Online Platform Definition:
What is an Online Platform and How Does It Work

What do Airbnb, Uber, Google, Facebook, YouTube, eBay, Alibaba, and PayPal have in common, aside from being among the most valuable startups of recent or upcoming years? According to the Online Platform Definition, they are all platform companies! The success of these enviable companies has made the platform business model the holy grail of business models.

An online platform definition is relevant for startups, young companies, and established companies. For startups, it offers the opportunity to gain a foothold in established markets and grow rapidly. But established companies can also use it very successfully. Apple is the best example. Part of the success of their iPods and iPhones is based on the fact that they used the platform business model. Before these two products, the company was in trouble for more than a decade.

The Key Points at a Glance

Which Online Platform Do You Want to Create?

Online Platform Definition: What Is an Online Platform?

An online platform in e-commerce connects buyers and sellers of specific services or products directly. The best-known examples of this are Airbnb, Uber, Google, Facebook, Immobilienscout24, MyHammer, eBay, and many more.

What Is the Online Platform Definition?

Let us first clarify what we are talking about: Not every technological platform is, according to the Online platform definition, a platform company. For example, Microsoft Xbox, gaming consoles, and app stores are technology platforms that are based on a platform business model according to the Online Platform Definition.

In contrast, Amazon Web Services is a technology platform that is not based on a platform business model according to the Online Platform Definition.

Google, Facebook, YouTube, Airbnb, Uber, eBay, Alibaba, and PayPal use the platform business model. In this article, we use the terms “platform business model” and “Online Platform Definition” interchangeably. Economists also refer to them as Multi-Sided Platforms (MSP). Multi-sided platforms (MSPs) are technologies, products, or services that create value primarily through direct interactions between two or more customer or participant groups. But who are these participant groups? Well, that depends on the platform. In most cases, it helps, according to the Online Platform Definition, to distinguish between the supply side and the demand side:

Value Creation and Value Enhancement

Platforms, according to the Online Platform Definition, help sell products or services, generate content, and so on. But the platform owner does not produce the products that are sold, as is the case with eBay or Alibaba. Nor do they provide the services offered on their platform as with Freelancer, Taskrabbit, Uber, or Airbnb. These online platforms do not create the content that is generated every day as on Facebook, Twitter, or YouTube.

So, how does such an online platform create value? Some say they act as modern intermediaries according to the Online Platform Definition. But that is by no means complete. According to the Online Platform Definition, they must create added value for the entire exchange – while still being able to extract value – in order to remain relevant. Many platforms have struggled because they have failed to achieve this. Here are some examples of how platforms create value for their participants and generate value for themselves:

Asset-sharing platforms such as Airbnb create value:

• Supporting the supply side, such as homeowners/hosts: Increasing the utilization of their existing assets such as units/rooms/houses to generate additional income or achieve a higher return than otherwise possible.

• Helping the demand side, such as vacationers: Finding cheaper and more personalized accommodations, or securing lodging during peak times—such as special events—when all hotels are fully booked.

• Airbnb captures value by charging a percentage on each booking. At first glance, they are compared to large hotel chains, but on their balance sheet they resemble an online travel agency much more. They do not have to worry about financing their lodging inventory. In contrast, hotel chains design, build, and own most of their properties. Not only are they subject to the whims of commercial real estate cycles, but it also takes much longer and more capital to expand their supply and to absorb depreciation or impairments during downturns. However, in good times, commercial real estate offers many opportunities for financial engineering because it serves as excellent collateral.

Social, media, and content platforms like Facebook promote interaction with friends through the creation of user-generated content, according to the Online Platform Definition:

Facilitating the Exchange of goods and services, as with eBay:

• The Supply Side: From a monetization perspective, the users constitute the supply side. We create user-generated content. Facebook does not charge its users any fees, but it uses this content to analyze and target advertising. In contrast, traditional media such as newspapers employ journalists to create content under which they place their ads. You and we create the content for Facebook.
• The Demand Side: From a monetization standpoint, these are the advertisers. They are able to conduct more targeted advertising campaigns compared to traditional media. They gain access to an audience that is highly engaged due to updates from friends and family that matter to them.
• Facebook gains value by providing advertisers with the ability to target ads and access the overall Facebook audience. Through the voluntary sharing of our posts, our data, and the like, we provide Facebook with around 2000 data points about us—such as demographics, income, education, interests, and much more. This enables Facebook’s advertisers to spend their money on more targeted advertising than traditional broadcast channels allow.
• The supply side, meaning according to the Online Platform Definition the sellers or online retailers, consists of individuals who sell used goods, online retailers, small businesses, and the like. They derive value from the easy entry, save on advertising, and can utilize the legal and commercial framework of eBay along with its payment platform, PayPal.
• The demand side, such as the buyers, can purchase conveniently, have a starting point for their shopping inquiries, and know that they can obtain items at lower prices because many sellers do not bear the overhead of physical stores, benefit from eBay’s buyer protection framework, and so on.
• eBay extracts value by charging per transaction. The benefits they offer to both sides make this possible. However, they also face the problem that participants can conduct their transactions outside the platform—all with significantly lower investments and operating costs. They do not hold inventory themselves, let alone develop or manufacture products. Like shopping centers, they offer, according to the Online Platform Definition Advantages, agglomeration benefits. And they are not exposed to location-specific risks that have turned many malls into well-documented dead malls.

