Uber Mathematics 5

Continuing a series of posts on Uber's business model.  Much of this material also applies to Lyft and other similar operations. For previous posts, see https://rvsoapbox.blogspot.com/search/label/Uber

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Another thing about Uber is that it operates as a two-sided platform, matching passengers with drivers. Two-sided platforms can only operate successfully if there is sufficient demand on both sides - people looking for rides, drivers looking for work.

As I noted in an earlier post, Uber might initially have been able to recruit more drivers than it needed, in order to provide a high quality of service to its customers. Many people may have signed up as drivers based on unrealistic estimates of the likely earnings, costs and overheads, but obviously this is not sustainable for long.

So if Uber's pricing model can't pay the drivers enough to make the job worth doing, who would be surprised that Uber is now facing a shortage of drivers? While Uber customers experience increasing prices and worsening service levels.

So after years of what they regarded as unfair competition, traditional taxi services are now returning to popularity in large cities such as London (black) and New York (yellow).

But this has also resulted in an excess of demand over supply. In recent years, traditional cab driving has been hit by a triple whammy - competition from Uber et al, environmental regulations forcing older polluting vehicles off the road, and of course the COVID pandemic forcing many potential passengers to stay at home. So there is now a shortage of drivers and vehicles across the industry.

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Will Dunn, Why is there an Uber shortage? (New Statesman, 8 November 2021)

Caroline Tanner, Why yellow cabs are (again) your best bet in New York City (MSN, November 2021)

James Tapper, Black cabs roar back into favour as app firms put up their prices (Guardian, 30 October 2021)

On the Nature of Platforms

There are several ways of thinking about platforms.

Economists tend to view platforms as essentially containers for transactions. Canonical examples: Amazon, Airbnb, iTunes, Netflix, Uber.

One of the economic advantages of these transaction platforms is that they also act as container for content. When it launched in 1995, the Amazon website boasted a million books - far more than you could find in any bookshop. (This is related to the concept of the Long Tail.) So it becomes a place you can browse books and check reviews, independently of any intention to buy.

Transaction platforms may also enable a significant reduction in transaction costs. This creates an opening for micro-transactions of various kinds - in other words transactions that would previously have been too small to be economically viable. Smaller-grained transactions can allow previously under-utilized assets to be used more economically - for example selling an empty passenger seat on a car journey.

Transaction platforms may also act as a container for data and/or metadata. Dave Chaffey describes "Customers Who Bought X ... Also Bought Y" as Amazon's signature feature. (Amazon.com case study, 30 June 2014)

This notion of platform can be extended to containers of other modes of activity or collaboration or exchange, where there may be no direct financial transaction. Canonical examples: Facebook, PlayStation Network, Linked-In, Skype.

There are various business models underlying these activity platforms, including freemium (Linked-In, Skype), post-sale delivery and engagement (PSN), and advertising. As many people have observed, Facebook inherits a principle that was originally formulated for commercial television - if you are not paying, you are the product. In other words, the underlying transaction is the one between Facebook and its advertisers, whereby Facebook rents out the user to its paying customers.

These platforms are typically described as two-sided or multi-sided. Among other things, multi-sidedness implies some choices about pricing strategy - how to distribute the costs and added-value of the platform between the different sides. For example, credit card provides a transaction platform between consumers and merchants - the credit card company has a choice whether to charge everything to the merchants or to charge the consumers as well. And Facebook and Google provide user services for free, although perhaps one day we shall be so addicted to their services that they can make us pay hard cash to continue.

A different way of thinking about platforms is as a container for capabilities or services. Here, the canonical example would be Amazon Web Services (AWS). At the CBDI Forum, we were writing about AWS over ten years ago, but many people only became aware of AWS when it grew into a massive business in its own right. (Amazon and eBay, August 2004)

The key idea here is that you can build a business on top of a platform. Thus a start-up online retailer doesn't need to build all the necessary capabilities in-house, because there is a platform of services already available. In the 1990s, telecoms companies were looking for ways to create value-added services on top of the basic communication platforms.

Many companies already have a platform, but they are trying to raise it. For example, the traditional role for telecoms companies is as a platform of telecoms connectivity. But it has been obvious for ages that there is no long-term profitability for telecoms from providing services at this level. So telecoms companies have long understood the need to raise the platform, to offer higher-value services. But they are still struggling to formulate and implement this strategic change. Why is it so difficult? (Business as a Platform, March 2006) 

Similar structures can be found in the physical world. In addition to managing real platforms at railway stations, Network Rail provides a "platform" on which the train operating companies can run their business. In theory these are services with strict service level agreements and contractual or regulatory penalties, although the actual stack geometry is arguably flawed. (Business Service Architecture - Railway Edition, June 2006)

In retail, some large department stores have turned themselves into marketplaces in which franchise retailers can sell their products. Other retailers have experimented with a business model in which the goods are owned by the supplier up to the point at which they are purchased by the supplier. Thus the store becomes a platform for the supplier to merchandise and sell products. See also Nick Vitalari, Walmart and The Power of the Business Platform (Sept 2011).

