Thursday, May 17, 2018

Moat, Moat, Who Has a Moat?

In case you missed it, CNBC, May 8:
Elon Musk Wants to Fill Warren Buffett’s 'Moat' With Candy, but It Still Holds Water

From Stratechery, May 15:

The Moat Map
A subtext to last week’s article, Tech’s Two Philosophies, was the idea that there is a difference between Aggregators and Platforms; this was the key section:
It is no accident that Apple and Microsoft, the two “bicycle of the mind” companies, were founded only a year apart, and for decades had broadly similar business models: sure, Microsoft licensed software, while Apple sold software-differentiated hardware, but both were and are at their core personal computer companies and, by extension, platforms…
Google and Facebook, on the other hand, are products of the Internet, and the Internet leads not to platforms but to aggregators. While platforms need 3rd parties to make them useful and build their moat through the creation of ecosystems, aggregators attract end users by virtue of their inherent usefulness and, over time, leave suppliers no choice but to follow the aggregators’ dictates if they wish to reach end users.
The distinction wasn’t entirely satisfying; first and foremost the power of both aggregators and platforms, however defined, ultimately rests on the size and strength of their userbase. Moreover, Google and Facebook have platform-type aspects to their business, and Apple has aggregator characteristics when it comes to its control of the App Store (that Microsoft does not is a symbol of the company’s mobile failure).

Moreover, what of companies like Amazon, or Netflix? In a follow-up Daily Update I classified the former as a platform and the latter as an aggregator, but clearly both have very different businesses — and supplier relationships — than either Google and Facebook on one side or Apple and Microsoft on the other, even as they both derive their power from owning the customer relationship.

Make no mistake, that bit about owning the customer relationship remains critical: that is the critical insight of Aggregation Theory. How that ownership of the customer translates into an enduring moat, though, depends on the interaction of two distinct attributes: supplier differentiation and network effects.

The Supplier Differentiation Spectrum
Consider the six companies I mentioned above: Facebook, Google, Amazon, Netflix, Apple, and Microsoft.
The degree of differentiation of tech company suppliers varies
These companies exist on a spectrum in terms of supplier differentiation (and, by extension, supplier power):
  • Facebook has commoditized suppliers more than anyone: an article from the New York Times is treated no differently from a BuzzFeed quiz or the latest picture of your niece or an advertisement.
  • Google gives slightly more deference to established content providers, but not much; search results are presented the same regardless of their source (although Google increasingly presents results differently depending on the type of content).
  • Amazon is a little harder to classify — that’s kind of entailed in the name The Everything Store — but generally brands are much less important than they are in a world of limited shelf space, and few people even realize they are buying from the 3rd party merchants that make up over half of Amazon’s sales.
  • Differentiation matters more for Netflix, particularly when it comes to acquiring new users; still, users are transacting with Netflix and, the longer they stick with the streaming service, first opening Netflix and then looking for something to watch, as opposed to the other way around.
  • Apple first and foremost attracts and retains users through its integrated experience, but that experience would quickly be abandoned were there not third party apps.
  • Microsoft traditionally succeeded entirely because of its ecosystem, not just applications but also the entire universe of value-added resellers, systems integrators, etc.
The extremes make the point: Facebook could lose all of its third party content providers overnight and still be a compelling service; Microsoft without third parties would be, well, we already saw with Windows Phone.

The Network Effect Spectrum
Another way to consider this spectrum is in terms of user-related network effects. The idea of a network effect is that an additional user increases the value of a good or service, and indeed all of these companies depend on network effects. However, the type of network effect differs considerably, as well as the extent to which the network effect directly improves a company’s core product (what I am calling an “internalized” versus “externalized” network effect):...