How do digital platform ecosystems like Amazon and Alibaba work? We show which business areas they have and what the future of such business models looks like.
„Free is not a business model“
Jumping back to 2005: “Free is not a business model” – that was Ebay China’s reaction at the time to Jack Ma’s announcement that Taobao.com, Alibaba’s online auction site, would remain free for the next three years.
Ma argued that offering the service for free was the right thing to do at this stage of China’s e-commerce development and that there was plenty of room for growth in the future – he was to be proved right. With his approach of free core interaction, he has thus been able to overcome – in contrast to Ebay, which is now no longer active in China – the fundamental “chicken-and-egg problem” in building digital platforms: what does a new platform have to offer user group 1 (e.g., consumers) and user group 2 (e.g., producers), and at what price, in order for them to come to the platform?
Functions of platforms and achieving “critical mass
Let us first consider the primary and secondary functions of platforms (adapted from Moazed & Johnson, 2016):
Secondary functions: First, the aforementioned “audience building” is the central task, i.e., building a liquid marketplace by attracting a critical mass of consumers and producers. Typically, one group (e.g., producers/traders) has to pay a small fee, whereas another group (e.g., consumers) can use the platform for free. Further important is “matchmaking,” i.e., using appropriate filters to connect the right consumers with the right producers, and providing appropriate standards and tools that lower the barriers to entry and transaction costs for platform participants.
Primary functions: When secondary functions are met, this enables frictionless interactions and transcations between platform users. Unlike a traditional pipeline company that takes in raw materials, manufactures products, and then sells them, a platform company usually does not own inventory – digital platforms bring together supply and demand in their eco-system on a data-driven basis and create the framework for smooth transactions.
“Indirect network effects” as economies of scale of the digital age
For the digital economy, network effects mean what economies of scale meant for industrial mass production. Through these, digital platforms form “systems with positive feedback,” i.e., through their growth alone they continue to grow. This is due to the mechanism of so-called “indirect network effects”: the more customers there are on one side of the platform, the more valuable the platform becomes for customers on the other side. Example: The more private individuals shop on Amazon, the more interesting the platform becomes for retailers. Here, a reciprocal indirect network effect also takes effect, since the logic also works the other way around: The more retailers there are on Amazon, the more interesting the platform becomes for private individuals (Obermaier & Mosch, 2019).
Amazon generated sales of $280.5 billion in 2019. Of this, approximately 67% is attributable to the home market of the USA. Amazon is becoming less and less dependent on the core business of online marketplaces: Only about 50% of its revenue comes from the marketplaces, 20% from so-called seller services, 13% from Amazon Web Service (AWS), 7% from Prime, 5% from advertising revenue, and 5% from retail sales (Amazon Annual Report, 2019).
It can be stated that, in addition to e-commerce, Amazon has already found two other strong growth areas with its cloud AWS and the advertising division Amazon Media, and with the digital assistant Alexa may also already have the next significant operating system ready. Amazon is also in the process of digitizing its retail business to bridge the gap between the online and offline worlds (“O2O”). At Amazon Go supermarkets in the U.S., customers can already go shopping without having to queue and pay at a checkout finally, thanks to proprietary Just Walk Out technology – they can just walk away as all purchases are recorded and accounted for in the Go app. There are already nearly 30 such stores in the US. Amazon had already underscored its ambitions in brick-and-mortar retail in 2017 when it acquired Whole Foods for $13.7 billion.
Amazon’s success in new business areas is not only due to its shrewd market entry strategies, but is also an expression of superior innovation and technology management. It is no coincidence that Amazon spends the most on research and development of any company in the world. By way of comparison, while Amazon has spent 36 billion US dollars on R&D in 2019, all German companies together only account for around 90 billion US dollars.
(the international portal), the cloud business (Aliyun OS, Ali Cloud) and the logistics service (China Smart Logistics), Alibaba also offers a broad range of services in the areas of entertainment, health, messenger, travel, financing and, of course, payment. Alibaba can therefore be seen as a full-blown “multiplatform” with a complex ecosystem. In this context, Alibaba generally has low tangible investments and only has to provide the technological infrastructure.