Economic Value Creation

The business model, according to the Online Platform Definition, must create added value for the individual participants. But it must also deliver sufficient overall economic benefit to remain relevant. For example, Uber uses:

At an aggregated level, this resulted in an economic benefit in 2015 of:

€2.9 billion in consumer surplus in the four US cities included in our analysis. This applies to Chicago, Los Angeles, New York, and San Francisco. On this basis, they estimate a consumer surplus (= economic benefit) of €6.8 for the USA alone in 2015.

There are several other economic savings associated with Uber. For instance, a productivity commission in Australia concluded that taxi signs—which cost the taxi owner somewhere between €200,000 and €300,000 depending on location—can lead to the following results:

Indirect Network Effects According to the Online Platform Definition

Every business model and every industry has its own important business concepts. Many traditional companies, for example, optimize integrated supply chains, manufacturing processes, and supply-side economies of scale. For the platform business model, the concept of network effects—also known as demand-side economies of scale—is of utmost importance.

Network effects are the impacts that incremental participants and their participation have on the value of the network for other participants.

Within the framework of the Online Platform Definition for multi-sided platforms, it is important to recognize that we distinguish between two different types of effects:

•  Direct Network Effects: If only a few of your friends were on Facebook, its value to you would be low. But as the number of users increases, the value of the network rises for you and other users. They are essential for social media platforms according to the Online Platform Definition. Direct network effects, also known as same‑side network effects, are the effects of participants on one side of the network on other participants on the same side.
•  Indirect Network Effects: These are the effects of one type of participant on other types. Take Uber, for example. Drivers and passengers are on different sides of the platform. Uber would create very little value for a passenger if there were hardly any drivers. The waiting times would be frustratingly long. Similarly, without a sufficient number of drivers, the platform would have little value for the drivers. Idle times for drivers would result in a low-value platform.
•  According to the Online Platform Definition, the value of the network increases with the number of cross‑side participants. Indirect network effects are also referred to as cross‑side network effects. Both direct and indirect network effects can be positive (value-enhancing) or negative (value-diminishing).

Platform business models, according to the Online Platform Definition, connect multiple sides or independent participant groups. This leads to both direct and indirect network effects. They are crucial for the growth and value creation of the platform for its participants. The illustration shows some examples of positive indirect network effects

Balance between supply and demand is extremely important for online platforms: Uber would create very little value for a passenger if there were hardly any drivers.

Transaction Costs

Platforms make transactions cheaper and easier. According to the Online Platform Definition, online platforms can reduce both search and shared costs.

Search Costs

A key feature of the platform business model is the reduction of search costs for its participants. Search costs can mean many things, including time and effort. Platform companies almost reduce search costs by their very existence. When you want to buy something online, you know that you can jump on eBay and most likely find what you are looking for.

When the demand side searches, the results can be filtered and roughly displayed based on keywords, location, or ratings. Early platforms like Craigslist could do this as well. But more advanced platform companies are continuously refining their search and matching algorithms to create more value.

Here is an example that shows you the sophistication with which search algorithms operate.

Airbnb

Have you ever searched for something on an online platform and abandoned your search after a few minutes? You may have found something you liked, but one of the details did not meet your expectations. Whenever this happens, it is a missed opportunity for both the participants and the platform.

Airbnb has found that transactions sometimes fail because they do not match the host’s preferences for gap days between bookings. Based on these insights, they have refined their search algorithms.

The algorithm learns, based on past preferences, which types of booking requests various kinds of hosts are more likely to accept. According to the Online Platform Definition, the search algorithm promotes those that are more likely to result in a conversion in the results by ranking them higher. Analysis revealed that hosts in large markets prefer to have as few gap days as possible, while those in smaller markets prefer some gaps – or at least are not bothered by them.

