Platform Business and Pipeline Business: How to Leverage Your Network

Platform companies of all sorts are booming in the world of startup However, even pipeline companies could benefit by the fundamentals that make a business model viable.

Once the realm that was the domain of Silicon Valley technology wizards, non-tech companies such as WeWork up to Sweetgreen have been now adopting an alternative to the platform model to increase their worth.

In their simplest form platforms “bring the two parties together in exchanges of high value. Their primary assets are interactions and information that together form the foundation of the value they generate and their competitive edge,

Platforms are on the rise. Knowing what makes them effective can help the owners of any type of business to accelerate growth.

What Makes a Platform Business Different?

It’s important to remember that although platform companies facilitate high-value exchanges, they’re also not necessarily the sole ones responsible for supplying products or services in the manner that pipeline companies do.

To show this Let’s make a basic comparision between two popular companies: Target, a traditional pipeline company as well as Amazon’s marketplace segment which is a platform-based business.

As a pipeline company, Target has relationships with several suppliers, from whom it purchases items to sell in its stores. Target is accountable for the money needed to keep inventory in order and also for marketing to ensure that customers are able to are able to access its stores (among numerous other expenses). The ultimate goal of Target is to sell its inventory at a price that is based on the different expenses.

However the marketplace business of Amazon does not manage inventory, and sellers are mostly responsible for their own advertising, which could include buying advertisements from Amazon.

Although neither is a perfect instance of a pipeline, or platform, they can serve as helpful references to discuss. At the end of 2020 according to analysts from Marketplace Pulse, Amazon’s platform was worth more than one-and-a-half times its pipeline business. However, even though Target has a little dipping into the model of a platform for the stores Starbucks counters Ulta’s stores for beauty and Target Plus marketplace but it’s only the tiny portion of the overall business.

The Network Effect

The advantage of the model platform is due to something known as”the effect of the network. As per Van Alstyne Parker and Choudary the term “network effect” refers to the process by where the rise in the number of retailers and consumers generates a rise in value.

It is clear the differences in the case that we have of Target Amazon and Target. Amazon.

Because of the marketplace aspect of its business Amazon can benefit from a cycle of virtuous when more sellers are added to the platform, more customers can find what they’re looking for and this results in more sellers, and so on. Since Amazon doesn’t have to worry about increasing inventory or making payments for marketing, it is able to continue to add new sellers efficiently and increase its competitive edge all over the world.

Target On its own is able to grow its product range however, these decisions are usually a zero-sum bet. To stock a item, Target must move allocation from another item or choose not to carry it completely. Additionally an increase in the number of customers at a Target store does not always lead to the addition of vendors who sell through Target in general.

The network effect can transform from a positive one to one that is vicious if users quickly abandon a platform such as Facebook, for example, companies that have profited from the effects of the network have been paid handsomely.

Financial Analysis: Amazon vs. Target

The advantages that come from platforms stand out in a financial analysis. Also, it’s important to note that, while neither company is a perfect example of the model of business it represents however, the numbers can be instructive.

Financial Comparison

Scroll to the right to view the Target data. All data is in USD million and taken from every financial year’s end (Amazon December 31, Target, January 31 Target January 31) Enterprise Value calculated at December 31 every year. Averages are all straightforward to the lines analyzed. EBITDA and EV taken from Morningstar All other figures derived from public filings.

Amazon surpasses Target in every metric that are related to the efficiency of balance sheets. In part due to Target’s pipeline model of business that requires the company to hold more than two times the amount of in inventory that it has on the balance sheet, as a proportion of its total assets. If you use enterprise value, also known as the EV, as a proxy for the value that is created through balance sheet assets the disparity becomes more evident, as Target is on average 15.38 percent of its EV held in inventory, whereas Amazon is only 2.21 percent.

The income generation statistics reveal an identical situation in that Target being required to spend significantly more on the products sold–70.52 percent of revenue in the average, as compared to Amazon’s 60.53 percent. Additionally, Target spends much more on general, sales and administrative expenses that include marketing–20.59 percent versus Amazon’s 7.88 percent. Amazon’s efficiency relative to its competitors gives it an EBITDA–earnings before interest taxes, depreciation and amortization margin of 11.91 percent, compared to Target’s 9.25 percent.

Due to this overall efficiency improvement and the fact that it has been able to outperform Target, it comes as no that Amazon has grown its revenue at a minimum per year of 29.67 percent from 2017 even though Target has only generated 9.02 percent.

Markets have always given a boost to Amazon for its ability (among several other aspects) by granting an EV-to EBITDA multiplier that is three times the value of Target’s.

How to Integrate Platform Best Practices Into Your Company

In light of all the possible advantages, it is logical to integrate the elements of a business model platform in an existing company.

Even though Silicon Valley may lead people to think the platforms represent a new model, it can be stated that platforms exist for quite a while.

