In physics, theories are judged by their predictive power. That is why the theory of relativity is revered even today. It took an existing theory (Newton’s laws) and enhanced the predictive accuracy of an already successful equation. It is also the reason why string theory gets such a bad rap: it has no predictive power.
Whenever, I hear of an idea in business or finance, I wonder about its predictive power. And I’m often surprised by how so many theories have zero to very little predictive power.
Let’s take an example, I will henceforth call it ‘the platform theory’. It’s an idea pervasive in the current business zeitgeist: i.e. that platforms represent the future of distribution’. McKinsey, BCG and Bain have done all done some fancy reports on this idea over the past few years. Now, there’s nothing wrong with the idea per se. I actually am fully bought into it: distribution will likely shift to platforms or ‘super-apps’ in the coming decade. But the theory doesn’t pass the ‘predictive smell-test’. If you’re an executive trying to use this statement to understand which companies will grow or how you might become a platform yourself, the idea hardly adds anything. Current literature on the topic is generic stuff around customer centricity and digitization as the way to respond. But these ideas predate the ‘platform era’. Before I offer a better version of this theory, let’s go down the annals of tech history. We won’t visit Silicon Valley though - our story starts in the neighboring city of Seattle.
It is 2002. This is Amazon. But this isn’t the giant we know today. The stock trades for $15, a far-cry from the $1760 level it trades at today. There is no Prime, no 2-day shipping, no AWS, no Echo - so nobody really talks about the company then. Jeff Bezos, a maniacal micro-manager, sends an email to all his staff. The email is likely the single most important email in the history of the company. Heck, it might even be the most important email in the history of retail. Here’s how it reads:
1) All teams will henceforth expose their data and functionality through service interfaces.
2) Teams must communicate with each other through these interfaces.
3) There will be no other form of interprocess communication allowed: no direct linking, no direct reads of another team’s data store, no shared-memory model, no back-doors whatsoever. The only communication allowed is via service interface calls over the network.
4) It doesn’t matter what technology they use. HTTP, Corba, Pubsub, custom protocols — doesn’t matter. Bezos doesn’t care. 5) All service interfaces, without exception, must be designed from the ground up to be externalizable. That is to say, the team must plan and design to be able to expose the interface to developers in the outside world. No exceptions.
6) Anyone who doesn’t do this will be fired.Now if you’re somebody who has read a bunch on Amazon history, you likely already know about this email. But people often miss the key point of it. The email isn’t what created the ‘two-pizza teams’ or ushered in the Agile/DevOps era. Or it wasn’t something that made AWS an inevitability. Amazon already had product-teams even before Bezos pressed the send button then. And Bezos had been banging on about innovation and failure for a decade at that point already.
No, the email isn’t so much about what it said than what it did. It did two separate but related things. And neither of these were about the company’s IT or organization structure. Here is what these things were:
Every team at Amazon now started eating its own ‘dogfood’Every team at Amazon must offer their (internal) product or service at a price which could be benchmarked externally
Let’s start with the first bullet - Eating your own dogfood
The idea predates Bezos’ email by at least three decades. There was even a popular TV ad in the 1970s. A dogfood company CEO feeds his own dogs the company’s product to show how good the food actually is. However, we don’t have to take things so literally. The insight here is that individual teams will optimize and continuously enhance their product or service only if they and their colleagues are constantly being exposed to the outcome. If that’s a mouthful, let me explain this with an analogy. Imagine you are a fruit shop owner and sell fruits for a living. Now let’s say, I tell you one day that you and your family will henceforth be eating fruits only for breakfast everyday. And the fruits will be randomly chosen from your shop. To up the stakes, all your friends and family will actually always be buying fruits from your shop. And much like you, they’ll get a random assortment from your store. So you have lots of ‘skin-in-the-game’ now. In this scenario, I am certain that most folks will start by ensuring that the quality of fruits they source are the absolute best. What else might you do? Well, over time you will try and enhance the ‘fruit-eating’ experience. You might squeeze a few fruits and offer customers the ability to buy bottled fresh juice. You might try and break the rules slightly and create some fancy pina-coladas and mix a few fruits. Basically, you constantly iterate and improve the product. And that is what the ‘eat your own dogfood’ mindset really brings.
So when Bezos tells folks ‘I don’t care what technology you use, I want the service to be externalizable’, every team at Amazon suddenly become an end customer and an end supplier to others. And remember how we upped the quality of our fruit-product when we were the ones eating and selling it to our colleagues daily? Something similar happened at Amazon gradually. The quality of the Amazon’s IT architecture, its internal services and its products, all improved. And that’s really what made all the difference.
Now, let’s tackle the second bullet - Offering an internal service at a price which can be benchmarked externally.