Platforms are sometimes described as more or less open or closed. For example, the Open Banking Platform. Platform controllers often seek to impose quality or technical constraints on businesses using the platform - for example, Apple iTunes. Thus the notion of openness has a range of meanings, from market openness (e.g. no barriers to entry and exit) to technological openness (e.g. flexibility of mechanism). (Types of Openness, November 2001)

So when business strategy consultants talk about a platform business, this can also refer to the flexible and open-ended exploitation of an asset or capability, to create or co-create value in as many ways as possible. For example, here is John Hagel in 2006, talking about Steve Jobs and Disney.

In a world of scarce attention, creators of media products will need to compete with those who re-conceive media products as platforms. What is the difference? Products are designed to be used on a standalone basis – you buy it and you view it or listen to it in the specific way the content creator intended. Platforms are designed to be built upon – they create opportunities for the original creator, third parties or the customers themselves to extend, enhance and tailor the content in ways that the original creator never anticipated. Offered as a platform, content can create far more value than any equivalent standalone product. (Disney, Pixar and Jobs, Feb 2006)

Finally, we may note that although many of these platforms may be described as "digital", many of the same basic characteristics can be found in both digital and non-digital modes. And what even counts as "non-digital" these days, when every aspect of our lives can be wired to the Internet? So I prefer not to talk about digital platforms any more - they are just platforms.

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Further Reading

Philip Boxer, What Distinguishes a Platform Strategy? (Asymmetric Design, May 2012)

Diane Coyle, The Social Life of Platforms (Enlightenment Economics, May 2016)

For John Hegel's latest thinking about platforms, see The Big Shift in Business Platform Models (Edge Perspectives, January 2017)

Related posts: Business Geometry (September 2004), Multi-Sided Platform Strategies (April 2013)

Uber Mathematics 3

Where are Uber's real competitors? The obvious answer would be the traditional taxi operators in large cities. Taxi services are usually controlled by city authorities or other regulators, to ensure that the prices are fair, and that the drivers and the vehicles are safe. Taxi drivers in various cities have protested against Uber, arguing that it cheats regulation by using unlicensed drivers to undercut prices. However, regulators (such as the UK CMA) have sometimes decided that consumer interests are best promoted by allowing Uber to compete with established providers.

Uber is therefore selling itself three ways - not only to passengers and drivers but also to regulators. In a sense, this makes it a three-sided platform.

However, as discussed in my earlier posts, some commentators are dubious that Uber can ever be profitable in this competitive space, even with substantial deregulation in its favour. What Uber really wants (they argue) is to persuade city authorities to stop investing in public transport, to stop subsidizing buses and subsidize Uber transport instead. If other competing modes of transport are decommissioned, the Uber business model starts to look quite different - just another privatized yet publicly subsidized monopoly, supposedly independent but effectively underwritten by the government.

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All you need to know about Uber (BBC News, 9 July 2015) Uber says TfL cab proposals 'against public interest' (BBC News, 2 October 2015)

Does Uber have an ally in the CMA? (Maclay Murray & Spens, 12 October 2016)

Anne-Sylvaine Chassany, Uber: a route out of the French banlieues (FT, 3 March 2016)

Dave Lee, Is Uber getting too vital to fail? (BBC News, 10 December 2016)


Related Posts
Uber Mathematics (Nov 2016) Uber Mathematics 2 (Dec 2016)

Uber Mathematics 2

Aside from the discussion of Uber as a two-sided platform, addressed in my post on Uber Mathematics (Nov 2016), there is also a discussion of Uber's overall growth strategy and profitability. @izakaminska has been writing a series of critical articles on FT Alphaville.

Uber is wildly unprofitable, suggest that prices will rise once they've succeeded at monopolizing the industry: https://t.co/m3HB3q5YZV pic.twitter.com/taXcHfD2g5

— Justin Wolfers (@JustinWolfers) December 1, 2016

There are a few different issues that need to be teased apart here. Firstly, there is the fact that Uber is continually launching its service in more cities and countries. Nobody should expect the service in a new city to be instantly profitable. The total figures that Kaminska has obtained raise further questions - whether some cities are more profitable for Uber than others, whether there is a repeating pattern of investment returns as a city service moves from loss-making into profit. Like many companies in rapid growth phase, Uber has managed to convince its investors that they are funding growth into something that has good prospects of becoming profitable.

Profitability in Silicon Valley seems to be predicated on monopoly, as argued by Peter Thiel, leveraging network effects to establish barriers to entry. This is related to the concept of a retail destination - establishing the illusion that there is only one place to go. Kaminska quotes an opinion by Piccioni and Kantorovich, to the effect that it wouldn't take much to set up a rival to Uber, but this opinion needs to be weighed against the fact that Uber has already seen off a number of competitors, including Sidecar. Sidecar was funded by Richard Branson, who asserted that he was not putting his money into a "winner-takes-all market". It now looks as if he was mistaken, as Om Malik (writing in the New Yorker) respectfully points out.

