How digital platforms are rethinking their business models

In April 2018, one of the world’s leading digital services announced that they would file for an initial public offering. The Swedish music streaming service Spotify was formally listed on the New York Stock Exchange with an initial valuation of close to $30 billion—well above the expected $19 billion. The difference can be explained by the eventual confidence of tech investors in its business model.

In the past, economies were driven by companies that sold products to customers or provided services to clients. Today, margins are low for sellers and service providers across most industries, and very little value is being generated from traditional business models. Instead, companies like Google, Facebook, Uber, and Amazon are defining new monetization strategies for the 21st century and are shaping the new platform economy.

The platform economy is a vast digital ecosystem that interconnects cloud computing, Big Data, and mobile apps. It encompasses food-delivery services like Uber Eats, video-streaming services like YouTube, and ride-hailing apps like Uber. What these platforms have in common is their shared focus on establishing digital marketplaces that connect users and facilitate transactions that wouldn’t otherwise have been possible.

Over the past two decades there has been rapid growth in the number and profitability of companies seeking to build platforms, rather than offer products or services directly. According to global professional services firm Accenture, the platform economy has reached $2.6 trillion in worldwide market capitalization and will account for up to a quarter of the entire global economy in 2020. Despite the enormous amount of transactions that these platforms now account for, it’s not always easy for them to make money.

When Spotify listed on the stock exchange, they needed to explain to investors how they intended to turn a profit. In 2017, the company’s revenues grew by 39% to $4.7 billion, but their large operating costs meant posting an overall loss of $1.4 billion. Without a clear path to profitability, they were expected to struggle on the stock market in the same way that Snap, the makers of Snapchat, did the year before. However, Spotify’s platform eventually convinced investors to part with their money.

As Spotify and Snap both demonstrate, platforms can be enormously expensive to operate. Most platforms choose to monetize their operations on a transaction model where they take a cut of each sale that is facilitated by the network. Uber, for example, charges a variable booking fee that averages at around 20% of the transaction, while Airbnb charges guests a 5% to 15% service fee plus tax. Platforms like Apple’s App Store, Google Play, and Amazon also build their business models around transaction costs, but this means that their revenue is directly determined by the volume of sales on their network.

Subscription models are growing in popularity across the platform economy. Netflix has 182 million subscribers worldwide who each pay $12.99 per month. Often, platforms will offer users a free service with the option of a premium upgrade. Dropbox has 600 million users, but just over 2% are paid subscribers. In contrast, as of the first quarter of 2020, Spotify had 130 million premium subscribers worldwide, up from 100 million in the corresponding quarter of 2019, representing over half of its total users.

Platforms don’t have to be entirely subscription or transaction based either; increasingly companies are exploring ways of creating a hybrid of the two.

In November 2017, the European food delivery service Deliveroo announced they would be rolling out a subscription service. The platform had previously only offered a fixed delivery fee of $3.25, but decided to introduce unlimited free deliveries for a $10.85 monthly subscription. This reduced the margins for each individual delivery but incentivized users to increase the total volume of transactions on the platform.

As platforms have grown to become the dominant force in the digital economy, a growing number of governments and municipal authorities have been voicing complaints about their business practices. Uber was ruled to be operating illegally in London by not treating its drivers as employees. In Spain, Barcelona resorted to limiting Airbnb because of the rapid inflation of local property prices. The city’s chief technology officer, Francesca Bria, explained the problems with platforms at a conference in 2016:

“While the platform economy has a clear potential to generate economic impact, there are several important issues that need to be resolved: first and foremost, around ownership, control, and management of personal data. Can cities embrace a different model that socializes data and encourages new forms of democratic innovation? How can cities help ensure that such data is not locked in corporate silos, but is rather turned into a public good?”

Bria has proposed that municipal authorities have an obligation to create alternative digital platforms for the benefit of local residents. These platform cooperatives would be state funded through the tax system and would not operate based on conventional business models. They could create fairer pay conditions for drivers by not taking a transaction fee or not charging users a subscription fee.

Digital marketplaces have transformed lives and reshaped the global economy, but they’re still figuring out how to consistently turn a profit. The long-term success of companies like Spotify depends upon striking the right balance between maintaining the loyalty of their users and being able to consistently provide value for money. As the world’s leading tech companies consolidate the platforms they’ve created, it’s going to become more and more difficult for new entrants to find users who aren’t already connected to the new platform economy.