Recent successful IPOs of internet companies (MakeMyTrip, Naukri, JustDial) have rekindled interest around IT startups amongst investors. Some have had a good start (RedBus) but have decide to exit (some believe prematurely). However, we have also seen the demise of many Internet firms who could not survive on extended periods of low margins. It is estimated that out of 200 or so e-commerce companies started in 2012, over 100 have gone bust. Why do some Internet firms thrive and others slowly degrade? A possible answer could be found through the understanding of 2-sided platform markets.

Basic form

A large number of internet firms provide platforms for two or more, normally heterogeneous sets of users to exchange goods or service. These platforms operate as a multi-sided (normally 2-sided) market (2SM), in which there are two sets of users who complement each other’s usage thereby increasing the network effect for enhanced value for both. The more one side of users grow, the value for the users on the other side also grows, typically in a non-linear form and hence provides the required cross side network effects. Examples abound. RedBus has created a platform to bring travellers on one side and bus operators on the other side; Bharat Matrimony provides a platform for potential brides and grooms to select each other; MakeMyTrip is a platform for travellers on one side and flight and hotel operators on the other side; JustDial provides a way for users of a product/ service to connect to the providers.

There are certain characteristics of these 2SM that define their success. First, the platform is possibly the only way for the two sides to come together and exchange their needs. For example, in an unorganised bus transportation service in India, RedBus managed to bring them closer to the bus travellers through its platforms; and JustDial managed to bring together contacts of a large number of product/ service providers, large and small across the country; yatra.com brings together unorganised hotel sector and travellers. Further, the transaction cost of using these platforms is much less compared to their alternatives. We all know how difficult and tiresome it is to go to the bus stations to get tickets and to search for budget hotels in a city! Same holds good for the bus operators and hotel owners, most of whom cannot afford maintaining a full-fledged online presence. This attracts both sides to use the platform, which reinforces the network effect. Contrast this with the online portal of a single enterprise – for example the Web site of Jet Airways, by definition is not a two-sided market, since it only provides access to the products or services of that enterprise (e.g. booking of seats on the airline routes of Jet Airways).

Entry barrier

The second key success factor for Internet companies is that barriers to entry should be high. The e-commerce portal of a regular retailer for example would just display and provide buying options for whatever is normally displayed in the storefront. However, in the case of RedBus, JustDial and Yatra have leveraged two-sided network effects to create a large set of users on each side, which is hard to replicate by new entrants (Mani of JustDial worked over a decade to build enough users on both the sides and Phanindra of RedBus over seven years). Since the barriers to entry are high, 2SM typically leads to monopolies (winner takes all) or to oligopolies (two or three successful firms). This removes the threat of competition and gives the firms great control over pricing over the long term horizon.

Pricing details

The third aspect of 2SM is that asymmetric pricing is common wherein one side may end up subsidising the other side. While JustDial levies no fee for user enquiries, the shop owners pay a small charge to list their contacts in the platform. While Bharat Matrimony has paid membership, typically both sides do not have to pay, being subsidised by the advertisers. The asymmetric pricing introduces a subsidy to one side of the 2SM and increases the switching costs for a user on that side, thus creating some loyalty. This subsidy cannot usually be passed on to the other side of the 2SM, and has to be borne by the firm till a critical mass of users is built up. This is the main reason for the negative or very low profit margin of internet firms. Even after 15 years, the global e-commerce giant Amazon has a near zero net income while revenue has grown exponentially! Same is the case with Flipkart in India though it managed another round of large funding recently.

Desirable traits

Do the venture capital firms look for the above traits while funding? The alternative to creating a 2SM is for the internet firm to maintain a powerful roadmap of innovative platform features (often referred to as product envelopment strategy) that provides the required glue for users to stick on. A case in point is Amazon, which has augmented its online store by offering digital books through its Kindle devices and apps; and cloud services for others to host their online stores. Amazon is also expected to move in to providing Big Data services including analytics. Indian internet firms would need to either adopt the niche 2SM approach or to broaden their offerings by doing platform envelopment.

(The writers are employed at Sasken Communication Technologies. Views are personal.)

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