But is Uber economically sustainable even as a monopoly? Kaminska has raised a number of  questions about the underlying business model, including the increasing need for capital investment which could erode margins further. Meanwhile, Uber will almost certainly leverage its cheapness and popularity with passengers to push for further deregulation. So the survival of this model may depend not only on a continual supply of innocent investors and innocent drivers, but also innocent politicians who fall for the deregulation agenda.

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Philip Boxer, Managing over the Whole Governance Cycle (April 2006)

Izabella Kaminska, Why Uber’s capital costs will creep ever higher (FT Alphaville, 3 June 2016). Myth-busting Uber's valuation (FT Alphaville, 1 December 2016). The taxi unicorn’s new clothes (FT Alphaville, 13 September 2016) FREE - REGISTRATION REQUIRED

Om Malik, In Silicon Valley Now, It’s Almost Always Winner Takes All (New Yorker,
30 December 2015)

Brian Piccioni and Paul Kantorovich, On Unicorns, Disruption, And Cheap Rides (BCA, 30 August 2016) BCA CLIENTS ONLY

Peter Sims, Why Peter Thiel is Dead Wrong About Monopolies (Medium, 16 September 2014)

Peter Thiel, Competition Is for Losers (Wall Street Journal, 12 September 2014)



Related Posts Uber Mathematics (Nov 2016) Uber Mathematics 3 (Dec 2016), Uber Mathematics 4 (September 2021)

Uber Mathematics

UK Court News. Uber has lost a test case in the UK courts, in which it argued that its drivers were self-employed and therefore not entitled to the minimum wage or any benefits. Why is this ruling not quite as straightforward as it seems, as @JeffreyNewman asks? To answer this question, we have to look at the mathematics of two-sided or multi-sided platforms.

Platforms exist in two states - growth and steady-state. A mature steady-state platform maintains a stable and sustainable balance between supply and demand. But to create a platform, you have to build both supply and demand at the same time. Innovative platforms such as Uber are oriented towards expansion and growth - recruiting new passengers and new drivers, and launching in new cities.

New Passengers

Every week in London, 30,000 people download Uber to their phones and order a car for the first time. The technology company, which is worth $60bn, calls this moment conversion. It sets great store on the first time you use its service ... With Uber, the feeling should be of plenty, and of assurance: there will always be a driver when you need one. Knight

New Drivers

They make it sound so simple: Sign up to drive with Uber and soon you’ll be earning an excellent supplementary income! That’s the central message in Uber’s ongoing multi-platform marketing campaign to recruit new drivers. McDermott

New Cities

Uber has deployed its ride-hailing platform in 400 cities around the world since its launch in San Francisco on 31 May 2010, which means that it enters a new market every five days and eight hours. ... To take over a city, Uber flies in a small team, known as launchers and hires its first local employee, whose job it is to find drivers and recruit riders. Knight

But here's the problem. In order to encourage passengers to rely on the service, Uber needs a surfeit of drivers. If passengers want instant availability of drivers (plenty, assurance, there will always be a driver when you need one), then Uber has to maintain a pool of under-utilized drivers. (Knowles)

Simple mathematics tells us that if Uber takes on far more drivers than it really needs, some of them won't earn very much. Furthermore, people with little experience of this kind of work may underestimate the true costs involved, and may have an unrealistic idea of the amounts they can earn: Uber has no immediate incentive to disillusion them. (This is an example of Asymmetric Information.) Even if the average earnings of Uber drivers are well above the minimum wage, as Uber claims, it is not the average that matters here but the distribution.

The myth is that these are drivers who can choose whether to provide a service or not, so they are free agents. Libertarians wax lyrical about the gig economy and the benefits to passengers. However, the UK courts have judged that Uber drivers work under a series of constraints, and are therefore to be classified as workers for the purposes of various regulations, including minimum wage and other benefits.

Uber has announced its intention to appeal the UK judgement. But if the judgement stands, what are the implications for Uber? Firstly, Uber's overall costs are likely to increase, and Uber will undoubtedly find a way either to pass these costs onto the passengers or to pass them back to the drivers in some other form. But more interestingly, Uber now has a financial incentive to balance supply and demand more fairly, and to avoid taking on too many drivers.

Uber sometimes argues it is merely a technology company, and is not in the transportation business. Dismissing this argument, the UK courts quoted a previous judgement from the North California District Court:

Uber does not simply sell software; it sells rides. Uber is no more a technology company than Yellow Cab is a technology company because it uses CB radios to dispatch taxi cabs.

However, Uber's undoubted technological know-how should enable it to develop (and monetize) appropriate technologies and algorithms to manage a two-sided platform in a more balanced way.

