Platform Business Model explained

How do platforms work and what is the platform business model?

Platform business models create value by enabling direct interactions between groups. This overview covers their key characteristics, major types, benefits, risks, examples, and strategies for successfully building platforms.

Platform business models define our (digital) world. Simply put, platforms create value for us by enabling interactions between two or more different parties who need each other in some way or who facilitate the interactions. Platforms thus act as intermediaries that connect these groups and enable value-creating interactions and transactions.

Unlike traditional linear business models, where companies create value by controlling a supply chain, platforms usually rely on strong network effects, and also need them to grow rapidly. As they bring different groups together, platforms usually also create their own (digital) ecosystems in which further services are built and which can serve as a basis for more innovation.

Leading technology companies such as Amazon, Alibaba, Apple, Google, Microsoft, and Facebook use platform business models, and platform dynamics have allowed them to achieve tremendous scale, market power, and profitability.

Platforms can emerge in a wide variety of industries and are not just tied to digital content. They are transforming taditional industries such as transportation, medicine, and even topics such as crafts. Overall, platform business models represent a fundamentally different way of organizing and monetizing business.

This article provides a detailed insight into platform business models and also still explains key features, types of platforms, benefits and risks, as well as examples of successful platforms in various industries. The aim is to explain this increasingly important but often misunderstood business model.

4 Key Characteristics of Platform Business Models

Platforms are fundamentally different from traditional linear business models. Linear business models are, for example, a production company – which buys raw materials, processes them and sells the finished products. To better understand the difference, one should understand the following characteristics of platforms:

  1. Multi-sided: Platforms serve two or more different groups of customers who need each other. A classic example is Uber: Uber’s platform connects drivers and passengers.
  2. Network effects: A network effect makes the value of each participant greater as more participants join. Thus, the value of platforms grows as more users participate. For example, an online marketplace becomes more useful for buyers and sellers when it has more users or more merchants offer their goods. An example of this is Amazon: Here, a large number of customers find a large number of offers from various merchants and sellers.
  3. Scalability: Digital platforms can grow very quickly with relatively low marginal costs to serve additional users or enable more transactions. This allows for potentially massive scaling of these platforms. For example, an additional user usually costs next to nothing and an additional provider also costs next to nothing. For example, a server could serve 1 million customers for $200 USD. Thus, the cost per customer/user is marginal and almost negligible.
  4. Data as power: Since platforms stand between supply and demand, and they capture and manage intermediation between different groups, platforms get extensive behavioral and transactional data about all participants. With this data, platforms can improve their services or create a digital ecosystem that covers more of the customer journey. (Insights-Driven Organization)

These 4 characteristics fundamentally differentiate platforms from traditional business models or reseller models. These characteristics of platforms create powerful feedback loops that can lead to “winner take all” market dynamics.

Advantages of platform business models

Some of the most important characteristics of platform business models also provide various advantages over traditional business models:

  • Efficiency: platforms significantly reduce transaction and coordination costs between different groups. This can create added value for all groups. As platforms facilitate transactions, they can also claim or retain some of the value for themselves.
  • Network effects: Platforms grow rapidly due to self-reinforcing network effects. The more users join, the more valuable the platform becomes for the entire ecosystem and this also makes these platforms less vulnerable or even hard to replace in some cases.
  • Innovation: While it is still debatable whether platforms always lead to more innovation, certain types of platforms stimulate innovation. For example, iOS or Windows is a technology platform on which the development of applications has been made easier, and the standardization has also created standards that make it easier for network participants to offer new products.
  • Scalability: Platforms can scale exponentially with low marginal costs. A platform with 100 million interactions can easily handle 500 million and can increase revenue 5x while costs increase only marginally. This leads to a potential winner-take-all dynamic as these companies can achieve much better profit margins and use them to drive potential competitors out of the market, because should new competitors emerge they can squeeze margins and make the competition unprofitable.
  • End-to-end insights: because platforms manage and record all data that is communicated between groups, detailed insights into behavior, performance, and market opportunities can be gained. Platforms convert these insights into new value or, using Amazon as an example, can place their own products that drive other market players out of the market with data-driven decision-making at scale.
  • Flexibility: Established platforms with a modular design can quickly add new functionality by bringing in specialized providers. AWS offers over 200 cloud services through this flexibility and can add new services relatively quickly. This will be difficult for other players to keep up and offer the same experience.

