Invisible Engines

To be successful, multisided platforms must bring at least two participants to their ecosystem, find the right price for both sides, and identify what incentives need to be present to attract each side. In pursuit of these goals, they have three key decisions to make: level of integration, pricing, and which features and functions to include. 

Invisible Engines: How Software Platforms Drive Innovation and Transform Industries by David S. Evans, Andrei Hagiu, and Richard Schmalensee

“Invisible engines” are software platforms, software which makes services available to other software through Application Programming Interfaces. A multi-sided business must determine what sides it should expose to its ecosystem and participants. To determine scope and integration of the business a platform provider must ask whether to produce complements that work with the software platform, or leave that to someone else. Pricing is essential because it is a key incentive to get all sides on board and to interact with each other. Similarly, the level of profit to seek from each side is a key consideration. Platforms must also determine what features and functions to provide to their participants.

Integration

Platform ecosystems include end users, producers of complements, and sometimes other platforms. Video game consoles are platforms for gamers, game developers, tool developers, and peripheral manufacturers. Mobile phone ecosystems include consumers, content providers, handset accessories, and carriers. Platforms must ultimately provide an entire solution to their customers, but there are many alternatives for how they assemble a set of complementors for all required components. Components may include peripherals, tools, applications, and content. Apple tends to cover the entire spectrum while other platforms focus on one foundational layer such as an operating system. Game console makers have always integrated hardware and software. In many cases, the platform owner will be the driver of innovation within the entire ecosystem. Microsoft has often played this role in the personal computer space. Platforms also take the evangelism roles to ensure the development community it aware of the benefits of participating in the market.

In early markets, platform providers often produce software and hardware to jump start growth and attract end users to a complete solution. As platforms and their markets mature, third party integration becomes less risky and more attractive as standards are built and integrations become more stable. Multi-sided platforms work best when integrations with complementary products are standardized and mature. Competition among input and complement providers is a sign that a multi-sided market is healthy. The video game industry dis-integrated twice: once to separate hardware and applications into separate ecosystem groups, and a second time to separate game development studios who create the games and game publishers who bring the games to market. Some platforms acquire component producers to ensure control over the initial phases of market introduction.

Pricing

Platform pricing is complex due to the many relationships contained within the ecosystem and the need to keep everyone happy and interacting profitably with everyone else. Typically software platforms charge either for access or for usage, but not both. As other businesses, platforms take advantage of price discrimination to fine tune the business relationships supported between the participants. End users are usually the group that provides the bulk of the profit for platform operators, except in the case of game console producers who subsidize game players but make up for it by extracting licensing fees from developers. The authors found that “the pricing structure that ignites the business is generally the pricing structure that persists over time.”

Key pricing decisions include: will the platform charge for access or usage or both; what will the different platform participants be charged; and which side will be subsidized by the other and get a free ride.

If there are costs associated both with providing access and providing usage, it seems more common for firms to make the bulk of their profit from usage, which measures strength of demand, rather than from access.

A common platform pricing strategy charges one side, but not the other. Credit card providers give cards away for free to consumers, but charge merchants a percentage of every transaction. Some merchants rebel against this by directly passing that cost on to consumers. Similarly, newspapers and magazines make more from advertisers than they do from subscriptions.

Features

Platforms often use feature bundles to segment their customers and increase profits. Bundling features has an interesting side-effect for platform owners. Enticing one side by bundling may increase the number of users on the other side. The book discusses “feature accretion”, the process where platforms continue to add new features over time with the result of doubling in size approximately every two years. Although platforms can offer bundles, they typically do not offer models (like cars); rather, they provide a take-it-or-leave-it set of functionality.

Published in 2006, one year before the introduction of the iPhone and two years after the founding of facebook, this book looks at software platforms through an economic lens. The early chapters of the book contain a description of programming languages, operating systems, networks, computers in general, APIs, and Open Source. The next few chapters are dedicated to case histories of 1970’s to early 2000’s computer industry history including programming languages, operating systems, mobile phones, personal computers, digital music players, and digital music platforms. These case studies feature Palm Pilot, iPod, RealNetworks, Microsoft, Apple, and DoCoMo.

The last section of the book discusses key decisions that platform owners need to make. First is the scope and level of integration that the business undertakes. Second is pricing, enticing all parties to participate, and overall business model. Finally, features and functionality for the platform must be selected. The book contains a detailed discussion of pricing models and strategies in the context of economic theory. The authors also examine trends and popular pricing strategies and profit profiles of software platforms.

Invisible Engines was one of the first books on platforms and contains analysis and models that are still relevant. Although the examples are all pre-2006, there’s a lot of history to enjoy and compare to today’s landscape. It is limited in scope relative to books like Platform Scale by Sangeet Paul Choudary and Platform Ecosystems by Amrit Tiwana, but it is an in-depth portrayal of early platform pioneers with an emphasis on business models and pricing. It takes some close reading, but Invisible Engines holds many valuable patterns and insights.

Invisible Engines focuses on economics, business models, and industry case studies. Platform Scale covers the dynamics of platforms, their underlying models, and how to achieve growth. Platform Ecosystems is a vast textbook that covers all aspects of platforms from technology through governance.