenting the traditional value chain. For established B2B companies, platforms may be friend or foe, but they are always different. Networks are the most important characteristic of platforms, and networks operate very differently than linear value chains. If platforms are an enemy, traditional distribution professionals cannot allow them an uncontested space from which to battle for customers. If platforms are partners, B2B companies need to understand how they work as a foundation for designing equitable partnerships. If platforms turn out to be a fad—a waypoint on the way to something else—B2B innovators may jump ahead to whatever is next. In all cases, it is critical for leaders and innovators to closely examine how networks work—but not just through the terminology, methods, and science that platform professionals and technologists use. We must understand networks and platforms relative to value chains and look for ideas, competitive advantages, and opportunities from the customer's perspective. Working off The Network Effects Bible—a free e-book from the venture firm NFX—I do just that. I started my analysis in this previous Deep Dive edition. I continue in this edition and in several more to come. There is a lot of ground to cover, and I welcome your feedback, insights, experiences, and direction.
Why network effects are important
The italicized text below is verbatim content from the NFX e-book. I’ve lifted what seems to me to be the most important information, working from start to finish, in some cases skipping words or paragraphs to be clear and concise. My observations follow. I encourage you to read the e-book and challenge me if my approach or comments are wrong or incomplete.
Network effects are mechanisms in a product and business where every new user makes the product/service/experience more valuable to every other user.
Does every new customer acquired by a distributor or manufacturer in a traditional value chain make the product, service, or customer experience more valuable to every other user? I don’t think so. On platforms, scale leads to better experiences familiarly—more prominent companies have more capital to invest. Scale works almost the same way in value chains, except platforms can often achieve unbelievable scale unavailable to manufacturers and distributors. Consider Amazon’s warehouse. Can any company match Amazon’s use of automation, robots, artificial intelligence, and more? Very few can, if any. If Amazon is a competitor fighting your business for your customers, you are competing at a massive disadvantage in terms of warehouse operations and probably other go-to-market capabilities as well.
But there is more to networks. Much more. As I explained here, networks allow individuals or organizations to help other users or organizations. As a platform, Airbnb connects people with rooms and homes to people that need them. Every time a new guest uses Airbnb, Airbnb becomes more valuable because Airbnb attracts more hosts, all delivering lodgings according to Airbnb’s standards and methods. A platform is infinitely scalable, and as it attracts more and more users, it becomes unmatchable and dominates. Among platforms, this is referred to as “winner takes all.”
A distributor does not operate as a platform. Distributors buy products, store them, and resell them. A customer essentially receives the same, nearly undifferentiated service from all distributors and does not benefit when new customers purchase from the distributor. More prominent distributors may invest in technologies that improve efficiencies, but the same product is available from smaller distributors as well. Distributors have been growing for decades in many lines of trade, but to my knowledge, no distributor has captured an entire line of trade. A distributor does not create a product, service, or experience that gets better and better by adding customer after customer after customer.
Network effects are important because they are the best form of defensibility, and thus value creation, in the digital world (the three other major defensibilities are brand, embedding, and scale).
Networks are how platforms compete with one another. The experience offered on one network is better than another, attracting more users, eventually hitting a critical mass, sucking up all available oxygen (meaning all users), and making it impossible for other networks with similar products, services, and experiences to compete.
But it’s not just the size of the network that matters—it’s how the network operates and is optimized. Looking ahead, the e-book covers these variables, but I will cover them in later editions, not this one. I’m working through the e-book one section at a time. If you read ahead and want to chat, please reach out.
I think it is interesting that the e-book’s authors refer to a platform’s networks, brand, and embedding as a “form of defensibility.” This seems to assume that a platform shares a successful future if only it can defend against other platforms. In the value chain, manufacturers and distributors think of customer loyalty, brand, product selection, service portfolios, and scale as capabilities and competencies used to go on offense, converting new customers, entering new markets, earning higher margins, and so on. I’m not sure if this is a meaningful distinction, but it is one that I will explore as I continue working through the e-book.
Network effects account for the majority of value created in the technology industry in the past few decades since many winner-take-all companies in tech were powered by network effects.
I accept this statement because I am not an expert in platform design, operation, or competition. If a network is defined as connecting users or organizations with other users or organizations and enabling them to help each other, then that dynamic does not exist in value chains. So, what is the characteristic or execution of the value chain that accounts for the majority of the value it creates? I have not seen a study, but the answer seems obvious. The value created by a value chain lies in that which is created by products when users use them and by the value added by distribution in the form of education, delivery, installation, advice, maintenance, repairs, and so on. Networks might arrange for these services between users on the network, but the network may not provide them. The only true overlap seems that both a network and a value chain have a core competency around processing transactions.
Therein lies a critical distinction. Platforms are almost entirely about connecting customers with solution providers, and in platform terminology, both are referred to as “users.” Users may be individuals or organizations. In channel terminology, the value offered by platforms is mainly associated with presale and transaction activities, which are about helping a customer find and understand solutions, procure products or services, and receive them. These are only a part of what a B2B value chain does. And so it seems to me that there is a critical question to be answered: Does a platform itself offer enough value to wrest business customers away from the value chain? Does the help offered between users on a platform match that provided by the value chain? Is it up to standard? And perhaps most importantly, does the platform offer business customers the same leverage and control they exert in the value chain—or more, or less?
Where I stand so far
I’ll stop here in my exploration of NFX’s invaluable e-book. When I pick up my analysis of networks again, I’ll dig into how networks work, covering topics including nodes and links, density, and directionality. These terms seem roughly analogous to channel flows, distribution policy, coverage, and conflict from my channel design perspective. We’ll see—lots of work ahead.
In the meantime, I find that the idea that “every new user makes the product/service/experience more valuable to every other user” on a network needs a deeper dive. I suspect that there is truth in this assertion, a truth that I do not yet understand. In my experience, creating value requires expertise and incurs costs. If users create value for other users, does that mean they are incurring costs? If so, is the platform pushing costs on users? I suppose it depends on the exact value that a platform is enabling between users.
In channel design, cost transfer is an essential concept. There are specific activities that are immutable, meaning that customers will not buy a product or pay for a service unless very specific actions are performed for the user. These activities create value over and above the product or service's value. If the activities are not performed for the user, the user will take their purchase elsewhere and decline to purchase. Cost transfer theory is about who performs the immutable channel activities. For example, immutable activities might include explaining features and benefits, justifying a purchase, taking orders, delivery, installation, setup, and so on.
In B2B channels, the customers are businesses. Businesses exert power in making purchases, and there is no smoke and mirrors in executing the immutable channel activities. They must be performed and done to the customer’s exacting expectations. All this is about doing business, and none of it has changed because customers can now source from platforms.
Manufacturers lead the discussion because they make the product and select channels, direct and indirect, to take their products to market. If a manufacturer chooses to authorize a distributor, some of the immutable channel activities are transferred to the distributor and codified in distributor authorizations, program requirements, channel compensation, and more. These are the control systems that allow a value chain to function. I am looking for the control systems that make a platform work, enabled by its network, and how the immutable customer activities are performed and by whom.
Join our community by asking questions
I am just getting started on all of this. As I begin, I have three questions for you:
Is my analysis tracking? That is, am I asking the right questions and seeking valuable answers?
Can you point to others that have done the work I have undertaken? I can’t find it, but if you know of thought leaders, books, podcasts, or studies that analyze platforms, offering practical answers for B2B leaders and innovators, please share them with me.
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