From Standard Oil to Google
Over time, business success patterns have changed. The engine of industrial era giants such as Carnegie Steel, Standard Oil and General Electric was supply-side economies of scale. These companies achieved market power by controlling high fixed cost resources, by ruthlessly increasing efficiency and by extending their customer bases with competitive prices. Ever since the industrial revolution, a central strategy has been to build a moat around the business that protects it from competition. At the end of the last century, highly successful companies like Coca-Cola, Procter & Gamble and Nike still functioned with this pipeline model of business, controlling a linear series of activities mostly within their own companies – the classic value chain. By investing heavily in mass communication and brand building, however, they stimulated demand and focused more on the power of consumers. Since the beginning of the 21st century, fueled by information technology and the internet, the demand side has become even more important and has, in fact, turned the basic business principles of resource-based pipeline thinking upside down. The new giants, Google, Facebook, Apple, Amazon and the like, function differently.
Online platforms and the network effect
The driving force behind our internet economy is now demand-side economies of scale, also known as network effects. These arise when users create value for other users. They are enhanced by technologies that create efficiencies in social networking, by demand aggregation, by app development and by other network-expanding activities. In the internet economy those companies that achieve higher volume than competitors by attracting more platform participants are able to offer a higher average value per transaction: The larger the network, the better the matches between supply and demand and the richer the data that can be used to find matches. As users create value for users, value spirals upward, attracting further users. Network effects gave us Alibaba, which accounts for over 75 % of Chinese e-commerce transactions; Google, which accounts for 82 % of mobile operating systems and 94 % of mobile search; and Facebook, the world’s dominant social platform. Platform business has turned the traditional logic of success inside out and has established new rules for success. The reason is simple: Network effects cannot scale inside a company as easily as they do outside. This means that value-creating activities that used to take place inside must now also take place outside companies.