David Evans and Dick Schmalensee on “The New Economics of Multisided Platforms”: An interview by Bob Morris

David Evans and Dick Schmalensee are among the early pioneers in the research of “multi-sided markets” and the economic principles that inform the unique design of business models, pricing and incentive structures, and product design for these platform-based businesses.

Evans, DavidDavid is an economist, business adviser, and entrepreneur. He cofounded, and helps lead, two consulting organizations: Global Economics Group, which provides economic expertise on antitrust and regulatory matters, and Market Platform Dynamics, which advises companies on multisided platform strategies. He is also Chairman of PYMNTS.com, a multisided media and data analytics platform he cofounded. He has consulted for many of the largest multisided platform businesses in the world and served as an adviser to a number of start-up matchmakers.

In addition, David has an active academic career. At the University College London he is Executive Director of the Jevons Institute for Competition Law and Economics as well as a visiting professor. He is also a lecturer at the University of Chicago Law School. David is the author, coauthor, or editor of ten books and has written more than one hundred scholarly articles, many of which address the economics of entrepreneurship, business dynamics, and multisided platforms.

Schmalensee, RichardDick has served as a business advisor and board member to some of the world’s most prominent platform businesses, including The International Data Group. He is also a principal at Global Economics group and is the Howard W. Johnson Professor of Management and Economics, Emeritus at the Massachusetts Institute of Technology (MIT) and Dean, Emeritus of the MIT Sloan School of Management. He is one of the world’s leading authorities on industrial economics and a Distinguished Fellow of the Industrial Organization Society.

Dick served as a Member of the U.S. President’s Council of Economic Advisers from 1989 through 1991, where he had primary responsibility for domestic and regulatory policy, including environmental and telecommunications policy, and for U.S. assistance to Central and Eastern Europe. He co-wrote Paying with Plastic, Invisible Engines, and Catalyst Code with David Evans and is the author or co-author of 11 books and more than 120 published articles, and he is co-editor of volumes 1 and 2 of the Handbook of Industrial Organization. Dick holds a SB and a Ph.D. from MIT.

Their latest book, Matchmakers: The New Economics of Multisided Platforms, was published by Harvard Business Review Press (May 2016).

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Morris: Before discussing Matchmakers, a few general questions. First, who has had the greatest influence on your personal growth? How so?

Evans
: My Mom, Dad, and older brothers and sister for creating a home filled with books and intellectual curiosity nurtured. Sometimes it helps being the youngest.

My family, without question. My mother gave me intellectual curiosity; my father taught me the value of hard work; and my grandfathers taught me to treat everyone with respect.
Morris: The greatest impact on your professional development? How so?

Schmalensee: Paul MacAvoy. In a course I took from him as a sophomore I developed what has turned out to be a lifelong interest in how markets really worked as well as an appreciation for his style of research.

Evans: Milton Friedman and Jim Heckman are tied here. I took Friedman’s graduate price theory course as an undergraduate and learned how to think like an economist—which goes far beyond the math. And I ended up there, and learned so much about economics as a science, from Heckman, my first economics professor, who pushed the boundaries in every article he did.

Morris: Years ago, was there a turning point (if not an epiphany) that set you on the career course you continue to follow? Please explain.

Evans: My most recent epiphany, which is related to Matchmakers, occurred in around 2000, when Jean Tirole previewed his work with Jean-Charles Rochet that showed that Visa and Microsoft had the same business model. I realized immediately that these businesses were so interesting, and so unknown, that I should focus on them for many years.

Morris: To what extent has your formal education been invaluable to what you have accomplished in life thus far?

Evans: A foundation for sure but like many economists I’ve learned the most by doing research, writing articles, getting it past smart referees, and getting published.

Morris: What do you know now about the business world that you wish you knew when you went to work full-time for the first time? Why?

Evans: That great entrepreneurs, great artists, and great athletes have a lot in common. What they do looks easy but involves incredible skills and remarkable intuition that precious few posses.

Schmalensee: I wish I had understood the importance of what Douglas McGregor called “the human side of enterprise.” As a young economist, I viewed business as numbers, but it is fundamentally people, and the ability or inability to bring out the best in people makes all the difference in business – or any organization.
Morris: Here are several of my favorite quotations to which I ask you to respond. First, from Lao-tse’s Tao Te Ching:

“Learn from the people
Plan with the people
Begin with what they have
Build on what they know
Of the best leaders
When the task is accomplished
The people will remark
We have done it ourselves.”

Evans: Fine advice for mature business organizations but new ventures need entrepreneurs who can lead people to a destination only they know, and that only they know how to get to.

Morris: From Michael Porter: “The essence of strategy is choosing what not to do.”

Schmalensee: I repeat this quote all the time. Successful companies often try to become even more successful by going into markets for which they are ill-equipped, and failing companies often try to succeed by trying something completely different. Success requires focus.

Morris: From Richard Dawkins: “Yesterday’s dangerous idea is today’s orthodoxy and tomorrow’s cliché.”

Evans: It reminds me of an exchange between Milton Friedman and Paul Samuelson. Friedman said something like one man and the truth is a majority. Samuelson retorted that one man and nonsense is a crank. Unfortunately, dangerous ideas are often dangerous ideas.

