The push for platforms
Smartphone penetration into a global user base has upped the ante on the business of connecting people, writes The Finance Ghost
If a founder gets lucky, a product will turn out to be a success. If a founder gets lucky twice, there will be another successful product that complements the first one. If the universe continues to smile upon that founder, the products might even become a platform.
If you google “platform businesses”, you’ll find that Google is a good example of one. If you bing “platform businesses”, you’ll have just used a search engine with plenty of potential but limited success to show for it, despite Microsoft’s muscle being behind it. That may change in years to come.
A platform business connects one group of consumers or businesses to another. It’s as simple as that. Facebook is a perfect example, with a huge user base on one side and many companies that want to reach that user base on the other. By using Facebook’s free tools (such as posting to a news feed), companies can achieve some success. By tapping into paid tools such as targeted advertising and associated analytics, that success can be turbocharged. Of course, the algorithm is designed to make sure that success is limited without money changing hands. That seems to be where Twitter got it wrong with its monetisation.
When Facebook listed on the Nasdaq as recently as a decade ago, people didn’t understand platform businesses. Investment professionals didn’t know how to build a spreadsheet that would show explosive growth, revealing business models that didn’t exist in the company yet. The world was familiar with companies that needed a lot of time to evolve their business models. The concept of a pivot wasn’t well understood. “Freemium” wasn’t a word your local portfolio manager had ever heard before.
Fast-forward to today and the technology giants dominate the list of the world’s most valuable companies, despite the best efforts of the US Federal Reserve to crush any form of equity returns in the market. Even Berkshire Hathaway, the doyen of value investing, has Apple as its largest exposure.
With higher smartphone penetration into a global user base and a decrease in the cost of data, the business of connecting people became far more lucrative. Not only did user growth explode, but engagement went through the roof as well. We spend more time on our smartphones than ever before and that isn’t about to change, especially with the level of investment going into a trend such as artificial intelligence.
We live in a world where banks are trying to build super-apps and traditional telecommunications businesses (such as Comcast) are trying to build or acquire media empires. The concept of a platform business is loosely thrown around by executives desperate to carve out a place in the new world order. As advertising revenue on linear TV networks comes under pressure, the push into streaming continues. But
instead of doing contentbased deals, studios are trying to build their own streaming platforms at great cost.
The studios had no desire to own the world’s cinemas, yet they are willing to crush their profits by investing heavily in streaming operations. Why? The answer lies in the power of platforms and the desire to own the user experience. This is a defensive play in some cases, as companies may face existential risks if they don’t have their own distribution model in a connected world.
If the financial performance of Netflix, Disney+ and Peacock within NBCUniversal is anything to go by, streaming will be a winner-takes-all, or at least a winner-takes-most, industry. The technology is expensive to build and implement, with a seemingly simple concept such as accepting payments around the world actually creating a number of challenges. When you add the costs of content to the mix, streaming becomes particularly expensive. This is why the MultiChoice-Comcast deal makes sense, as it
The likes of MTN and Vodacom hold the keys to the most powerful distribution network of all
combines a mix of global and regional content and allows existing streaming technology to reach a far greater number of people.
The cellphone networks are taking a different approach to the platform model. Unlike the content studios, they already own the distribution network. It’s sitting right there in your hand or in your pocket: your smartphone. The likes of MTN and Vodacom hold the keys to the most powerful distribution network of all, particularly in emerging markets, where a smartphone is the only digital device for millions of consumers.
Best of all, that distribution network is profitable. In fact, it’s always been the core business, with the cellphone networks having been in exactly the right place to benefit from this global trend of smartphones. Before you get excited and invest all your money in telecoms, just take a look at long-term share prices. They might be well positioned for the platform trend, but the cost of maintaining and upgrading underlying networks has blunted the benefit for shareholders. “Capital intensity” is a core metric in these businesses, and that tells you everything you need to know about free cash flow conversion.
The best way to maximise the value of expensive infrastructure is to push more revenue through it. In regions such as Africa, a cellphone network can become a payments and value-added services business. In frontier markets, just sending money around is the biggest financial need for consumers. This is a nifty business made much easier when everyone has a smartphone app that can send and receive money. If it wasn’t so appealing, African governments wouldn’t be doing their best to tax this business model to death.
In a great example of how everything is now a platform business, we find the wonderful world of mobile virtual network operators (MVNOs). While cellphone companies are trying to generate revenue through other service offerings, we now have banks and retailers trying to make money from airtime.
In this model, the cellphone networks still provide the infrastructure that provides connectivity to clients. But instead of taking out a deal directly with one of the telecoms companies, you’re buying airtime from Capitec or data from Mr Price. Providing this service is now core to the strategy of Cell C, a business that has managed to lose money spectacularly during every iteration of the cellphone era. Perhaps this is the model that will finally work, bringing some relief to Blue Label Telecoms shareholders.
The MVNO model is opportunistic, with retailers and banks hoping to win additional revenue through convenience. When you’re logged into your banking, you may as well buy airtime (or prepaid electricity). When you’re shopping at a retailer, why not buy data at the same time?
A true platform business isn’t just an opportunistic distribution deal. A strong platform has high switching costs that create significant value. Google+ was an attempt to compete with Facebook.
You’ve possibly never heard of it, which tells you everything. It turned out to be Google Minus, as it was just too hard to convince
Facebook users to switch to another platform. When the goal of using the platform is to see what your friends are up to, switching costs become much higher as there’s no point in being the only person in your friendship circle on a different platform. This is why Facebook’s recent strategic shift is peculiar, focusing on delivering more third-party content to users. While I understand the need to compete with TikTok, seeing less from your friends and more from random other people definitely reduces switching costs and makes the platform less valuable.
When it comes to switching costs, nobody can match Apple. You are either in or out when it comes to the iOS ecosystem. If you switch to an Android device, you lose your access to the entire Apple ecosystem and all the data built up over the years. Apple enjoys client loyalty most companies can only dream of, partly because of a highly aggressive strategy of making the platform exclusive. Android-based companies are left fighting for scraps, while Apple earns the bulk of the economic profits.
The e-commerce businesses can’t be ignored here. Amazon is clearly trying to be far more than just an online shopfront, investing heavily in a value chain that includes a logistics network and content creation. Amazon wants a particular kind of user on the platform, one who values a combination of entertainment and the convenience of online shopping. For sellers and advertisers, this positions Amazon as a lucrative way to gain access to a user base of economically active, relatively high earners. It’s particularly interesting to note the progress being made in advertising revenue, a threat to Google as many product searches are now starting in Amazon rather than Google.
Amazon’s platform business is loss-making, funded by the breathtaking profitability of Amazon Web Services. Mercado Libre doesn’t have that luxury, so the Latin American giant has needed to focus on building a profitable platform with a regional focus. This makes it a far tighter business model in my view, with a management team that builds responsibly rather than too quickly.
With greater similarity to Alibaba than Amazon,
Mercado Libre seems to have nailed the model for building a platform business in emerging markets. A combination of ecommerce and financial services makes sense, as there is a transactional underpin across the ecosystem. Fintech business Mercado Pago has developed to the point where offplatform payments are significant, which means the group is earning payment commissions for purchases that don’t even touch the ecommerce business any more.
Operating in a fastgrowing region that doesn’t have anywhere near as much political interference as China, Mercado Libre may well be the perfect platform business. Amazon is up less than 20% over five years; Mercado Libre has returned nearly 220% over the same period.