Google's Complex Execution of simple Two-Sided Business Model Strategies
While researching a forthcoming Executive Briefing on Google's business model, we realised that there are certain strategies that come up again and again when you deal with two-sided business models. In fact, these are so regular we numbered them - Strategy One, Two, and Three.
Strategy One: Transactions
If your business is all about facilitating transactions, as two-sided businesses frequently are, then an obvious way to make money is to work on commission - to charge a percentage of each deal for your services. This is of course the traditional way of remunerating people whose jobs consist of buying and selling - salesmen , stockbrokers, investment bankers. It sets up incentives to maximise the number of deals and secondly to maximise their value.
Amazon's merchant pricing is simple enough - when a sale is made, it takes a percentage. But the interesting element in this is that it maximises the number of sales by giving away all its services up to the point of sale. It costs nothing to list your products on Amazon.com - it also costs nothing to carry Amazon products on your own e-commerce site. It costs nothing to use their superb analytics tools to understand your customers. It costs nothing to use their payments system. It costs nothing to ship through Amazon's forward and reverse logistics...until you actually make a sale, collect the cash, and ship out the goods. There is also no upfront cost for the use of their superlative IT infrastructure - S3, SQS, and EC2 users pay for the capacity they use.
Similarly, the global credit-card network VISA works on commission. It receives revenue from two sources - fees paid by merchants for service, and a percentage transaction charge. The interesting element is that much of the money taken in transaction fees is redistributed through VISA's internal economy to the banks involved in that transaction, essentially subsidising both the issue and acceptance of credit cards and therefore maximising the volume of transactions. Rather than paying a fee for a credit card, you pay for it in transaction fees, a cost you share with the merchants, who are therefore sharing the incremental revenue from credit card customers with VISA.
Strategy One can be summed up as free entry and transaction charging.
Strategy Two: Bar Takings
Lloyds of London started out as a cafe; everyone knows that. It became an insurance market because a lot of marine insurance brokers went there for their coffee, and stayed for the rumours. Eventually some bright spark realised that if you wanted to buy the rumour and sell the fact, it helped to be close enough to the source of the rumours (and, good heavens, perhaps even the facts) to trade immediately.
But Lloyds Coffee House was still a coffee house. It didn't make its money by participating in the insurance market; it didn't levy a percentage commission. It made its money by selling coffee. The more brokers turned up, and the more they spent their time working from the coffee house, the more coffee they sold, and presumably the higher the volatility index rose, what with all the caffeine. Which created opportunities for cooler heads, and any proto-Michael Spencer who planned to run a matched book and make money on volume, running their own little Strategy One business.
Essentially, you're creating a big pool of customers to sell things to; it doesn't matter what they actually come to do, and in fact the reality of this may get quite a long way from the original intent. Lloyd didn't go into business to start a marine insurance market, after all. Perhaps the canonical example of this is London itself; the City originally came there because of the ships, but by the time the port moved downriver and containerisation led to the triumph of Rotterdam, there were plenty of people doing business there for entirely different reasons.
This is also the case of those container ports - businesses spring up in their duty free zones, providing crewing, provisioning, freight forwarding, ship repair and many other services to the passing ships.
Another example of this phenomenon is the way in which the owner of major British airports, BAA plc, has progressively become a company dominated by retailers; its Strategy One landing fees are state-regulated because of its natural monopoly at Heathrow, so it put more and more effort into selling things to passengers waiting for their flights. But this is a slightly different strategy...
Strategy Three: Access
If you've accumulated a pool of customers by subsidising one side of the business, you're in a position to sell them something. Therefore you're also in a position to sell the opportunity to do business with them to others. Alternatively you can charge the customers for the opportunity to take part; £20 to get in, shut up and dance. Which one you choose depends on the crucial question - where is the scarcity?
To begin with, credit cards were scarce, and therefore merchants were uninterested. VISA arranged things so that the banks benefited from cutting the price of credit cards, and merchants were suddenly under pressure to join in. Lloyds' 18th-century marine insurers would no doubt have found somewhere to meet up, but without the coffee house they would have had to do so uncaffeinated.
Selling Web ads as if they were billboards has important restrictions - the chance of a sale from any given display ad is low, so advertisers need to buy a large volume. The price of an individual ad is also high because of limitations on display ad inventory. The costs (monetary and non-monetary) of building a reasonable Web site continue to restrict the available inventory and keep prices up. So, all in all, web advertising remains an expensive business for most companies.
Google reverses the logic of display ads (that advertising opportunities are scarce, expensive, and risky) by forcing down the marginal cost of an advert on one side, and by subsidising the creation of ad space on the other. Blogger blogs, Google Maps, Gmail, Google Search are free and so very popular and all create both ad opportunities to sell, and more information to refine the ad-matching process. Contextual advertising, and mass production IT, expand the volume of possible buyers. Google also subsidises the creation of content to advertise against with actual cash payments through its affiliate program and through wholesale deals with major content sources.
The power of combinations
Like all the best ideas, the basic strategies offer much scope for innovation by combining them. Google is trying to build up businesses that generate subscription-like revenues, mostly through Google Apps for Business, and it may respond to the economic crisis by flipping its model and devoting more effort to the buy-side. At the moment, Google's revenue-earning services are all marketed to upstream customers - the sell side. What could they achieve on the buy side, in terms of Vendor Relationship Management?
The great container ports combine charging for transactions (port fees), charging upstreams for access (businesses in their free zones pay rent), and selling to the crowd (providing services for passing ships).
Two-sided success for telcos will require a similar integrated strategy. Success will not come from a simplistic strategy which involves subsidies on one side and revenues on the other: a successful Telco platform will have a web, or ecosystem, of commercial relationships underpinned by complex business models and pricing strategies. A chart from our strategy report, The Two-Sided Telecoms Market Opportunity, illustrates this point:
Note: We look at two-sided business model strategies and execution in a forthcoming briefing report on Google which is available as an individual purchase or as part of the Telco 2.0 Subscription Service.
Also, you can apply to join the industry's leading business model thinkers at the 6th Telco 2.0 Executive Brainstorm on 6-7 May in Nice here.