Update: similar concerns have been raised about Amazon delivery drivers. I have previously praised Amazon on this blog for its pioneering understanding of platforms, so let's hope that both Amazon and Uber can create platforms that are fair to drivers as well as its customers.

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Mr Y Aslam, Mr J Farrar and Others -V- Uber (Courts and Tribunals Judiciary, 28 October 2016)

Sarah Butler, Uber driver tells MPs: I work 90 hours but still need to claim benefits (Guardian, 6 February 2017)

Tom Espiner and Daniel Thomas, What does Uber employment ruling mean? (BBC News, 28 October 2016)

David S. Evans, The Antitrust Economics of Multi-Sided Platform Markets (Yale Journal on Regulation, Vol 20 Issue 2, 2003). Multisided Platforms, Dynamic Competition and the Assessment of Market Power for Internet-Based Firms (CPI Antitrust Chronicle, May 2016)

Sam Knight, How Uber Conquered London (Guardian, 27 April 2016)

Kitty Knowles, 10 of the biggest complaints about Uber – from Uber drivers (The Memo, 5 November 2015)

Barry Levine, Uber opens up its API – and creates a new platform (VentureBeat, 20 August 2014)

John McDermott, I've done the (real) math: No way an Uber driver makes minimum wage (We Are Mel, 17 May 2016)

Hilary Osborne, Uber loses right to classify UK drivers as self-employed (Guardian, 28 October 2016)

Aaron Smith, Gig Work, Online Selling and Home Sharing (Pew Research Center, 17 November 2016)

Ciro Spedaliere, How to start a multi-sided platform (30 June 2015)

Amazon drivers 'work illegal hours' (BBC News, 11 November 2016)

See further discussion with @wimrampen and others on Storify: Uber Mathematics - A Discussion


Related Posts
Uber Mathematics 2 (Dec 2016) Uber Mathematics 3 (Dec 2016)
Uber's Defeat Device and Denial of Service (March 2017)



Updated 6 February 2017. Reformatted 18 July 2022

Multi-Sided Platform Strategies

A multi-sided platform business has the following characteristic features.

1. The platform serves two or more distinct categories of customer. For example, a credit card platform serves both cardholders and merchants. For example, a heterosexual dating agency serves both men and women.

2. The platform provides a mechanism for connecting customers from different categories. The credit card increases the potential interaction between cardholders and merchants, as well as processing the transactions. And the dating agency brings men and women together.

3. The value of the platform to one category of customers depends on the quantity and quality of the other categories. For example, the value of a credit card to the cardholder depends on the number of merchants that accept the card. Meanwhile, the value of the card to the merchant depends on the number of cardholders.

Under certain circumstances, it might be possible to build one side of the platform first. For example, if you had some brilliant idea for a entirely new kind of credit card, and had a lot of funding and a persuasive sales team, you might conceivably be able to recruit a large number of merchants into the scheme before you had any cardholders at all. Or imagine persuading a group of men to invest all their spare time for two years building a nightclub that would (when finished) attract the hottest women in the city. But this strategy requires a considerable degree of confidence and trust. So in practice it usually makes sense to build up both sides at the same time.

There are various strategies that can be used to create a multi-sided platform. Sometimes it is possible to start small. When Frank McNamara created Diners Club in 1950, he started in a small geographical area (Manhatten), with 14 merchants and a few hundred cardholders. Within a year, he had 300 merchants and 40,000 cardholders.

When American Express wished to enter the market in 1958, it needed to create something quickly that could compete with Diners Club. One way to do this was to acquire and consolidate some existing schemes. But the key element to the American Express's success was a marquee strategy - recruiting the most desirable customers (e.g. business travellers on expense accounts) and the most desirable merchants (e.g. high status hotels, restaurants and stores).

A marquee strategy depends on a degree of exclusivity, real or imagined. In a multi-sided market, you don't gain directly from the number of people on your own side, since they may be competing with you for the attention of the people on the other side.

American Express is now much larger than Diners Club. So much for first-mover advantage then. The most desirable customers are not necessarily the ones with the greatest willingness to experiment with a novel platform. Novel platforms tend to attract early adopters and low-value customers (AltaVista, MySpace, OnSale). Once the platform concept is understood, a new entrant may be more successful in recruiting the high-value and mainstream customers (Google, Facebook, eBay).

Among users of Facebook and Twitter, a gulf is emerging between celebrities and other users. Facebook is currently experimenting with charging a fee for ordinary users to send messages to celebrities. According to the Independent, Facebook plans to keep this money itself. Presumably the only benefit to the celebrity is helping to filter incoming messages. And of course many celebrities are now dependent on Facebook and Twitter for maintaining their public profile, so they are not able to walk away.

The growing distinction between different categories of user marks a transition from same-side network effects (which assume a single category of user) into a multi-sided platform. Linked-In is another platform that is making this transition. Linked-In gets much of its revenue from the recruitment business, so it is essentially a market-making platform. Whereas Facebook and Twitter remain largely audience-making platforms.

