Here’s the advantage that keeps Silicon Valley ahead of the world

A trait shared by the fastest growing and most disruptive companies in history – Google, Amazon, Uber, AirBnb, and eBay – is that they aren’t focused on selling products, they are building platforms. The ability to leverage the network effects of a platform is something that the technology industry learned long ago – and perfected. It is what gives Silicon Valley an unfair advantage over competitors in every industry; something that is becoming increasingly important as all information becomes digitized.

A platform isn’t a new concept, it is simply a way of building something that is open, inclusive, and has a strategic focus. Think of the difference between a roadside store and a shopping center. The mall has many advantages in size and scale and every store benefits from the marketing and promotion done by others. They share infrastructure and costs. The mall owner could have tried to have it all by building one big store, but it would have missed out on the opportunities to collect rent from everyone and benefit from the diverse crowds that the tenants attract.

Apple learned this the hard way in the 1980s when it created the first versions of the Macintosh. It built its own proprietary, closed, hardware, operating system, and applications. Bill Gates, on the other hand, realized that key to power and profit was the operating system and a thriving ecosystem. He designed Microsoft Windows as an open system in which other players could provide the hardware and software. The more programs that ran on Windows, the more users wanted it, and therefore more developers created applications. Windows became a near monopoly the 90s—while Apple came close to bankruptcy.

Fortunately for Apple, by 2007, Steve Jobs had figured out Microsoft’s advantage. He built the iPhone App Store and iTunes as open platforms on which other players could provide content. The top five mobile phone carriers—Nokia, Samsung, Motorola, Sony Ericsson, and LG—had owned 90 percent of the industry’s profits. Yet Apple was able to leap ahead and capture literally all of this.

The power of platforms is explained in a new book, Platform Revolution: How Networked Markets are Transforming the Economy and How to Make Them Work for You, byGeoffrey Parker, Marshall Van Alstyne, and Sangeet Choudary. The authors show how platform businesses bring together producers and consumers in high-value exchanges in which the chief assets are information and interactions. These interactions are the creators of value, the sources of competitive advantage.

Apple was able to connect app developers with app users in a market in which both sides gained value and paid it a tax. As the number of developers increased so did the number of users. This created the “network effect” — a process in which the value snowballs as more production attracts more consumption and more consumption leads to more production.

Just as malls have linked consumers and merchants, newspapers have long linked subscribers and advertisers. What has changed is that technology has reduced the need to own infrastructure and assets and made it significantly cheaper to build and scale digital platforms.

Traditional businesses, called “pipelines” by Parker, Van Alstyne, and Choudary, create value by controlling a linear series of processes. The inputs at one end of the value chain, materials provided by suppliers, undergo a series of transformations to make them worth more. Apple’s handset business was a classic pipeline, but when combined with the App Store, the marketplace that connects developers with users, it became a platform. As a platform it grew exponentially because of the network effects.
The authors say that the move from pipeline to platform involves three key shifts:

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