Transaction Costs

When the reduction of search costs helps bring two or more parties together, lower transaction costs help facilitate an exchange between the parties. Reducing transaction costs can be even more complex than reducing search costs. We will keep it brief here and provide further examples of transaction costs:

Airbnb has helped reduce a large portion of the transaction costs that would have otherwise posed barriers to offering and accessing accommodations:

Strategy

Create a new demand network for an existing offering: Platforms such as Yelp, Expedia, and Groupon create new demand or demand networks for an existing supply. They often do this by aggregating demand through reducing the search costs in terms of time and effort on the demand side. According to the Online Platform Definition, they monetize this in various ways.

• Expedia receives bulk discounts from hotels and often bundles its offers with flights. However, they do not leverage network effects as much as other platforms.
• Yelp truly creates a new demand network according to the Online Platform Definition. They then provide the supply side—such as restaurants or stores—with improved access to this demand network. Note that these platforms can launch without direct interaction with the supply side. By building a demand network, they become very attractive—and unmistakable—for the supply side. Search platforms, deal platforms, and demand aggregation platforms follow this strategy.
• Create a new delivery category: Platforms such as Uber, Airbnb, Freelancer, Taskrabbit, and first‑generation game consoles create a new supply category. According to the Online Platform Definition, this can be embedded in an existing industry, but it truly merits being labeled a new delivery category. This often requires significant efforts to reduce transaction costs in order to make the individual competitive with larger companies such as a hotel within the same industry.
• Build an incremental, competitive supply network and connect it with a new demand network: Alibaba has helped many existing small businesses in China connect nationally and internationally with a new demand network. Many of these companies would not have had the chance to afford an advertising budget. Many of the players may have existed before, but the network is new. Likewise, there was no established transaction framework.
• To some extent, eBay has done the same. They have connected this with a demand network. Note the difference from Strategy 1. Strategy 3 initially focuses strongly on the supply side, whereas Strategy 1 does not. In some cases, Strategy 1 almost completely ignores direct interactions with the supply side until monetization begins to play a role. The difference from Strategy 2 is that Strategy 3 starts with an existing offering—such as offline shops and online stores that alone are unable to reach a very broad demand network. As the network grows, players that did not previously exist join, according to the Online Platform Definition.

Look for underserved networks and give them what they urgently need. Get users on board and take it from there. This can be on the demand or supply side, which is why you should focus on it. You may not know what your endgame looks like, but once you have many users, you can monetize access to them in some way. We recommend adding some social networks, as they do not really fit the supply-demand model. They build large user bases, for which they charge advertisers targeted access.

Add a new side to your existing one-sided business: Expand your existing assets and infrastructure to bring a new side on board. This, too, can be on the demand or supply side, which is why you should focus on it.

On the Way to Critical Mass According to the Online Platform Definition

Once you begin, you must reach the point where you have enough users on your platform to meet their needs. Here are 8 tactics that have helped some of the most successful platforms reach critical mass:

Get Engaged!

Network effects must be actively fostered. It is not enough merely to remove friction. Engagement is essential for participants to return to the platform. Having only participants who rarely engage is not enough, according to the Online Platform Definition, to achieve network effects. Here are some thresholds that platforms must reach for users to remain active on their platform:

• Facebook found that an important driver of engagement is that new users make 10 connections within the first 14 days. Building on that, Facebook imported contacts from users’ emails, suggested connections, and engaged additional users with games, media, and the like.
• Uber observed a high dropout rate among drivers before they completed 25 rides. A widely noted New York Times article described “How Uber Used Psychological Tricks to Push Its Drivers” to overcome this threshold.
• OpenTable discovered that they must have at least 25 restaurants available in a given area (of suburban size) to offer users sufficient choice. Based on these insights, OpenTable changed its overall approach. Instead of diluting their efforts across many cities, they withdrew from all but four cities and focused on reaching 25 per relevant area in those four cities.

Medium, Wikipedia, and many other user-generated content platforms follow the 1-9-90 rule: 1% of users create content, 9% edit, and 90% just read.

If you are launching a platform, try to determine which engagement drivers and their critical thresholds are relevant.

Revenue Models According to the Online Platform Definition

• Charging a transaction fee: Whenever money is exchanged in a transaction between participants, charging a transaction fee is a viable approach. This can be a fixed fee, depending on the type of transaction, or it can be a certain percentage of the transaction value. Uber and Airbnb apply the latter. And since most of their payments go through the platform, it is completely invisible to the participants. This approach can deter transactions if the transaction size is large. If you request a large project via Freelancer, a 10% transaction fee might encourage participants to conduct their transactions outside the platform.
• The same applies to many service platforms where the parties interact closely—either online or in person during the transaction. This is less so with Uber, where the advantage lies in deploying the nearest driver very quickly. The attempt to prevent communication prior to the transaction was one of the reasons for eBay’s struggles in China with unfavorable results for eBay. And that was one of the reasons why Alibaba chose a different monetization approach.

Conclusion

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