(For the distinction between market-making and audience-making platforms, as well as a third category of demand-coordination platforms, see David S Evans.)


I spoke at the IASA UK Architecture Summit on 26th April on Architecting the Multi-Sided Business. Please contact me if you have any practical challenges in this area.

Architecting multi sided business 2 from Richard Veryard

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Pieter Ballon, Platform Types and Gatekeeper Roles: the Case of the Mobile Communications Industry (2009)

Mark Bonchek and Sangeet Paul Choudary, Three Elements of a Successful Platform Strategy (HBR Blog Network Jan 2013)

David S. Evans, Managing the Maze of Multisided Markets (Strategy+Business Fall 2003)

David S. Evans, The Antitrust Economics of Multi-Sided Platform Markets (Yale Journal on Regulation, 2003)

David S. Evans and Richard Schmalensee, Failure to Launch: Critical Mass in Platform Businesses (Sept 2010)

Thomas Eisenmann, Geoffrey Parker, and Marshall W. Van Alstyne, Strategies for Two-Sided Markets (HBR October 2006)

James Legge, Facebook now charges you for messages sent to celebrities and people you aren't friends with (Independent 7 April 2013)

Lisa O'Carroll, Facebook starts charging users up to £11 to contact celebrities (Guardian 8 April 2013)

Geoffrey Parker and Marshall Van Alstyne, A Digital Postal Platform: Definitions and a Roadmap (MIT Jan 2012)

Richard Veryard, The Component-Based Business: Plug and Play (Springer 2001)

Understanding LinkedIn Business Model (BMI Matters May 2012)


Related Posts: On the Nature of Platforms (July 2017)

Links added 7 September 2017

Showrooming and Multi-sided Markets

As a retail phenomenon, #showrooming exposes a conflict of interest between online and traditional retailers. Many shoppers will examine a product in a traditional store, and then buy it from an online retailer or discount warehouse. The first retailer incurs costs - including cashflow, wear and tear on the product, as well as unproductive use of staff time and knowledge - while the second retailer takes the revenue.

To complete the story, there may be another class of customer, who is happy to buy the ex-demonstration product from the first retailer at a discounted price. Thus there are five distinct roles in this game: the product supplier, the first and second retailer, the first and second customer. (In addition, if the customers are using their mobile phones in the stores, we should add the players in the mobile ecosystem.)

The earliest manifestation of this I can remember was buying records. You could listen to an LP in the record store, and then get a pristine copy (without the shop assistant's fingerprints) by mail order from a company appropriately called "Virgin".

Many retailers believe they lose out from this phenomenon, and some have attempted to prevent it. (Ever wondered why you don't get a good cellphone signal inside a large store?) Earlier this year, both Target and Wal-Mart decided to stop stocking Amazon devices, although continuing to stock Apple devices. More recently, Wal-Mart has changed its position, and now claims to embrace showrooming.

By singling out Amazon, Target and Wal-Mart were making it clear that it is Amazon's role as a retailer that they regard as a competitive threat. Although Apple also sells its devices online, it is presumably not regarded as an equivalent threat. In which case, banning Amazon products looks like a gesture of despair rather than an effective tactic.

Thinking of this as a multi-sided market prompts us to look at the direct and indirect flows of value between the players. It is as if the first retailer is providing an unpaid "service" to the second retailer, and the first customer is providing an unpaid "service" to the second customer. At present these are not genuine services, but it is possible to conceive of an ecosystem in which the product supplier or second retailer paid some form of commission to the first retailer. For all I know, that may already happen in some sectors.

Wal-Mart hopes to control showrooming by encouraging its customers to use its own mobile app, which attempts to steer customers towards its own online store. I wonder how many customers will accept this control, and how many will take the trouble to resist it.

Some large High Street retailers seem to have given up the idea of stocking goods: if you like something on display, you can order it. This has long been true for large furniture items such as beds, but is becoming more common for smaller items, as Simon Heffer complains.

Meanwhile, showrooming can work both ways. Last week I ordered a book from my local bookshop, having previously looked it up on Amazon. It was 5pm Friday when I placed the order, and they phoned me at 11am on Saturday to tell me it had arrived. (If I'd ordered it from Amazon, paying extra for 48 hour delivery, when would it have arrived? Monday, Tuesday?) So that's showrooming in reverse.

Finally, instead of selling individual products, the showroom itself can become the experience. @KBlazeCarlson sees IKEA as a prime example, and quotes Alan Penn, professor of Architectural and Urban Computing at UCL, describing the IKEA experience as "psychologically disruptive". "Part of their strategy is to take you past everything," he says. "They get you to buy stuff you really hadn’t intended on. And that, I think, is quite a trick."

Chris Petersen adds, "Instead of product centric merchandising, IKEA’s showroom is perhaps the ultimate place merchandising, where the consumer solution is focused on the most personalized dimension – the consumer’s own lifestyle and living space." Whether IKEA can replicate this experience online in the virtual world, as suggested in Patrick Nelson's piece, is another matter.

