There are two broad business models: pipes and platforms. You could be running your business the wrong way if you’re building a platform, but using pipe strategies.
First a few definitions.
Pipes have been the dominant business model for as long as we’ve had industries: firms create stuff, push them out and sell them to customers. Value is produced upstream and consumed downstream. There is linear flow. Examples of pipes: essentially every consumer good – all of manufacturing runs on a pipe model, broadcast television is a continuous content pipe and prior to the internet, much of the services industry ran on a pipe model as well.
This model was brought over to the internet as well. Ecommerce stores work as a pipe, and so do single-user SaaS.
Unlike pipes, platforms do not just create and push stuff out – they allow users to create and consume value. At the technology layer, external developers can extend platform functionality using APIs. At the business layer, users (“producers”) can create value on the platform for other users (“consumers”) to … consume.
Broadcast tv channels work on a pipe model but YouTube works on a platform model.
This is a massive shift from any form of business.
Business Model Failures
Why is the distinction important? Because platforms are a fundamentally different business model. This means that platforms can’t be built the way pipes are built: traditional retail is a pipe. And it’s being disrupted by the rise of marketplaces and in-store technology, which work on the platform model.
Pipe Thinking vs. Platform Thinking
So how do we avoid this pitfall? Here’s a quick summary of the ways that these two models of building businesses are different from each other.
User acquisition: for pipes it’s straightforward – get users in and convert them to transact. Online stores for example focus on getting users and converting them. And that’s where the first pitfall for platforms is – don’t try to get users in and make them perform some actions – because platforms have no value when the first users come in. Indeed, users (as producers) produce value for other users (consumers). Hence, without producers there is no value for consumers and without consumers, there is no value for producers.
Platforms have two key challenges:
1. Solving the chicken and egg problem to get both producers and consumers on board.
2. Ensuring that producers produce, and create value
Without solving for these two challenges, driving site traffic or app downloads will not help with user acquisition. As a matter of fact, companies, especially during a digital transformation, often fail when they are actually building platforms but use Pipe Thinking for user acquisition.
Product Design and Management: Creating a pipe is very different from creating a platform. Pipes require to be built with the consumer (only) in mind. (Expedia is a pipe: all features are built with a view to enable consumers to find and consume travel tickets).
In contrast, a platform requires the curator to build tools for producers (for example, video hosting for YouTube) and do the same for consumers (for example, video viewing for YouTube).
The most important thing to consider is that for pipes, the use cases are well defined from the get-go. But for platforms, the use cases emerge through usage (example twitter started as a tool to express yourself in less than 140 characters but today is a platform for sharing and consuming news and content – creating an entirely new model for consuming trending topics) – as user uses often take platforms in entirely new directions.
Monetization. For a pipe, it’s pretty straightforward – Calculate all the costs of running a unit though a pipe all the way to the end consumer and make sure that price = cost + wanted margin.
On a platform business, monetization isn’t quite as straightforward. When producers and consumers transact (Airbnb, Etsy), one or both sides pays the platform a transaction cut. When producers create content to engage consumers (YouTube), the platform may monetize consumer attention (through advertising). In some cases, platforms may license API usage (Trello, Stripe).
Platform economics isn’t quite as straightforward either. At least one side is usually subsidized to participate on the platform. Producers may even be incentivized to participate. For pipes, a simple formula helps understand monetization:
Customer Acquisition Cost (CAC) < Lifetime Value (LTV)
This formula works extremely well for ecommerce shops or subscription plays. On platforms, more of a systems view is needed to balance out subsidies and prices, and determine the traction needed on either side for the business model to work.
The End of Pipes
In the future, every company will be a tech company. We already see that in all the digital transformations occurring in every industry as companies move to restructure their business models in a way that uses data to create value.
As we are moving from linear to networked business models, from pipes to platforms, all businesses will need to move to this new model at some point, or risk being disrupted by platforms that do.
(To be continued!)
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My name's phil mora and I blog about the things I love: fitness, hacking work, tech and anything holistic.
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