In the high-stakes race of start-ups, scalable ideas have traditionally held the winning ticket. This trend has been even stronger in the case of ‘platform-based’ businesses which connect ‘customers’ with ‘suppliers’, from Amazon to Uber or DoorDash. The logic behind this is deeply tied to the ‘network effect‘, the phenomenon where increased numbers of users enhance a product or service’s value. In theory, a higher user base (demand) attracts more suppliers (supply), setting in motion a cycle that often culminates in a ‘winner takes all’ market. When successful, the prize is huge: according to McKinsey, 7 of today’s 12 largest companies are platforms.
For that reason, over the last few years, investors, mostly under the form of venture capitalists, have backed these platform-based businesses with the expectation that, by capturing a market, the winning platform would then be able to exercise sufficient pricing power to reach profitability – a move Uber, among others, has been struggling with for years. However, the changing economic dynamics, characterized by higher inflation, rising interest rates, and slowing growth, have exposed the shortcomings of this model, leaving these platform-based businesses struggling to achieve sustainable profitability. As Warren Buffett famously said, “Only when the tide goes out do you discover who’s been swimming naked.”
A key concept to understand this challenge is “unit economics“, which balances a service’s price against all related costs. Let’s take the example of food delivery. Against the price of the order, one would have to account for the cost of food preparation (bore by the restaurant or dark kitchen) as well as the delivery cost. However, in this equation, the ability to set prices and the corresponding demand are largely influenced by the availability of alternatives, both direct (rival platforms) and indirect substitutes (cooking at home or using personal transportation). An inflationary environment often leads customers to cut back on non-essential expenditures, reducing demand and making the market less profitable, while triggering wage increase demands, especially for gig economy workers like delivery riders or Uber drivers, and increasing raw material costs.
Furthermore, beyond unit economics, another sizeable, and often underestimated, cost is marketing. Attracting users through promotional campaigns and discount codes forms a substantial part of a platform’s expenses. While crucial for user acquisition, these costs can significantly dent profitability in the short-term, and prove more essential than originally planned in the long-term.
In this challenging landscape, the initial growth catalyst—the network effect—can become a liability. As these platforms expand, the challenges of scaling, maintaining service quality, and defending market share against substitutes add complexity.
The changing economic tide has revealed that the business models of many platform-based businesses were not as resilient as expected. As Buffett’s quote reminds us, it’s easy to appear successful when the conditions are favorable. But when those conditions change—when the tide goes out—the shortcomings and vulnerabilities are laid bare.
Will the platforms show enough robustness and stability to withstand the headwinds currently hitting the economy? While some will survive, others will probably sink. Let’s not forget that, to survive, platforms need to bring more value by facilitating transactions than costs. Under that lens, not all markets are “platformable”.