Morris: Finally, from Peter Drucker: “There is surely nothing quite so useless as doing with great efficiency what should not be done at all.”

Schmalensee:
This happens often when a company is really great at something that the market has left behind. It is hard to walk away from something you are really good at, but the best buggy makers couldn’t out-compete the auto industry – and Motorola’s analog mobile phone business was destroyed when digital phones took over.

Morris: Looking ahead (let’s say) 3-5 years, what do you think will be the greatest challenge that CEOs will face? Any advice?

Schmalensee:
For many CEOs of established firms it will be to react in time new forms of competition, from unexpected directions and often from unexpected places. At any time some CEOs have always faced this threat, but I think it will be more pervasive as innovation and globalization continue. For CEOs of new firms, the greatest challenge will be what it has always been: survival. The advice to both is simple: watch the market you serve carefully, and be ready to change course when necessary.

Morris: Now please shift your attention to Matchmakers. When and why did you decide to write it and do so in collaboration?

Evans and Schmalensee: We had done a good deal of work together on the theory of platform businesses as well as a good deal of consulting for new and established platforms, and we talk a lot with each other. The idea for this book jelled in early 2015, and, once we had settled on an organizational design, the writing went quickly.

Morris: Were there any head-snapping revelations while writing it? Please explain.

Evans and Schmalensee:
Yes, we were trying to fill in simple statistic on retail trade from the Census Bureau data and discovered that their published data on online sales made little sense and were probably wrong.

Morris: To what extent (if any) does the book in final form differ significantly from what you originally envisioned?

Evans and Schmalensee: It differs mainly in the ordering of chapters. We knew almost from the start what points we wanted to make, and we had a pretty good idea of what examples we wanted to use to make them. Ordering the chapters took some discussion, but we got it right (we think) fairly quickly.

Morris: For those who have not as yet read Matchmakers, what is a “multisided platform”?

Evans and Schmalensee:
A multi-sided platform is a business that adds value by facilitating valuable interactions between members of two or more distinct groups. For members of any one group, the platform’s product is the ability to access members of the other group or groups involved. Examples abound: shopping malls bring shoppers and merchants together, so, in a different way to payment cards, and Uber brings passengers and drivers together.

Morris: Please explain the reference to this business model’s “ancient roots.”

Evans and Schmalensee: Our title makes the point that village matchmakers in many traditional cultures operated platform businesses. Medieval and renaissance trade fairs were platforms bringing buyers and sellers together. In the book we discuss a platform in ancient Athens that brought together ship-owners, merchants who wanted to travel to foreign ports, and investors interested in financing foreign trade.

Morris: What are its unique advantages and potential benefits?

Evans and Schmalensee: The unique advantage of this business model, particularly when turbocharged by modern information and communications technology is the potential for explosive growth with modest capital requirements. Once Airbnb had attracted enough people willing to rent rooms, in the right places, and enough people interested in renting them, each group attracted new members of the other group, and growth took off. On the other hand, the unique disadvantage of this business model is that unless a new platform can attract the critical mass of members of all groups it serves necessary to trigger explosive growth, it will fizzle and fail.

Morris: What are the core principles of “the new economics” of the multisided platform?

Evans and Schmalensee: There are three basic requirements for success. First, the matchmaker needs to reduce a significant friction that inhibits valuable interactions. Unless this is the case, there is unlikely to be enough value in the business to keep all necessary groups on board and to provide a decent profit. Second, the matchmaker needs to be able to reach critical mass. It is much easier to design a platform that will be a great success if almost all potential users get on board; it is much harder to get enough members of all groups on board to launch successfully. Third, the matchmaker must balance the interests of all groups. This involves pricing – it is often necessary to provide services for free or at least below cost to one or more groups – as well as platform design, rules for platform participants, and managing the platform’s ecosystem.

Morris: What are the defining characteristics of a matchmaker company?

Evans and Schmalensee:
The matchmaker is always facilitating exchange between parties. Could be exchange of pecuniary value, like Uber, or an exchange of non-pecuniary value, like dating and mating.

Morris: When specifically are the economics of traditional firms preferable to those of matchmakers?

Evans and Schmalensee:
There may not be any universal rules here, but two relevant issues come to mind. First, it is often easier to launch a traditional business. Amazon began as an online bookseller, a traditional business. It didn’t have critical mass or balancing problems: it just bought books and resold them, then added other products. After it had attracted enough regular customers, it could launch Amazon Marketplace, effectively an online mall, and attract merchants because of its customer base.

Second, traditional firms have more control over its customers’ experience. Zappos began as an online mall but switched to a traditional business model so that it could guarantee good customer service. Third, it may just not make any sense to be a matchmaker because the business is just producing a good or service. If you want to make cars, or you want to have a rock band, you can’t be a platform.

Morris: Here are several matchmaker companies, listed in alpha order. Please suggest what you consider to be the most valuable business lesson to be learned from each. First, Alibaba

Evans and Schmalensee:
A matchmaker needs to reduce an important market friction. Business to business exchanges failed in the US because the frictions keeping buyers and sellers apart really weren’t that important. When China first began encouraging private businesses, however, those frictions were enormous, and Alibaba prospered enormously by finding a way to reduce them.