Alibaba generated $56 billion in revenue in 2019 (Alibaba Financial Report, 2019). Approximately 60% of this comes from its advertising business, which is handled through its online marketing platform, Alimama. This makes Alibaba’s net profit margin exceptionally high (close to 30%). Although Alibaba’s internationalization continues to progress, the platform still makes about 65% of its revenue in its home market of China. Through Ant Financial, Alibaba provides access to credit for consumers and small businesses. Ant Financial’s planned IPO would have been the largest of its kind to date at $34.5 billion. However, regulatory concerns about online lending have now put the plans on hold for now.
Alipay is the dominant player in online, mobile and mobile proximity payments with a market share of 54.4% (2019). This dominance in mobile payments is one of the enablers of Alibaba’s “New Retail” initiative to digitize retail, as smartphone payments in Alibaba-owned Freshippo supermarkets, like the ubiquitous QR code, bridge the gap from offline to online. Digitization of even the upstream value creation steps enables the generation and sharing of seamless online and offline data records from initial contact through to purchase, possible return and evaluation, which are incredibly valuable for Alibaba and its manufacturers and retailers – customers, on the other hand, enjoy the benefit of faster throughput times at the checkout and increased convenience when shopping.
Comparative assessment and a look into the crystal ball
As can be seen from the brief overview, there is a great deal of overlap between the two representatives of the dominant Western and Eastern platform players. But in what do they differ? At the moment, mainly in their depth of integration and – related to this – their handling of customer data. In contrast to U.S. platforms, Chinese platforms offer integrated applications for all steps of the customer journey, either with their own offerings or via third-party providers, and also enable their platform participants to analyze data from the users themselves. Because of this data transparency within the ecosystem, brands have the ability to combine their platform data with their own first-party data to better target customers (Bünte, 2020).
Why don’t U.S. platforms share their data to the same extent? On the one hand, this is due to data protection, but on the other hand, it is also due to the fact that Amazon offers its own products, i.e. private labels, in many categories. So for retailers, Amazon is both a platform and a direct competitor. This is a challenge for online retailers in particular. The European Commission already has antitrust concerns in this regard and is currently initiating a second investigation into Amazon’s e-commerce business practices (European Commission, November 2020). In the U.S., there have long been voices calling for the breakup of the large tech corporations (Galloway, 2018). And the Chinese intervention in the planned Ant Financial IPO in November 2020 should probably also be seen as the first serious warning shot for Alibaba. So it could well be that the two powerful platforms, which for years have been able to grow and thrive under the protection of their home markets, are slowly outgrowing their respective authorities. Thus, arguably the biggest threat to both Amazon and Alibaba comes not from the future strengthening of any competitor, but from targeted government regulation.
Related article: 9 disruptive business models
Alibaba (2020). Alibaba Financial Report. https://doc.irasia.com/listco/hk/alibabagroup/annual/2020/ar2020.pdf
Amazon (2020). Annual Report 2019. https://s2.q4cdn.com/299287126/files/doc_financials/2020/ar/2019-Annual-Report.pdf
Bünte, C. (2020). Die chinesische KI-Revolution. Springer Books.
European Commission (2020). Press release “Antitrust: Commission sends Statement of Objections to Amazon over use of non-public data of independent sellers and launches second investigation into the company’s e-commerce business practices”. https://ec.europa.eu/commission/presscorner/detail/en/ip_20_2077
Galloway, Scott (2018). The Case for Breaking Up Amazon, Apple, Facebook and Google. https://www.stern.nyu.edu/experience-stern/faculty-research/case-breaking-amazon-apple-facebook-and-google
Moazed, A., & Johnson, N. L. (2016). Modern Monopolies: What it takes to dominate the 21st Century Economy. St. Martin’s Press.
Obermaier, R., & Mosch, P. (2019). Digitale Plattformen–Klassifizierung, ökonomische Wirkungslogik und Anwendungsfälle in einer Industrie 4.0. In Handbuch Industrie 4.0 und Digitale Transformation (pp. 379-417). Springer Gabler, Wiesbaden.