Three-Dimensional Strategy: Winning the Multisided Platform
Done right, companies competing as a multi-sided platform often win with higher percentage profit margins than those enjoyed by traditional resellers. The problem is that a winning strategy is far from self-evident. Professor Andrei Hagiu explains the potential and the pitfalls for life as an MSP.
When start-up thredUP launched its peer-to-peer online exchange for used children's clothes two and a half years ago, its creators were the latest generation of entrepreneurs competing online as multi-sided platforms (MSPs), alongside trailblazers such as eBay, Yelp, and eHarmony.
MSPs create value by facilitating direct connections between multiple types of affiliated customers, which most often leads to network effects. Think of what a shopping mall accomplishes in bringing together a multitude of sellers and buyers who interact directly with each other under one roof rather than through a third party. By contrast, a grocery store also creates a space for consumers and multiple brands to meet—but the store controls the transaction, serving as a reseller.
Done right, the MSP model has proven extremely lucrative, throwing off much higher percentage profit margins than those enjoyed by traditional resellers. Also, MSPs can be less capital intensive for start-ups. No wonder, then, that an increasing number of entrepreneurial ventures such as thredUP have been attracted to the MSP model.
But in 2012 thredUP's management changed course—it abandoned its multi-sided platform strategy to become an online reseller of used children's clothes, buying inventory from parents and reselling it to other parents.
"The problem with the MSP model is that it is sometimes too slow and not sufficiently convenient for either side," says MSP expert Andrei Hagiu, an associate professor at Harvard Business School whose former students James Reinhart and Chris Homer (both MBA 2009) cofounded the company. "Buyers valued the convenience of quicker service and more consistent quality, so thredUP pivoted to a reseller model. From the customer's perspective there's less hassle that way; with an MSP, you have to interact with both the thredUP website and its sellers."
Clearing the air
A general misunderstanding of how MSPs work has hampered entrepreneurial attempts to create them and venture investments to bankroll them, says Hagiu.
In the working paper Multi-Sided Platforms, Hagiu and Julian Wright, an economics professor at the National University of Singapore, set out to clearly define MSPs, contrast them with traditional resellers and input suppliers, and address the strategic consideration of where firms "choose to position themselves on the continuum between MSPs and resellers, or MSPs and input suppliers."
Hagiu and Wright bring clarity to an often cloudy term by defining an MSP as an organization that creates value by enabling direct interactions between at least two distinct types of affiliated customers.
Direct interactions could be commercial (e.g., transactions or contractual relationships) or noncommercial (e.g., communication on a dating website). Affiliation requires platform-specific investments of time or money or both. For example, a supermarket would not qualify because it is a reseller: there is typically no direct interaction between the store's suppliers and its customers. The electronic ink technology produced by the company E Ink is an essential component of electronic readers such as Amazon's Kindle and Barnes & Noble's NOOK. But it is an input supplier to the manufacturers of such readers, not a true MSP, because consumers and publishers have no direct affiliation with E Ink.
By contrast, Hagiu and Wright present examples that fulfill all of the MSP requirements. In the case of eBay, both buyers and sellers must create accounts with the online marketplace; that affiliation then enables direct interactions between those sellers and online shoppers, fulfilling Hagiu and Wright's definition.
Amazon's e-commerce website encompasses multiple models, which place it somewhere along the MSP-reseller continuum. Amazon.com is a pure MSP when it offers products that are sold by third-party sellers (these are typically lower-demand, long-tail products); it is a reseller for items that it sells under its own name and guarantee (these are more likely to be popular products). And Amazon also functions as an input supplier when it offers web hosting and data-processing services to entities such as Netflix.
Hagiu and Wright note that there are interesting strategy implications for entrepreneurs when deciding where to place their business on the continuum that runs from pure reseller to pure MSP. These trade-offs were evident for thredUP, which shifted from more of an MSP model to one that brings buyers and sellers together in more of a classical reseller model.
"Having started as an MSP, the challenge [for thredUP] is that you have to go back to investors to explain that you're going to pivot to a much higher-cost model," Hagiu says, "since being a reseller involves building a warehouse, taking inventory, and sorting all these clothes." But with those additional inventory risks and associated expenses come greater control and higher absolute dollar margins.
Growth is much easier and more capital efficient, however, under the MSP model.
"eBay can open up a new product category as long as it has buyers and sellers to populate it," Hagiu notes. "On the other hand, if you operate as a reseller, you don't have the chicken-and-egg problem of populating a site with buyers and sellers. You just obtain the product and resell it."
Sometimes a company will adopt different models for different parts of its business. Apple functions as a reseller in its iTunes store; as a result, it can price music at a level that is attractive to consumers ($.99 or $1.29), thereby boosting sales of iPods.
"If Apple functioned as an MSP in this case, and allowed the music companies to charge different, most likely higher prices, it would not have benefited nearly as much," Hagiu says. "When Apple came in with its iPod, it was the only option. The music companies didn't anticipate that iTunes would become a dominant platform. They were in a weaker position, so they agreed to this Faustian deal in which they allowed a reseller to completely control prices, and the prices were quite low."
On the flip side, Apple manages its iPhone App Store as an MSP, creating a space where application developers can market and sell a wide range of applications for which Apple makes few guarantees and takes a cut of the transaction. "It functions that way for the same reason that eBay doesn't buy all of the products offered on its website," says Hagiu. "There's just too much stuff and too much risk. It can grow much faster and serve a wider range of tastes with an MSP model."
Pros and cons
Deciding how to position one's organization on the MSP-reseller continuum is an important strategic decision for many intermediaries. What drives that decision? In their paper, Hagiu and Wright identify four key economic trade-offs between operating as a reseller and an MSP:
- Resellers enjoy economies of scale for high-demand products; however, an MSP model is more cost-effective if a business is built on sales of low-demand items.
- Resellers have a greater ability to aggregate their bargaining power, bundle, and otherwise benefit from complementary products and product substitutions that independent sellers would miss out on.
- Resellers can offer significant added value (and benefit from reputation effects) by verifying the quality of goods when that quality is difficult to confirm. But that position can be prohibitively risky and costly if large numbers of unverifiable products are on offer, in which case the MSP model becomes more attractive.
- When a product doesn't work out, the buck all too often stops with the reseller, not the supplier; an MSP is immune to this risk.
Different issues come into play in the decision to be either an input supplier or an MSP. Many firms, such as chipmaker Intel, have vied to become MSPs instead of input suppliers because they want to enjoy the economic value and power created by the indirect network effects typically (though not always) associated with MSPs.
Hagiu and Wright note, however, that achieving MSP status doesn't necessarily ensure greater profitability; sometimes, the cost of being affiliated with end users exceeds the benefit.
With more clarity brought to what makes MSPs special, Hagiu and Wright expect future research to further refine the modeling of strategy decisions around the MSP versus reseller and the MSP versus input supplier positioning.
"The status of MSP has been claimed right and left," Hagiu says. "I hope our work will bring more clarity to the discussion, and contribute to a better understanding of strategy and investment implications."