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Kathryn Blaze Carlson, Enter the maze: Ikea, Costco, other retailers know how to get you to buy more (National Post, June 2012)

Dani Deahl, Amazon granted a patent that prevents in-store shoppers from online price checking (The Verge, 15 June 2017)

Simon Heffer, My futile hunt for a lamp in John Lewis reveals why the High Street is doomed (Daily Mail 15 January 2013)

Brett Molina, Is 'showrooming' behind Target move to drop Kindle? (USA Today, May 2012)

Patrick Nelson, Brick-and-Mortar's Showrooming Scourge (E-Commerce Times, Nov 2012) via First Insight

Sarah Perez, Amazon, now a physical retailer too, is granted an anti-showrooming patent (TechCrunch, 16 June 2017)

Chris Petersen, To beat showrooming … change the showroom! (IMS results count, June 2012)

Marcus Wohlsen, Walmart.com CEO: We Embrace Showrooming (Wired, Nov 2012)

Amazon's Showrooming Effect And Quick Growth Threaten Wal-Mart (Forbes, Sept 2012)

Related posts: Showrooming in the Knowledge Economy (December 2012), Predictive Showrooming (December 2012)

Updated 16 June 2017

A Cautionary Tale

Heard an interesting story recently, from a software developer advocating Scrum. I shall omit the names of the companies and individuals, and I may get a few of the details wrong, to avoid embarrassing anyone.

Our hero was working for a mobile device company, responsible for defining software requirements. At one point in this job, he was sent to negotiate an interface with a social networking company. The programmers at the social networking company were very keen that the social networking application (app) should be zero-rated - in other words, the users should not have to pay network charges for using the app - so our hero dutifully recorded this as a requirement and built it into the app.

When our hero returned to his company's offices, he discovered to his dismay that the sales and marketing people were very cross with this arrangement. They felt that this damaged the interests of the device company and their network partners (who usually want to generate network revenue from the use of such apps).

Our hero felt bad. Clearly he had let his company down, by failing to consult all the stakeholders before agreeing to this arrangement.

For my part, I thought our hero was being too hard upon himself. After all, the device company was operating in a highly competitive multi-sided market, and deciding how to balance the interests of different stakeholders was therefore a delicate strategic judgement. Our hero was sent off to perform this delicate task without any proper briefing or guidance or policy. Or architecture. I thought it significant that it was the sales and marketing department that got cross, because this implied the absence or abdication of any strategic planning or architectural function who, if they were doing their job properly, should have anticipated this difficulty. How was our hero supposed to know who all the possible stakeholders were, if he didn't have a decent model of the ecosystem?

So this is also a story about the proper balance between agile development (with all its potential advantages) and architecture (with its attention to strategic risk). A proper architecture will look at the business and its ecosystem from several viewpoints including the Motivation View, which highlights value conflicts and differences of interest between different partners.

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In response to @allankellynet who commented "Scrum/Agile irrelevant, guy was not briefed, had not spoken to stakeholders. Could happen on any method", I should make clear that I'm not blaming Scrum as such, I'm bemoaning the lack of effective architecture. There is a great deal of guidance about combining Scrum/Agile with architecture - for example, see this Linked-In discussion Does Agile/Scrum negatively impact software architecture?
 

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@brwalsh, Monetization: Money for Nothing (Cisco Communities, June 2011)

@mutlu82, Facebook Does A Deal With Mobile Operators To Produce New Mobile Site With Zero Data Charges! (Mobile Inc, May 2010) 



updated October 23rd 2012

Coherence Premium

Interesting article by Paul Leinwand and Cesare Mainardi, The Coherence Premium. HBR June 2010 http://www.booz.com/media/uploads/HBR_Coherence_Premium.pdf

The authors define the "coherent company" as one that "has aligned its differentiating internal capabilities with the right external market position". They claim that most companies lack coherence because they pay too much attention to the external and not enough to the internal. "We are suggesting that companies start from the opposite direction, figuring out what they're really good at and then developing those capabilities (three to six at most) until they're best in class and interlocking. From there, strategy becomes a matter of aligning that distinctive capabilities system with the right marketplace opportunities."


We may observe in passing that enterprise architects are often criticized for the opposite tendency - paying too much attention to internal structure without knowing how to align this to external demand. 



The authors offer two examples of enterprise models that could be expressed as an interconnected set of capabilities, although the detail of the interconnections are not described in the paper.

Retail (based on Wal-Mart)

• vendor management
• point-of-sale data analytics
• logistics
• working capital management

Consumer healthcare (based on Pfizer)

• Science-based innovation (I interpret this to be "technology" rather than "product")
• Influencing regulation and government policy
• New product development (including licensing and acquisition)
• Claims-based marketing (in other words, giving the consumer verifiable and relevant chunks of knowledge)
• Channel management
• Portfolio management

The authors claim to have a procedure for quantifying something they call "Coherence Premium" for a company.

