Economy of the Future: Platforms and Network Effects

In the current issue of the Heilbronn city magazine “Hanix”, Prof. Dr. Helmut Krcmar, Founding Dean and Delegate Officer of the President – TUM Campus Heilbronn, and Prof. Dr. Jens Förderer, Professor of Innovation and Digitization at TUM Campus Heilbronn, talked about platform economy as a form of (future) trade.

Marketplace vs. platform

A marketplace and a platform differ in two ways. “Let’s take a marketplace in the city center, where many people may well be crowded together. In contrast, platforms are more attractive the more users are there – that’s what we call network effects,” explains Prof. Förderer. The more people there are on the platform, the more value the platform has. A good example is Facebook: It only makes sense to sign up if there are a lot of people on the platform to connect with. “The second difference is: it’s not just about trading goods. Platforms can also have an innovative, creative element. Vendors can come up with new offerings or combine existing ones based on the platform, making the marketplace even richer.” In addition, a “real” marketplace is physically limited. “More than a certain number of shops cannot be set up in a certain area. This is exactly where the crucial difference lies when it comes to creating network effects. Because the possibilities are more comprehensive if I can make the marketplace in cyberspace unlimited in size. The physical constraint that makes real space scarce in a traditional market is no longer there in the virtual. A digital platform can be infinitely large. This also explains why these network effects can become so large globally. And everything that can be represented digitally can be pushed onto this virtual marketplace,” explains Prof. Krcmar. A platform is therefore a business model that enables transactions and/or innovations between several players in the presence of network effects.

Advantages and disadvantages of the platform economy

If one understands a platform as the provision of a transaction or innovation space, then the question arises as to which business model applies to that space and what it is, that we actually pay for. Do we pay in order to be allowed to trade something on that platform, or do we pay for each individual transaction? “There are very different approaches and combinations here. On the digital platform, the network effect means that all market participants prefer to set up their shops where customers are already there, and that is easily possible in the virtual world. However, the temptation is great for a platform provider to abuse the power that arises thereof. As a result, we have to ask ourselves what regulatory structures are possible and adequate, and how their rules are motivated and can be implemented – politically or purely technically,” knows Prof. Krcmar. Moreover, while network effects ensure that the value of using a product increases with the number of people who use it, at the same time standardization is needed so that products from different providers are compatible with each other. “When it comes to apps, for example, the manufacturers of the operating systems built into cell phones have tried to set different standards in order to create unique selling points. And so it happens that we cannot, for example, exchange apps so easily between devices in the different operating system worlds, i.e. IOS and Android, even if these devices all use the same mobile telephony standard,” says Prof. Krcmar.

What it’s all about: Network effects

Network effects are really the central issue in platforms or marketplaces, and they give rise to a variety of challenges for companies. One of them is critical mass. Prof. Förderer explains: “Network effects mean that the value of a good increases and only has value if many people own this good. Conversely, this implies that if no one uses it, the platform is worthless. If a company wants to establish a new platform on the market, then it will be without users at the beginning. The platform has no value. That’s what we call the chicken-and-egg problem. Critical mass is a kind of fictitious number of users that has to exist at a minimum for such a platform to have value, so that people find interest in it and want to join.” So how can companies solve this chicken-and-egg problem? “A classic tactic is to be able to announce a certain number of users and providers already at the launch of the platform. To do this, you have to get the first users and providers on board before the platform is launched, possibly even pay them to join. Another solution would be to start as an individual retailer, sell something to customers, and then, as soon as a large customer base is available, broker access to the customer base to third parties. We have developed a whole catalog of measures that we can give companies to help them successfully establish platforms on the market. This catalog and much more is available on the website of our platform economy initiative.”

Read the original interview published in the current issue of “Hanix” (Issue No. 73, June/July 2021, p. 46-47) here:

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