Some of these advantages are also so strong that, as mentioned earlier, it may become impossible to compete as a new entrant. Especially the network effects make it difficult to compete with an existing platform and create a so-called “moat”.

Risks and challenges of platform business models

However, pay attention – It’s not all glitz and glamour. Although platform business models are very promising, they also carry some (big) risks and challenges:

  • Network effects can dissipate: Platforms are vulnerable to user loss, which has cascading effects. Erosion of trust or competition can trigger this. Twitter, for example, has seen this firsthand, how quickly the loss of trust can lead to a loss of key content creators and influencers can lead to a drop of over 50% in revenue. Through threads and alternatives, the strong platform Twitter thus became an example of how network effects can also collapse.
  • Regulations: Not only due to their size, power or excessive data collection, platforms are often on the list for regulations. Platforms also often start in legal gray areas that can become more stringent over time. Examples include debates over labor practices, privacy, and often the arbitrage of missing laws. This has been seen as Uber started illegally in various countries and then lobbied to change laws in their favor as they could demonstrate a large user base and thus exert pressure.
  • Governance: Platforms have to balance the interests of different stakeholders, which can be a challenge. Policies on this “regulation” that unduly favor one side can discourage others and often spur debates about freedom of expression vs. user safety.
  • Power imbalances: the platform provider controls key channels to end users, owns their data, and often the only means of communication. This could allow platforms to exploit and compete with their customers or partners through high fees or direct competition.
  • Information asymmetry: platforms have extensive data about ecosystem participants, leading to information imbalances. This raises questions about transparency and fairness.
  • Cultural friction: legacy linear companies often struggle to transition to open and collaborative platform models that require new capabilities.
  • Market consolidation: As platforms take over the intermediary function and also exploit economies of scale, the market can consolidate strongly and squeeze out smaller businesses in the market. This can lead to complete dislocations in various industries and also promote oligopolistic structures.
  • Hard to build: Platform business models are hard to build and maintain. In order to achieve the size where network effects help and also to invest into forming these large technological solutions, companies need to invest heavily for years in order to create succesful platforms.

Examples of Different Platform Business Models

Transaction Platform Business Models

Transaction platforms like Amazon Marketplace and eBay generate revenue by taking a cut of the transaction value between buyers and sellers. The more transaction volume they facilitate, the more revenue they generate. Examples Include:

  • Online Marketplaces – Amazon, eBay, Etsy, Shopify. Facilitate transactions between buyers and sellers.
  • App Stores – Apple App Store, Google Play Store. Enable app developers to sell to mobile users.
  • Payment Networks – Visa, Mastercard, PayPal. Connect consumers, merchants, card issuers to facilitate payments.

Innovation Platform Business Models

Innovation platforms like iOS and Android make money by charging access fees and revenue shares. Apple charges $99 annual fee to app developers and takes 30% cut of app revenues. This rewards Apple for creating innovation opportunities. Examples include:

  • Mobile Operating Systems – Android, iOS. Help developers build complementary apps and devices.
  • Gaming Consoles – PlayStation, Xbox, Nintendo. Enable game developers to reach console users.
  • Developer Tools – GitHub, Docker, Twilio. Allow developers to build on core platforms.

Integration Platform Business Models

Integration platforms like AWS generate revenue primarily from usage fees. AWS charges for computing resources used by developers to build applications on top of its infrastructure. The more activity, the more AWS earns. Examples include:

  • Cloud Infrastructure – AWS, Azure, GCP. Provide basic computing resources for developers.
  • Embedded Operating Systems – Android, QNX, VxWorks. Allow device makers to build on OS.
  • Blockchain Networks – Ethereum, Polkadot, Cosmos. Foundational protocol for decentralized apps.

Communication Platform Business Models

Communication platforms like Facebook and LinkedIn rely heavily on advertising as their business model. By attracting more users and engagement, they are able to sell more valuable advertising slots. Examples include:

  • Social Media – Facebook, Twitter, LinkedIn, Snapchat. Connect users and facilitate sharing.
  • Instant Messaging – WhatsApp, Messenger, WeChat, Slack. Enable real-time communication.
  • Video Chat – Zoom, Skype, Google Meet. Host video conferences and events.

Matchmaking Platform Business Models

Matchmaking platforms like Uber and Airbnb earn commissions on transactions enabled between groups. Uber takes 20-25% as a fee on rides facilitated between drivers and riders. Examples include:

  • Ride Hailing: Uber, Lyft, Ola. Match riders with drivers.
  • Home Sharing: Airbnb, Vrbo, Match travelers with property owners.
  • Freelance Marketplaces:Upwork, Fiverr, Freelancer. Connect businesses with freelancers.