Morris: Aventura Mall

Evans and Schmalensee: Malls show the importance of design and of balance. To go from one of the major, anchor stores to another consumers normally have to walk past a number of other stores, which benefit from the foot traffic. But a mall can’t make it too hard to get from one anchor to another, or customers will be turned off.

Morris:
Google

Evans and Schmalensee: Google’s model is a classic media model, turbocharged by technology. Google provided the best search for free and, by outcompeting other search engines for consumers’ eyeballs, assembled an audience that it could sell to advertisers. This is not basically different from newspapers, which sell papers at or below cost and then sell the audience to advertisers. Google, like many platforms, has a money side – advertisers – and a subsidy side – searchers.

Morris: eBay & PayPal

Evans and Schmalensee: eBay was a marketplace—not any different than a flea market or a bazaar—that connected buyers and sellers. But by connecting buyers and sellers globally, and efficiently, it showed that you could create a dense market for obscure items (what sellers would call junk, and buyers would call collectibles). PayPal showed that a platform could create value by aggregating other platforms—it depended on the payment card networks, which were two sided platforms for the cards that consumers had—and made it easier for consumers and merchants to use them for payments online. And eBay and PayPal together show that platforms can complement each other—PayPal made it easier for buyers and sellers to engage in transactions and be able to trust each other.

Morris: Uber

Evans and Schmalensee: Uber shows the power of technology to turbocharge the matchmaker model. Uber’s ability to match drivers and riders everywhere in the world simply could not have been done even a few years ago.

Morris: YouTube

Evans and Schmalensee: YouTube is a great example of the explosive growth that a platform can enjoy when it attains critical mass – and of the difficulty of getting critical mass. The founders spent a long time trying to get people to upload videos that would attract viewers, but when they finally managed to do so, their growth was explosive. And, of course, once they became the place to upload videos and to view videos, other video-sharing sites fizzled, and only a few still hang on.

Morris: In Chapter 2, you identify and discuss six critical issues that multisided platforms must accommodate. Which seems to pose the greatest challenges? Please explain.

Evans and Schmalensee: This varies to some extent among platforms, but in the main the problem is getting to critical mass. OpenTable is a great success now, but if it didn’t have enough good restaurants in Boston, we wouldn’t use it, and if no consumers used it, no restaurant would go to the trouble of signing up. OpenTable got off the ground by, first, developing table management software that was valuable to restaurants even if no diners made online reservations and, second, by signing up enough restaurants in a few cities so the consumers in those cities would find it useful to make online reservations.

Morris: You also identify and discuss six new and rapidly improving technologies that have driven matchmaker innovation. In your opinion, which of them seems to have the greatest upside potential? Please explain.

Evans and Schmalensee:
We’re economists, not technological forecasters, but it is important to note isn’t any single technology that matters; it is the bundle of all of them. Thus improvements in any one of them will make the whole bundle and all of its other components more valuable. And it is easy to predict that there will be improvements!

Morris: In your opinion, how relevant is Joseph Schumpeter’s concept of creative destruction to the current VUCA marketplace? Please explain.

Evans and Schmalensee: By VUCA you mean violence, uncertainty, complexity and ambiguity we assume — one of the latest buzzwords. In the middle of a wave of creative destruction everything looks VUCA. It is hard to predict who will happen next and the turbocharged technologies we mention certainly add to this. We think history, though, will look back at the decades following the development of the Internet and see that the waves of creative destruction aren’t that much different than earlier ones. Some things will change rapidly but other disruptions will take decades to play out. Note that 20 years after the start of the Internet less than 10% of retail is conducted online and Amazon is just a piece of that.

Morris: Opinions are divided about the nature, impact, and significance of disruptive innovation. Your own thoughts about it?

Evans and Schmalensee: We think the basic notion has merit: innovations sometimes fundamentally change industries, displacing established firms. And industry leaders so often fail to see the potential of innovative technologies and business models. But the Christensen notion that disruptive innovations are always cheap initially seems too restrictive.

Morris: For more than 30 years, it has been my great pleasure as well as privilege to work closely with the owner/CEOs of hundreds of small companies, those with $20-million or less in annual sales. In your opinion, of all the material you provide in Matchmakers, which do you think will be of greatest value to leaders in small companies? Please explain.

Evans and Schmalensee: We wish we could say the answer is that you’ll read this book and be inspired to create a great matchmaker platform—like Jack Ma who sent from several failed small businesses to the massively successful Alibaba. That could be true for some and we sure hope it is.

Practically, though, we suspect that the greatest value if helping owners/CEOs understand the incredible risks and difficulties of starting platform-based businesses. Most of the successful owners/CEOs are probably thinking of this as investors and we’ve provided lessons that show that you should be very cautious about investing in, say, the next Uber-of-X. Others might be thinking that everything is going to become a platform and they better too. That advice is almost certainly wrong as well.

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David and Dick cordially invite you to check out the resources at this website.

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