The Risk that Ate the Digital Entrepreneur: Surviving Platform Risk

As a kid growing up in Brooklyn, my parents were consumed with the idea of “safety”. Judging by the elbow and knee pads they made me wear to play basketball, I was convinced I was in constant danger. Was my school safe? Would I be kidnapped if I flashed my Spider-Man wallet in public? As an adult, I realized a neighborhood is just a platform – a foundation on which you build your life – or your business. As our economy shifted from Model T’s to KFC’s, businesses took America’s stable platform for granted.  From Korean grocers in The Bronx to Best Buy in Compton, even our most daring businesses can rely on (mostly) safe streets, good transportation to bring in customers, and phone lines to process payments – and inevitably, dial 911. Even the most dire circumstances rarely threaten the existence of the business itself. Not so in the digital world. There, the platform isn’t public; it’s owned by a private business with shifting motives, profit pressures, and other nefarious powers only a venture capitalist could love. In mobile, many entrepreneurs rely on a stack of two or three platforms locked in an eternal, high stakes dance battle, like West Side Story with iPhones, instead of knives. Having worked with lots of start-ups and corporations, this post will help entrepreneurs understand and survive platform risk.

THE PHYSICAL WORLD: PLATFORMS = CONCENTRATION RISK

I’m sure Disney had good reasons for building a theme park in Orlando instead of say, Kabul or Kiev. Maybe it didn’t want warlords kidnapping Donald Duck, or oligarchs cutting power to Iron Mountain to until Putin gets his way.

Let’s say Disney allows vendors to open shops inside their park in exchange for rent and a percentage of sales.  A local bakery decides the high cost is worth it.  When the bakery becomes wildly successful, it opens locations in other parts of the park and in other Disney parks. Disney, not blind to this success, starts to salivate over the possibility of raising rates. After all, the bakery’s entire business relies on it!

That platform risk cascades to the flour supplier that gave up other clients to service the fast-growing bakery.  Same goes for the trucking companies delivering ingredients.  Each business is built on a “platform” created by the other.  In the brick and mortar world, this kind of dependency smells a lot like concentration risk, or the risk of over-reliance on one or too few customers or suppliers.

This becomes a bit more complicated in digital.

DIGITAL DANGER

The main difference between real and virtual world dependency is that most real world businesses could still exist off-platform.  The bakery makes cakes that everyone can eat – even if it had to start over outside of Disney.  If you build an app on Apple’s iOS or Facebook, you’re not just relying on their customers or location, but your product relies on their code, tools, and architecture.  Without them, there is no business.  Surely, platform owners would never throw their weight around… Like any good capitalist in heat, platform owners know a green thing when they see it:

HOW MUCH DANGER ARE YOU IN?

SAY HELLO TO IDEAFAKTORY’S PLATFORM RISK MATRIX

A lot of factors can affect how warm and cozy the platform you’re on will be once you start making money.  The two most important are the platform’s maturity and profitability. Consider the four stages of platform risk:

1. Desperate: A young platform that still hasn’t made a profit is desperate to find revenue streams. Many Twitter app providers have had the rug pulled out from them when Twitter began delivering the same features. Some of the better ones got bought by Twitter. Others suffered or shuttered as investors ran for the hills.
2. Dangerous: Facebook is very profitable, but still young.  It’s dangerous because it’s constantly reinventing itself, like when it got rid of tabs for applications or its forthcoming Timeline redesign. Or, it may even be subversively hurting third party clients to favor its own services.
3. Docile: Google is a far more mature and profitable business, so it’s likelier to use open source (Android), open API’s, or just offer free apps in exchange for page views (and your personal data, of course).  You’d have to be pretty darned big and menacing to attract their attention, but their services can also fail.  If you pitched investors on your huge plans for Google Buzz, well, R.I.P.
4. Defeated: RIM isn’t “defeated” yet, but it’s in trouble.  Android and iPhone have attracted all the heat.  Even the 1% are rioting in the streets over having drag their Blackberries on their yachts. Aside from just feeling sad, building on a defeated platform means a shrinking customer base, difficulty attracting top talent, and a that sinking feeling like someone is about to repossess your Ford Fiesta.

These are just basic examples (what did you expect for free?).  There are countless others scattered across industries ranging from cars to payments.