List of possible revenue Streams for Platform Business Models

As we have seen, there are various types of platforms and how they are structured. Therefore, the digital business models of platforms also vary have different ways of generating revenue. It is common for platforms to use a combination of monetization strategies

Some of the main ways platforms make money are:

  • Commission fees on transactions
  • Subscription fees
  • Premium accounts with premium features
  • Payment processing fees
  • Advertising to user base
  • Developer access fees
  • Revenue share on developer earnings
  • Licensing fees for platform technology
  • Consulting/support services
  • Usage fees based on resources consumed
  • Premium add-on services
  • Licensing platform technology
  • Customization and integration services
  • Premium service subscriptions
  • Transaction fees on virtual goods
  • Data licensing and analytics
  • Commission fees on matches
  • Subscription plans for high-volume users
  • Verification fees for users/listings
  • Referral fees bringing in new users

Building a platform business model – Don’t start too early

Platforms need time, strategic long-term thinking and some resources to develop and before you could even turn to monetization. The main focus at the beginning should be on attracting and growing the critical sides of the user base (the hard-to-reach sides) of the platform. Without critical mass on both sides, monetization can undermine the foundation for long-term growth.

For example, a ridesharing app like Uber should first focus on achieving a sufficient supply of drivers and demand from drivers in a city before it could receive commissions or charge fees. This requires thinking about free rides and incentives for drivers. This can create the network effects that the platform needs to thrive and also build both sides in this example.

Once both sites are sufficiently large, monetization is possible without compromising further growth. The platform has established itself to the point that users are “addicted” to it because it offers value that no one else would. In the case of ride-sharing, charging a small commission once the app is popular does not deter most users.

Moreover, once platforms reach a certain size, they can monetize a fraction of the activity and still generate significant revenue. A meal delivery app with 100,000 daily orders can generate significant income with a 10% commission. The same 10% commission on only 1,000 orders brings little value and usually results in small companies having difficulty scaling when there is an established platform.

However, as you can imagine, building the initial liquidity and user density needed to make platforms work can take a lot of time, marketing and resources. Companies need to either bridge these financial resources with smart ideas, or raise enough investment for this build-up phase and before you can really think about monetization.

Very important to understand: When choosing the timing and strategy for monetization, the competitive dynamics must also be carefully considered. In some cases, companies use free offers to disrupt incumbents before entering the market. However, it can also be wise to wait to monetize before competitors copy the model. There are trade-offs between size, speed and market share that need to be weighed here.

Conclusion – Powerful but Hard

Platform business models are one of the most powerful, yet difficult, ways to build a business and make money. When they work, platforms can grow exponentially and dominate or restructure entire industries. Network effects act like a self-reinforcing flywheel, driving growth beyond what normal linear business models could ever do.

However, getting a platform off the ground requires careful strategy and execution that takes into account hundreds and thousands of variables. Platforms need the right triggers to attract their initial user base. The technology must provide seamless value. The platform must stimulate desired user behaviors that create more value, and the user must also feel and perceive this added value.

In addition, platform developers must recognize potential monetization opportunities, but also recognize when exploiting those opportunities too early could undermine growth. Understanding competitive dynamics is critical, as are dozens of other issues.

That’s because for new platforms, getting all the key sides on board is a challenge, which can mean a lot of time, investment and loss before network effects kick in and scaling really works. Not every platform will reach a sufficient size and therefore usually only a small 1-digit % number of platforms become successful.

But for those that overcome the hurdles, get a handle on the complex interactions, the rewards can be overwhelming. Platforms like iOS and Amazon have created some of the most profitable and influential companies in history. Their network effects become insurmountable competitive advantages, the scaling effects make them super profitable, and all of this makes these companies almost unassailable.

The potential is huge for those who can master the complexity.

Benjamin Talin, a serial entrepreneur since the age of 13, is the founder and CEO of MoreThanDigital, a global initiative providing access to topics of the future. As an influential keynote speaker, he shares insights on innovation, leadership, and entrepreneurship, and has advised governments, EU commissions, and ministries on education, innovation, economic development, and digitalization. With over 400 publications, 200 international keynotes, and numerous awards, Benjamin is dedicated to changing the status quo through technology and innovation. #bethechange Stay tuned for MoreThanDigital Insights - Coming soon!

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