How to Identify the Most Successful Companies of the Internet Era
I have a problem with one part of your article, here:
"Interestingly, this dynamic is exactly what US law wants: a hypercompetitive market that is amazing for consumers. That’s why the US government has had such a hard time regulating aggregators. They realize something is askew, but the end result is great for consumers, and in the US the definition of monopolies depends on whether consumers are better off. "
This is true, and indeed the law as currently formulated focuses only on monopolies that are demonstrably bad for consumers. The issue is that the market power that makes Facebook and Google great investments is also the market power that they 1) wield against competition on their platforms and 2) abuse in ways that damage society. There are stronger protections against both in Europe, which is why Facebook is in such trouble there. But it is evident here in the damage Facebook does to society in pursuing the profit motive exclusively and amorally.
I went to Stanford and many of my closest friends there are in tech or VCs. I did work in the field myself, but I am a management consultant now, and some of my projects have been with companies at the very frontier of cyber. These issues are blind spots for my friends, and there's definitely a solipsistic and libertarian strain in Silicon Valley. But these are issues that society and the law will have to wrestle with, because it's crushing the middle class and destabilizing democracy. Some is starting to happen with things like the growing traction of trends like ESG and stakeholder capitalism, but society moves much slower than tech, and I fear we will not put a cap on it before we lose the formula for what is important - our people, rather than solely our profits.
By the way, I am very much a capitalist. But I have seen too much having lived in the tech world for decades of the unbridled, but amoral enthusiasm for the "next great business model" without a pause to consider the damage that's being done. I am against a heavy hand from the government, but "power corrupts" has never seemed more true than today with the rise of global, unaccountable elites. Capitalism is absolutely the best system at it's core, but there are absolutely market failures, and they have never been more consequential than today.
This is a lovely article.
It demands a measured and considered response.
I will try to do that here.
The first thing is some points about network effects are inaccurate.
Metcalfe's law is kind of true mathematically but is untrue realistically.
That's because every new member is not valuable to the entire network: no one's social circle has that sort of range.
So, even if I could talk with 4 million people on the telephone, I certainly don't want to talk with even a fraction of them: possibility is not the same as demand.
Even mathematically, the law is suspect. The growth in value should really be N² - N rather than N² since each node can't communicate with itself.
I'm surprised as to how very few people point either of these out.
Two, network effects are a very successful business model whose time, I suspect, will soon begin to set under the sun.
The reason is because platforms and to a lesser extent, aggregators, give up vertical control for the benefits of controlling supply and demand in one place.
The problems are twofold: one, it only works if there's a massive pool of supply, like with information (Google) or social relationships(Meta) or applications( Apple app stores). Uber and Airbnb, companies already dealing in huge markets, owe a considerable part of their success to creating new sources of supply: many people who had not drove a cab or put their apartment up for rent in their lives began to do so.
This is why it's difficult to have a platform business with carwashing or massages or something similar: both the demand and supply aren't high enough to make the marketplace truly liquid.
The second problem is the issue of vertical control. If you give up vertical control, you allow some bad eggs onto the platform. There's no other option.
That's fine when the bad egg is just a troll or an ideologue.
With other industries, it's different.
Industries like healthcare cannot be truly network-scalable because of this problem. And also because these are not one to many networks either, e.g a doctor can't treat thousands at once.
Network effects are great at transactions. They are not great at relationships.
So relationship businesses like law and accounting have remained fairly impervious to software's world-sized appetite.
Three, aggregators are kind of a patch. Aggregators bring the relationships back. That's what they do: bringing back the relationship with the writer ( Substack), the relationship with the retailer( Shopify), etc.
And so, they represent a sort of evolution.
I would add Stripe to this list too.
The companies of this decade and the next are going to be the ones who provide empowerment: those who own the infrastructure of the new relationships of the digital economy.
And on this, Tomas, as usual, is spot-on.
I look forward to seeing the related posts on these matters.
The terminology around platforms business models & strategy is not consistent. Most definitions of platform would look at "aggregators" as simply one type of platform. Ben Thompson is a smart guy, but his "aggregation theory" construct is a unique vocabulary and is not used by almost any other analysts.
Nice article - I think the one thing missing, is the lesson from the early internet days. Prior to the 90's, there were platforms - AOL, Compuserve , Prodigy, GEnie, Dialcom, GeoNet where you could send people email but only if both people had accounts with the same service.
In the '90s we built common protocols, and pretty soon anyone could email anyone else - the Network effect applied across everyone (much like interconnected phone networks) so overall it built the lock-in services.
That's still the case with email, and Web1.0 was designed on the same principles, but most of us have moved to messaging products that lock you in - we are back to a world where I need a Facebook account to send a message to X and a Telegram account for Y but X cant message Y, and I can't do a three way conversation.
The question is for how long will that persist, before we get so fed up with having a dozen messaging apps, that we demand the ability to cross-message. The unfortunate thing is that unlike email, we aren't the ones paying for the service (that's the advertisers), so there is less cost to the service if I take my business elsewhere, so its harder this time to see a change coming.
I get the impression from the end of your article that platforms are gaining in popularity vs. aggregators. What I would be interested to know is:
- Is that actually the case, or is it just my impression? I know lots of aggregators e.g. Amazon have done well in the pandemic, but then again so has Shopify.
- Do you think there are growing business reasons to pursue more of a platform model vs. an aggregator model? I know that big aggregators e.g. Google, Facebook and Amazon are all getting more regulatory attention and bad press than they did previously, and Milennials and Gen Z are more likely to want to work and invest in businesses that they are aligned with philosophically...are these risks enough to overcome the siren song of the stronger network effects that you get from being an aggregator? I understand that this could vary greatly depending on the industry, but would love to hear your thoughts.
I really enjoyed this article.
Wonderful as usual, Tomas. Thanks.
Great article. Few questions regarding it. I've seen companies that still succeed even without network effects for example: all utility category like Avira or Norton - those companies do not have strong network effects, what they do have is kinda strong tech and good historical organic traffic. Same goes for example Kape Tech - they have bunch VPN's and they don't have strong network effects either.