We will use another example to highlight what we mean here. Imagine, you and your friend want to start an insurance company. You likely start off as an MGA or broker. Over time, as you get a few customers you will likely backwards integrate across other parts of the value chain. Very soon you’ll have a bunch of departments - Finance, legal, pricing, compliance, customer service, claims etc. That is how most organizations are set up. In business parlance, you are a ‘vertically integrated’ company. But vertical integration and scale bring with it a related evil. Your departments now become monopolists. Companies set their prices by looking at market rates but also their internal cost structures. So while not explicitly doing so, every department becomes a mini-monopoly within the company. Legal tells the financial controller that it costs them $10M to run their department. And that’s how he accounts for it, treating as a ‘cost-of-doing-business’. Occasionally, there might be some negotiation around budget but that’s office politics. The legal department doesn’t get asked, ‘Hey btw competitor X’s legal department does the same job as you for half the price’. For one, such data is rarely available. But even when it’s available, it is usually masked under quips like ‘It’s not like-for-like etc’.
And that is where the problem comes. Fat around costs comes in because internal departments in vertically integrated companies become price-setters. The brilliance of Bezos’ email really shone in this area. I am not sure if he could have fully realized it at that point. But it made Amazon into a machine that makes machines. By making every single service into something externalizable, Amazon could monitor these costs closely. And if the ̶d̶o̶g̶f̶o̶o̶d̶ service was good enough, they could offer it to the market over time. So if Amazon was the insurance company in our above example, it’s legal department would offer its legal services to any company that didn’t want to deal with the ordeal of insurance-related legal affairs. And over time, it would offer such services for every single part of the insurance value chain - distribution, call center, claims etc. This externalizable architecture is the genius that brought us AWS and Amazon marketplace - the two juggernauts on which Amazon’s dominance has been built. Over time, as Amazon signs up more customers for such services, it offers these services at even a lower cost (due to scale benefits). This further tightens its moat by enhancing the proposition for end customers. And the Amazon flywheel gets set in motion.
I don’t want to make this post to be just about Amazon so I will conclude some final thoughts around platforms before tying things up. There are many successful platform companies today (Facebook, Shopify, Apple, WeChat, Go-Jek etc.). But other than have great addictive products, they share a key feature. They enable other individuals and businesses to launch things faster and cheaper than before. Consider Facebook’s decision to open up its third-party developer api early on, way before focusing on mobile monetization. Zuckerberg realized the potential value of letting others build on top of Facebook. But it was a great deal for third-party developers too. They now had reach and distribution at a scale never seen before. Very soon after the API launch, hundreds of thousands of developers were building their own games and tools on top of Facebook. As a result, users began spending more and time on Facebook. And while a user might be spending 8 hours on Facebook, 5-6 of those hours were spent playing a game like Farmville. So Facebook succeeded where previous social network like Orkut and MySpace had failed - and it did so by becoming a platform.
So, if the thesis is ‘Platforms will dominate distribution’ - What can most incumbents do? I believe there are a couple of options. One is to try and copy Amazon and ‘out-Amazon’ the Seattle giant within one’s own industry. This likely requires tonnes of capex, a re-investment of profits (to pay lower taxes ala Amazon), de-verticalization and a complete culture change. And while some executives might convince public markets, convincing employees may prove a lot more difficult. This is because de-verticalization requires setting up the organization such that every service is externally and internally consumable. This is quite antithetical to the concept of the modern corporation. So, I am skeptical that this will work as most workplaces have decades of cultural baggage around vertical integration.
The second idea is simpler. It is likely the correct approach for most companies. Focus only on your core strength (or IP) and outsource everything else to the low-cost player that is focused on just one thing. Consider this: Uber, the company that has most captured the public imagination over the past decade, is actually a company largely built on top of four APIs: Stripe, AWS, Checkr, Twilio. Most people know Stripe and AWS. Very few have heard of Checkr and Twilio. Checkr conducts background checks on drivers via an API. Twilio allows companies to send and receive text messages and calls via a simple API. All four of these companies are multi-billion dollar companies in their own right: Stripe ($35B), AWS ($500B+), Twilio ($16B+) and Checkr ($2.1B+). Uber didn’t try and re-invent the wheel on any of these services. And despite building on top of these services, it has a market cap north of $50B. And many predict it to be the next platform company. (If recent news is something to go by, it definitely seems so)
So, to conclude - here’s the better version of the ‘platform theory’.
Platforms will dominate distribution for most products and services in the Web 3.0 era. Incumbents may respond to this threat/opportunity by:
1. Making their services externally surface-able via commercially available APIs. Ultimately, they may try to corner the market around a particular niche and be the ecosystem of choice here (This is both hard, costly and time-taking)
2. Divesting most non-core functions and outsourcing these to the lowest-cost players available (This is relatively cheap and in-expensive but goes against individual bias for growth and larger revenues)
For startups, this mostly represents a huge opportunity. There are tonnes of verticals that have still not be attacked. Internet and smartphones have enabled distribution at a scale not seen before. Given that total addressable markets are 10x previous levels, the niches one need target to build something interesting is actually much smaller. Checkr has built a unicorn around something seemingly trivial like background checks. And yet, many such opportunities will arise to build businesses around ideas that might seen unappealing to the blind eye.
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