I wrote some time ago about the difference between a product and a platform. Platform business model is a very interesting topic, many businesses can benefit from understanding its dynamics and applying its principles into their own product or service. I participated in a panel last Friday at Endeavor’s Scale-Up Summit to discuss the platform revolution where we discussed different aspects of building and managing platforms. However, we didn’t have the chance to dive into a very important aspect of the platform business model, pricing. In a recent article, I discussed the pricing of digital products but platform pricing has its own intricacies.
When thinking about platform pricing, one question that probably will arise is: How to price a platform, especially when I’m interested in having as many people using it as possible to make it more valuable? And in some platform cases, I have people from different groups (buyers and sellers, app developers and smartphone users). That is, the ideal on a platform would be to charge nobody, to ensure the largest number of users; however, if I do not charge anything, how will I cover the costs of its development and operation?
There are four points to consider about platform pricing: who, what, how much and when we should charge.
Whom should we charge?
The first answer to this question is simple: who is least price sensitive. If you have a two-sided platform, identify which one is the least price-sensitive; This will be the side most willing to pay for a platform. The most sensitive side is the one we want to subsidize.
For example, if you are managing a platform that connects attorneys with potential clients, it is very likely that the least price-sensitive side is attorneys because they have high margins. On the other hand, suppose you are managing a platform that connects suppliers of equipment and chemicals – which have a small margin on their prices – with potential buyers; It may make more sense to charge buyers because of the low margin from suppliers.
However, as I said earlier, this is only the first answer. There are other factors to consider:
- Scale Sensitivity: If one side realizes that your platform is more valuable based on the number of users on the other side, this side will be scale sensitive and willing to pay for the platform. For example, on Google, the more people searching, the more interesting the platform gets for advertisers.
- Competition Sensitivity: If one side realizes that the platform is more valuable the smaller its side is and, consequently, the smaller the existing competition, this side will be the competition sensitive side and more willing to pay. An off-line example is the cover charge bars, which decide whether to charge women cheaper or not charge at all, but charge men full entrance, who will be willing to pay because they understand there will be less competition. To attract more female customers, bars often have a â€œno cover for womenâ€ policy, sometimes on a ladies’ night. In some cases, these policies have been challenged in lawsuits as discriminatory, and are illegal in some jurisdictions in the United States, but is a good example of competition sensitivity if we frame these bars as a two-sided platform were men and women go to meet.
That is, there are several factors to consider. In some cases, both sides may be willing to pay; in others only one. Cases like Google and Facebook are simpler to analyze:
- There are always two sides: who advertises and who consumes the platform.
- For advertisers, the more people consuming the platform, the better.
- For those who consume the platform, ads or the content itself can be an intrusion if Facebook and Google can’t make them relevant.
- For those who advertise, each new business initiated or closed through the platform represents a win.
- For those who consume the platform, each business started or closed through the platform represents an investment with a possible outlay of money.
- For these reasons, especially for the last two, it makes sense for advertisers to pay.
On the other hand, cases such as auction sites, employment, taxi search, and real estate for purchase or rent are more complex:
- There are also always two sides: advertisers and who has an interest in what is being advertised.
- For advertisers, the more people consuming the platform, the better.
- For those interested in what is being advertised, the more offers available, the better, as there are more chances of finding what you are looking for.
- For those who advertise, each business started or closed through the platform represents a win.
- For those who are interested in what is being advertised, every business started or closed through the platform represents the possibility of getting what you were looking for.
- For these reasons, especially the last two, it may make sense for both sides to pay to use the platform. On the other hand, considering items 2 and 3, it also makes sense that both sides can use the platform at no cost. In this case, it may make sense to analyze who is least price sensitive and what the market practices are.
What should we charge?
Usually, people are willing to pay for something when they see the value and benefit it brings to them.
There are 3 benefits that can be charged on one platform:
- Access: People may be charged to access the platform. Something like a monthly fee, for example. This is the least common way to charge, as one of its main benefits is the number of people on different sides. This model can be found in platforms that work on exclusivity, where member quality is their main value proposition, and quantity is not relevant. Some platforms, after reaching a certain critical volume, may decide to charge for access to ensure quality and exclusivity. It is also possible to implement two levels of access, one free and one paid, with different functionalities and service levels, such as who is free is only supported via the Q&A site, and who pays is entitled to personalized support by telephone.
- Usage: You can charge each time people use the platform. For example, on a job posting site, you may be charged for each job opening advertised. Another example is AdWords, where you are charged each time someone clicks on your ad, that is, each time your ad is used.
- Rate / Percentage: In this model, the amount to be charged is a percentage or a variable rate of the benefit that one side of the platform has with each business conducted on it. Typically, auction and payment intermediation sites (PayPal, PayPal, etc.) often use this billing model.
You can make combinations of these billing forms. For example, charge a monthly access fee plus a usage fee, or a percentage.
How much should we charge?
To answer this question, we need to think about lock-in, which means that a user of your platform is less likely to stop using it the more they use it and see benefits in its use. The cost of change to another platform is what explains the lock-in; The higher the cost to change to another platform, the greater the lock-in. Another important point to keep in mind when we are defining how much to charge for the platform is the network effect, i.e., how much value we generate to the user by having more people using the platform. Typically, the amount to be charged by a platform, whether access, usage, and / or fee, reflects lock-in and network effect.
These values generally change over the life cycle of a platform. In the beginning, when there are few users, and the lock-in and network effect are still small, it is very likely that they will have to be subsidized.
Dropbox can be viewed as a single-sided platform, where the benefit of the network effect appears as more users use it for file exchange. The cost of switching increases as you put more files in Dropbox and you have more acquaintances with whom to exchange there. That’s why he charges for GB and encourages inviting friends to use it too. This incentive – giving free GBs to you and the friends you invite – is the form of subsidy Dropbox uses to increase the lock-in and network effect of your platform.
Another interesting example is an avalanche monitoring service, which launched a platform on which ski resorts would share weather data to predict avalanches more accurately. To be able to participate in this system, the resort would have to install a monitor, and this installation process was costly.
The platform also intended to charge a monthly fee from resorts to use it. The problem is that they were not comfortable paying the monthly fee and had already paid the cost of installing the monitoring equipment. In addition, they did not want to pay monthly in the summer, when there are few or no avalanches and resorts have low occupancy. The solution was to subsidize the installation of monitor equipment in the resorts and to charge annual instead of monthly, with the price varying by the depth of analysis.
When should we charge?
You may be charged once or periodically. By periodicity, it may vary from monthly to multiple years. It is not uncommon to see cases where there are multiple period options (eg monthly and yearly), where discounts on longer period prices are offered.
In some cases, longer periods may be the only way to show the long-term benefit of your platform or to ward off concerns about its seasonal utility, such as the avalanche monitoring service.
When billing by use, the most common is to make this billing periodically, that is, each period the platform should evaluate how much was used and should be charged. The most common period is the monthly one.
Care should be taken with mixed charge models, with charge-for-access plus charge-for-use. If you charge for annual access, consider whether you can charge for annual use as well, or if it’s best to charge for monthly or quarterly usage.
When charging a fee or percentage, it is best to charge right after the transaction happens. If there is a high frequency of transaction events within a month, another option is to charge this fee monthly.
So here it is, the who, what, how much and when to price in a platform business.
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