1. Define the segments the company serves
2. Identify the capabilities that drive value for the company in each segment
3. Determine the number of common capabilities across all the segments the company serves.

They have calculated the coherence premium for a number of large companies including Campbell's, Clorox, Coca-Cola, ConAgra, General Mills, Heinz, Kimberly-Clark, Kraft, Nestlé, PepsiCo, Procter&Gamble, Sara Lee, Unilever and Wrigley's. These are then mapped against EBIT margin%, showing a very rough correlation.

Unfortunately, however, this graph doesn't show the two companies that they examined in greatest detail earlier in the paper, namely Wal-Mart and Pfizer. This may be because these companies face complex multi-sided markets, and this would cause difficulties for their simple procedure. It would seem that the kind of coherence they praised in these two companies would not be adequately represented by their simplistic "coherence premium" metric.


There have been many previous attempts to address the issues raised by Leinwand and Cesare Mainardi. In her blogpost Coherence - the new alignment, commenting on a Booz presentation of their concepts, Naomi Stanford recalls an earlier book on The Power of Alignment by George Labovitz and Victor Rosansky. Also see the discussion of cohesion costing in Nicholas Whittall and Philip Boxer, Agility and Value for Defence (pdf).

Asymmetric Demand for Defence Equipment

An independent review into the way the MOD buys equipment for Britain's Armed Forces has been published today, Thursday 15 October 2009. [Report, MoD News Article, BBC News]. Key finding.

"The Ministry of Defence has a substantially overheated equipment programme, with too many types of equipment being ordered for too large a range of tasks at too high a specification. This programme is unaffordable on any likely projection of future budgets."

That situation might sound familiar to a lot of managers, not just in the defence sector.

The report makes some favourable comments about the Through Life Capability Management (TLCM) programme, but indicates a lack of hard financial data that would be required to make quantitative decisions. There has been some discussion along these lines published in the RUSI Journal, including Agility and Innovation in Acquistion (Feb 2008) and The Meaning of Value-for-Money (Feb 2009).

The explanation for the current crisis can be found in the essential multi-sidedness of the defence acquisition ecosystem. Traditional cost accounting approaches (such as activity-based costing) fail to address the complexity of this multi-sidedness, and researchers are urgently seeking alternative cost accounting methods appropriate for complex systems-of-systems.

One of the key issues for Through Life Capability Management is that any errors or omissions in the long-term equipment programme must be repaired through what are known as Urgent Operational Requirements (UOR), which over the long haul can prove far more expensive and inflexible than the planned equipment.

The report also praises the Smart Acquisition programme, and expresses regret that the disciplines of Smart Acquisition have been somewhat diluted by recent reorganization.

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Is this report only relevant to the defence sector, or can other sectors glean anything useful? My view is that the complexities of multi-sided markets and asymmetric demand can be found in many, perhaps most sectors. And the question of coordinating effectively between short-term and longer-term spending can be found in many domains, notably IT. I have little doubt that whatever management tools and techniques are developed by the MoD and its partners to address this problem will eventually trickle into civilian management.

Economics of agility 2

In my previous post on the Economics of Agility, I noted how little material has been published on this topic.

As Nicholas Whittall and Philip Boxer point out in their contribution to the recent debate on The Meaning of Value-for-Money in Defence Acquisition (RUSI, February 2009), there is an important link between agility and alignment. See also their earlier piece on Agility and Innovation in Acquisition (RUSI, February 2008).

The first observation is that defence acquisition - just like systems acquisition most anywhere - operates on a much slower tempo than the requirements of the business. The "business" of a military organization is running military campaigns; thus when writing for the defence community, Whittall and Boxer refer to the Campaign Tempo and the Acquisition Tempo.

The second observation is that there is a complex set of activities (such as orchestration, customization, and improvisation) involved in bridging between Demand (the demands of the campaign or business) and Supply (the procurement of specific systems and devices). These activities operate on an intermediate tempo, which Whittall and Boxer call the Alignment Tempo.

"Meeting the campaign tempo then depends on the alignment tempo possible, which in turn depends on the acquisition tempo at which gaps can be filled. Any slowness in acquisition tempo leads to increased bricolage and process short cuts to enable the alignment tempo to keep up with the campaign tempo. Thus, ‘agility’ finds its richest expression in the ability of the alignment tempo to meet the required campaign tempo at the lowest cost – i.e. to maximise the value-for-defence."

The challenge is then to produce just enough variety within the acquisition to optimize the economics of alignment. Boxer has developed a technique of Cohesion-Based Costing (not yet published), which "offers a means to attach a value to the cost of introducing flexibility". This kind of technique will clearly be of enormous benefit within the SOA world.

 

Related post Enterprise Tempo (October 2010)

SOA as Multi-Sided Platform

One of the ways to think about the complexity of SOA is as a multi-sided platform.

