Wednesday 10 October 2012

The joys of Platform Risk

I've written in the past about why I love platforms. Putting on my investment analyst's hat, owning a platform is one of the greatest assets a company can have. It gives them a deep competitive moat to protect pricing (and ultimately margins), and the prevalence of platforms is one of the standout features of the tech industry versus other sectors.

I want to expand on this across a few posts and think about the flip-side of this, looking at things from the perspective of the companies which operate on top of platforms, rather than platform owners. For these they face one enormous peril - platform risk. Investors should also be aware of how this offers both threats, and opportunities.

Zynga's platform problem

I've been thinking this week about platform risk. It was Zynga's profit-warning zinger last week which reminded me of this, particularly this comment:
At the same time, we are continuing to invest in our mobile business where we have one of the strongest positions in the industry. These actions support our strategy to transition from being a first party web game developer to a multiplatform game network. [italics are mine]
This is Zynga's dilemma. They are overwhelmingly exposed to one platform for their revenues (Facebook, and specifically Facebook on the desktop), and customers are unwilling to engage with them on other platforms (such as mobile). The platform which was previously lifting their business like a magic carpet, has now turned into a falling stone.

That, in a nutshell, is platform risk.

Introducing platform risk

Platform risk is when you wholly or largely dependent on someone else's ecosystem, and that ecosystem moves suddenly against you. It could be the ecosystem starts failing (being a Symbian app developer would be a good example of this), or it could be that the platform you are working on starts competing against you. For example, for sellers of turn-by-turn navigation apps once Apple started to build it into iOS Maps 6 (okay, in this case they probably have another year or so before Apple gets it right!).

Technically speaking, a failing ecosystem is platform decline, and the platform owner turning round and competing with you is subsumption risk. Zynga currently has a rather nasty case of platform decline.

Note this should not be confused with the burning platform, so memorably popularised by Stephen Elop. A burning platform is when the platform you own and run is going down (and taking your P&L down with it). Platform risk is when the platform someone else owns (but you depend on) turns round and screws you. Platform risk for Nokia would be, for example, if Apple suddenly used its cash pile to buy up all the telcos and banned Nokia handsets from the networks.

Platform risk is everywhere

Modern dependency culture?
I blame the tech stack!
Platform risk occurs in other industries (one word: Betamax), but is particularly prevalent in the tech sector, particularly in the world of software. This is because much IT architecture looks like a stack, where each layer cannot function without all the layers underneath it. This is fine when you have a choice of vendors for your dependent layers (shall I buy an Apple or a Dell laptop to run my software on?) but it is dangerous when you have only one choice (Facebook is the only place where Zynga can find mugs willing to spend 99c on a virtual pink cow).

You only have to look around to see this isn't an uncommon problem. For example:

Dealing with platform risk

Platform risk is a nasty bug to catch, and in most cases prevention is much better than cure. Effectively platform risk is a symptom, not a cause. It generally arises where there is a competitive imbalance between the platform owner and the ecosystem which operates on the platforms. Either the platform owner is too weak (in which case their platform is going down), or they are too strong (in which case they think they can make arbitrary changes to the platform or start competing with the ecosystem).

The best solution is to operate on a platform where this imbalance does not occur. Typically you want a mature, open platform where the owner is making money but isn't incentivised to rock the boat. However there is a big catch - these tend to be the lower-growth platforms. The ones where you can double your revenues every year, or tap new and exciting markets - they tend to be the newer and more closed platforms.

Hmm. Do you really want to be playing this game?

So what you are left with is a sort of perverted Russian roulette. You have a pistol to your head; the platform owner on the other side of the table is equipped with an M1 Abrams. Get your choice wrong and you pretty much unlimited downside (see that car in the picture above? that's you). Get it right and he might offer you a lift on his little tank.

Which is where I will leave it for today. In my next post I want to outline the sort of platforms that exist in more detail, and suggest how tech investors can benefit.

PS One last thing - there is of course a whole bunch of businesses which thrive on subsumption risk - and that is start-ups who's main aim is to eventually be bought out by one of the platform giants (for example Facebook buying out facial recognition shop In fact often startups target this as a key exit strategy - after all in a world of technology behemoths very few startups have the wherewithal to play the long game (hat tip to Mr Zuckerberg). Most of them just take the money and run.

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