MOBILE EXAMPLE

One man’s platform is another’s app.  Nothing illustrates that better than the US mobile industry. Consider the mobile pyramid below.  On the left, you can see that telcos, build on public spectrum and a monopolistic legacy. Manufacturers build their products to work on those networks.  They also choose which operating system (OS) will power the device.  App developers then build their businesses on top of that OS. Some secondary app developers build apps on top of apps.  An example is Tasker, which allows you to automate phone functions.  An entire ecosystem of other apps extend Tasker’s functionality to make a buck or two. ($.99 or $1.99 to be exact.)

What’s interesting about mobile, is how unevenly platform power is distributed.  The network has lots of leverage to raise fees, impose bandwidth caps, and demand higher rates for certain services. Crippling video streaming services like Netflix using download caps is just one example.

Telcos can also choose not to carry certain phones or allow certain apps.  We haven’t seen a Nokia in the US since the Viking era.  Operating systems, like iOS (also a device manufacturer) and Android carry disproportionate weight.  They can dictate rules to app developers or just roll their functionality in future releases, cutting off an entire business. For large companies building apps, this level of risk is high, but many don’t rely on it to power their company.  Start-ups do.  Secondary developers are most exposed since they are subject to whims of whims of whims.  They will be treated as afterthoughts.

AAA: ALL ABOUT ALIGNMENT

As a start-up built on someone else’s platform, your success depends on how well you align with the platform owner’s interests. The minute your interests diverge, your risk increases…or possibly opens a door to sell out and move out of mom’s basement.  Consider what it means to be aligned or not aligned with the interests of your platform.

YOU ARE ALIGNED, WHEN YOUR BUSINESS ____:

• Attracts new customers or revenues to the platform (assuming the platform wants new customers)
• Complements features the platform doesn’t have
• Brings a proprietary asset to the table that the platform provider needs
• Has the platform provider as a direct, strategic investor
• Shares a sizable percentage of revenues with the platform, so your money is their money. Mi casa es su casa, …I can do this all day!

YOU ARE NOT ALIGNED WHEN YOUR BUSINESS ____:

• Competes with the platform in any way
• Does something better than the platform, revealing flaws in their business
• Also partners with competitors
• Presents long-term strategic threat or new business model
• Damages the platform’s brand (too ghetto or p0rn related, etc.)
• Brings too much traffic or volume and jeopardizes platform performance

This isn’t a comprehensive list, but you get the idea.  Timed right, you can turn either situation into a money maker.

WHAT TO DO?

Friends don’t let friends die from platform risk.  I’ve seen lots of young, ambitious, brilliant entrepreneurs fall ill to this scourge.  Even crusty old investors, unsuspecting business partners, and trusting customers are not immune to it. All must decide where to allocate trust, resources, and long-term commitments.

As in the mobile example, investors might need to dig a few platforms deep to evaluate true platform risk for any given business. Customers and partners might need to consider things like contract duration or other commitments to companies built on shaky platforms. For entrepreneurs, depending on where they are in their growth cycle, here are just a few ways they should manage platform risk:

• Business Planning: For new businesses building on 3rd party platforms, their strategy and product plans have to include eventual diversification and baked-in alignment with the platform’s needs. The idea is to have an exit event or an operating model in mind.  Who will buy you?  The platform itself? Or, others who want to play on it? Or, will you be a standalone business?  Will doing it on a single platform present too much risk?
• Alignment: If you see yourself growing, but you are beginning to compete with the platform, its best to revisit your strategy and re-align with the platform owner using the criteria above.
• Diversify or Run: Instead of running a bath filled with Facebook credits, reinvest those coins in building your own platform, or at least diversify on competing platforms. This will give you the leverage should you need to abandon or kill the cash cow. A perfect example is Netflix.  From day one, they planned to abandon the post office as a platform for digital distribution.  Blockbuster and countless publications were the exact opposite. They weren’t prepared to abandon the old model and many are dead or dying.
• Make a deal with the platform or sell out: Companies should ensure they have enough protection from future platform changes by negotiating their own deals (as Zynga did with Facebook). This works best when you have lots of customers, growth, or represent a massive threat or opportunity to the platform itself. Of course, you can always sell out completely. Deals, like good symphonies, have a crescendos.  Look for signs from your customers, investors, or even God that it might be time.  See Groupon example for what not to do.
• Community Pressure: Reserve this for when things start to go south. Let’s say Apple just demanded 30% of your magazine’s subscription fees on the iPad, which will cripple your economics.  You can try using community pressure or band with other affected companies to change the policy.

by Steve Faktor. For more be sure subscribe to ideafaktory