Some of the pioneering work on multi-sided platforms has been published by Andrei Hagiu at the Harvard Business School.  (Follow links from his homepage to some of his recent papers.)

In November 2006, I posted a brief commentary on Two-Sided Markets, referencing his work, and indicating its relevance to a service-oriented business strategy.

As yet, relatively few people have made the connection between multi-sided markets and SOA. In June 2007, Richard Friedman posted something useful on Multi-sided Platforms for Business or Software, and I found a paper entitled Optimizing the Supplier Selection and Service Portfolio of a SOA Service Integrator presented to a 2008 conference by a group of German researchers.

One of the attractions of SOA is that it should allow people and organizations to collaborate more effectively and cost-effectively. From the supply-side perspective, this means collaboration between the users of your platform. Your platform may or may not support a rich and open variety of collaborations, including mashups and other third-party initiatives, and this richness and openness significantly affects the demand-side value of your SOA platform.

The critical economic question here is not the economics of scale on the supply-side but the economics of scope and agility on the demand-side. Thus the critical question for platform design is how open/closed these platforms are, and the extent to which they constrain (overdetermine) or enable (underdetermine) demand-side activity.

Banking as a Platform 2

Last week in Banking as a Platform, I discussed how banks might use the platform concept (for example as discussed by Tom Steinthal in a post called Some Thoughts on Platforms in Financial Services) to support radical improvements in customer experience and service.

Tom has now replied. In a post called Platforms - Are They Coming, he mentions a banking product called PNC Virtual Wallet. [PNC Bank Takes on Mint & Quicken with PNC Virtual Wallet, NetBanker, July 14th 2008]

The NetBanker article mentions several companies offering financial management platforms that apparently sit on top of (and aggregate) online services from regular banks. These financial management platforms include Geezeo, Jwaala, Mint, Wesabe. I haven't studied these in detail, but from a quick review of the material on their respective websites they look fairly similar, and a lot more like real platforms (according to the criteria stated in Tom's earlier post) than PNC Virtual Wallet. Although PNC deserves some praise for innovating at all, I can't see anything very radical in the PNC innovation.

Among the comments to the NetBanker article, I note contributions from Aaron Patzer (CEO of Mint) and Andrew Taylor (CTO of Jwaala). This is not the first time these two have clashed in public: in September, Andrew put a post onto the Jwaala blog called Hi I'm Mint. Ugg., which prompted a robust reply from Aaron.

Behind the rivalry between Mint and Jwaala is a fundamentally important difference in platform strategy. Mint appears to be selling to customers - "use our platform to get a better service over and above your existing bank accounts and other financial service providers". Whereas Jwaala appears to be selling to banks - "use our platform to provide better services to your customers". (Back in 2005, I noted a similar dilemma for software billing specialist LaCayla - whether to market its services upwards or downwards. There are some complex questions of platform strategy here, as I indicated in my post on two-sided markets. There are also questions of trust.)

I really hope that innovations like these are successful, but there is a lot of work to do. Big banks like PNC may offer a watered-down and "safe" version of the innovation, but they might possibly have mixed feelings about the outcome. Meanwhile we can expect a lot of exciting stuff to be produced by small energetic companies with disputatious senior management; but it will be interesting to see how far they get with or without the active collaboration of any of the big banks.

Two-Sided Markets

There has been a lot of buzz around two-sided and multi-sided markets lately.

• Wikipedia: Two-Sided Markets

• Harvard Business Review: New Research Explores Multi-Sided Markets (March 2006), Strategies for Two-Sided Markets (Oct 2006)

• Emergic: Overview, Pricing, Examples, Business Application

In his HBS March interview, Andrei Hagiu identifies Wal-Mart as an example of an organization that is transforming from a traditional merchant into a two-sided platform. Let’s look at the (asymmetric) structure of this transformation.

The traditional retailer acts as a hub in the food supply chain, aggregating food supply from fields and factories, and distributing food to workshops and private kitchens. This is essentially a positional strategy: the retailer seeks to establish and maintain a strategic position within a value chain, as the bottleneck/hinge point between upstream and downstream. Within the positional strategy, the business drivers are understood in terms of the economics of scale and the economics of scope.



But if we shift from a value-chain perspective to a service-oriented perspective (effects-ladder), we can see that the retailer is providing a service (=delivering value) downwards as well as upwards - it is a food distribution platform for farmers and manufacturers as well as a food supply platform for consumers and catering companies.

So instead of drawing the merchant in the middle, we can draw the merchant as a new kind of platform providing various kinds of market interaction.




This takes us from a positional strategy to a relational strategy. No longer just focused on the economies of scale and scope, the relational strategy emphasizes how economies of governance are generated in relation to two kinds of demand context. The big question for a company such as Wal-Mart is how to balance the exploitation of each of these forms of asymmetric advantage.

 

See also

Philip Boxer, Asymmetric Demand is Multi-Sided Demand (October 2011)

Richard Veryard, SOA as Multi-Sided Platform (September 2009)