Consider the fast-food restaurant franchise for instance. Burger King, which consists mostly of franchises offers a general plan for restaurants, which includes menus and branding, however it’s the responsibility of the franchisee to offer worth to the customer. When it comes to establishing this network, Burger King takes a commission similar to how Amazon is paid a percentage of its sales through its Marketplace.

This is only one of the ways that integrating practices from platforms can be beneficial to a company. Here are some ideas to think about ways to apply the same principles to your business:

Best Practice No. 1: Think “Asset Light”

A platform-based business has advantages of having fewer capital assets (inventory or other fixed capital) in its balance statement. Reducing drag on assets increases the efficiency of the business.

Most useful Practice To Increase Commission-based Revenue, Lowering Reliance on Inventory Turnover

The best platforms can generate income without the expense that come with the turnover of inventory. Businesses that are able to make a share of transactions between two partners will be able to grow in a capital efficient manner.

Most reasonable Practice to Encourage Third-party Value Producers to Incentivize Customers to Join the Network

By placing incentivizing in the producers of third parties, platforms can leverage other members of the ecosystem to aid in the promotion of the platform. This lets the platform business outsource a portion part of their marketing as well as acquisition expenses.

Most suitable Practice Leverage to Increased Consumer Demand to Encourage More Producer Participation

This is the other face of the coin that is found in Best Practice No. 3. You can create a positive cycle by adding more producers to meet the increasing demand of customers, which results in more customers and the cycle continues.

 Practices to Identify Value to Third Parties Within Your Ecosystem to Create a New Revenue Stream

The most famous example is social networks, whose entire business model is centered around giving value to third-party advertisers. The main producers and consumers of social media content aren’t engaged in financial transactions but the data they create in the network is beneficial to third party advertisers. Additionally, harnessing the infrastructure you have constructed could lead to opportunities to generate additional revenue sources.

Case Study on How a Department Store Implements Platform 

Because best practices can appear to be to be a bit abstract however, it’s useful to examine a common illustration: an American department shop.

In almost every way in any way, almost every metric suggests that the American department stores are in trouble. Due to the growing eCommerce competition and the ever-growing cost of real estate, only a handful of businesses are more dependent on implementing the best practices of platforms than the old American giants of commerce.

What are they doing?

Using Subsidiary Stores to Reduce Their Assets

Instead of being the sole ones accountable for purchasing and sourcing inventory (and keeping the inventory to their own balance sheet) Certain department stores are now allowing brands to lease space, for instance, the way that cosmetics brand Sephora currently leases space inside JCPenney and mall storefronts. Brands are now able to establish subsidiaries and are accountable for storing the inventory in their balance sheets.

The subsidiary store usually will pay the department store that is hosting it rent in addition to the percentage of sales. This is very like Amazon that offers sellers a modest cost for being on the platform, and earns a percentage of every sale. In both instances it is less dependent upon direct turnover of inventory because the platform is earning an income percentage from topline sales instead.

Attracting Customers by Encouraging Subsidiary Stores to Shoulder Some of the Responsibility

In the typical wholesale arrangement, the company earns its income when it sells to the retailer, and the retailer is responsible for the risk that the product could or would not be sold. With the subsidiary store model it is the brand that takes on the risk of inventory and has a greater incentive to deliver the sales and marketing needed to win customers.

Leveraging Increased Foot Traffic for Subsidiary Stores to Attract More Brands

This is the second aspect of the cycle that is virtuous. As more shoppers shop at department stores and interact with the affiliate store other brands could find value in being a part of the department store. Although a department store’s real estate commitment restricts its ability to expand as compared with an online store, the potential to include more brands is still. most department stores carry the branded credit cards that permit an outside financing partner to profit from the transaction with the retailer and customer. Through offering discounts to customers who use the card, retailers may encourage customers to return and the finance partner typically receives higher rates of interest than conventional credit cards.

How Can You Implement Platform Best Practices?

With this in your mind, here are some questions to consider when you consider “platforming” your business:

  • What can you do to reduce some of the risk in the balance sheet to the company? That is how can your business model of the business become less “asset light”?
  • What can the revenue stream be made less dependent on turnover of assets (typically inventories) and more dependent on fees and commissions?
  • What can third-party companies do to become profit-making production companies (or service providers) and encourage customers to sign up?
  • What can you do to increase consumer activity? aid in attracting more producers to your business?
  • What are the ways that third parties can benefit from the consumers and producers in your ecosystem?

Takeaways

While not every company will be able or willing to –make the switch to Uber or Facebook however this doesn’t mean owners of businesses shouldn’t be thinking about ways in which best practices for platforms can boost their company’s effectiveness.

One of the most crucial things to keep in mind when applying the lessons learned from platforms to business is that even small adjustments can have a huge positive effect. In the end, looking at how the best practices of platform might fit into your own business can help you identify opportunities that you never thought of.

Leave a Comment