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Summary:

Platform companies from Apple to OpenTable take a commission from developers or merchants. But figuring out how much to take has huge repercussions on the business explains Benchmark’s Bill Gurley.

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photo: Shutterstock / Kristijan Zontar

Pricing is at the heart of every business, and pricing decisions are far more complicated than merely covering expenses. In the price of a good there are connotations of quality, the volume sold and even the perception of the brand. But when it come to digital goods — where the cost of goods sold is measured in AWS instances and engineers — setting prices can become almost pure strategy.

Bill Gurley, a general partner with Benchmark Capital, takes a look at this strategy when it comes to setting what he calls the rake, or commission, between a platform owner and those using the platform. Examples of the rake include Apple’s 30 percent fee on apps in its App store as well as the service fees associated with oDesk or OpenTable.

Gurley’s article, which is well worth a read, explores the relationship between the rake and the spread of the platform through a series of anecdotes. I just wish he had some documented research; not because I think his conclusions are wrong, but because I think we’d learn even more about how the cost of doing business on a platform affects volume in more subtle ways.

For example, Gurley makes much of the benefits of having a low rake, which encourages developers/end users/merchants to use the platform and also prevents a newcomer from coming in and undercutting you on price. What he doesn’t dig into is how the benefits of scale in the digital world mean that undercutting people on price is a race to the bottom. This is one reason people are concerned that no one but Google can compete with Amazon Web Services when it comes to cloud computing, despite Microsoft saying it will match AWS pricing on its own Azure cloud.

Here’s Gurley’s take on competition and the set rake:

If your objective is to build a winner-take-all marketplace over a very long term, you want to build a platform that has the least amount of friction (both product and pricing). High rakes are a form of friction precisely because your rake becomes part of the landed price for the consumer. If you charge an excessive rake, the pricing of items in your marketplace are now unnaturally high (relative to anything outside your marketplace). In order for your platform to be the “definitive” place to transact, you want industry leading pricing – which is impossible if your rake is the de facto cause of excessive pricing. High rakes also create a natural impetus for suppliers to look elsewhere, which endangers sustainability.

And here he is discussing a favorite business model for digital platforms — a low rake with a mechanism for people who want to spend more to do so in exchange for better placement or the opportunity to get favorable placement on the platform:

You start with a low rake to get broad-based supplier adoption, and you add in a market-driven pricing dynamic that allows those suppliers who want more volume or exposure to pay more on an opt-in basis. This way no one leaves the network due to excessive fees, yet you end up with a higher average rake over time due to the competitive dynamic. And when prices go up due to bidding and competition, the suppliers blame their competition not the platform (part of the genius of the Google AdWords business model). This also allows you to extract more dollars from those suppliers who desire to spend more to promote themselves (without raising the tax on those that don’t).

The article is worth reading, and I hope that some MBA professor takes it into his head to start some rigorous research on the best commission structures across digital verticals, or perhaps the biggest factors that should influence your rake rates. Because while generally low is good, if one could manage to be an area where high or medium works — at least for a while — then why not start there and see what happens?

Or better yet, invest in tools that allow for dynamic pricing based on the user’s need or demographics. That’s something more easily done online and is utterly neglected in Gurley’s article. In a digital world, the cost of goods is lower, so the risk of playing with pricing is lower as well. I think we’re going to see a lot more of it.

  1. The future will be won by the most successful ecosystems, not platforms. Platforms are so web 2.0. ;-)

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  2. Re: http://abovethecrowd.com/2013/04/18/a-rake-too-far-optimal-platformpricing-strategy/

    Clearly Bill has captured a topic of interest to many and conveyed it in a manner to compel a number of comments and retweets.

    While I am tempted to break his post down with multiple thoughts, here are 5 quick thoughts on 5 excerpts . . .

    EXCERPT 1:
    The most dangerous strategy for any platform company is to price too high – to charge a greedy and overzealous rake that could serve to undermine the whole point of having a platform in the first place.

    QUICK THOUGHT: It is always (yes, always) easier to lower your prices than it is to raise your prices. I would rather you start too high and carefully adjust down based on data and results than to price too low, dilute the value of your market/platform and then have to try to raise prices in order to remain a viable/sustainable business. So I get what Bill is saying within the context of his overall post . . but still, the “most dangerous strategy” is to price too low . . . yes, even for a marketplace / platform company.
    ***
    EXCERPT 2:
    If your objective is to build a winner-take-all marketplace over a very long term, you want to build a platform that has the least amount of friction (both product and pricing).

    QUICK THOUGHT: All of you readers thinking Bill’s kind post applies to your business by default . . . hello, Bill is clearly a smart and experienced professional . . . I am sure he would agree, stick within the context of his overall post and don’t assume it is relevant to the decisions that are critical for your business.
    Also, key words in the above excerpt are “winner-take-all” and “over a very long term”. Does that apply to you and the value of the marketplace or platform you are building / have built? How defensible are your value advantages over competitors, alternatives and new entrants?
    Additionally, he speaks to the “least amount of friction”, but this is within the context of your goals and the realities of your advantages and what sets you apart from alternatives. Keep in mind the “least amount of friction” from a pricing perspective is often assumed to be “free”. But as we know, “free” has its own challenges and friction . . . so do not assume that “least amount of friction” means the lowest possible price your business can handle.
    ***
    EXCERPT 3:
    In order for your platform to be the “definitive” place to transact, you want industry leading pricing – which is impossible if your rake is the de facto cause of excessive pricing.

    QUICK THOUGHT: My version of the above excerpt: In order for your platform to be the “definitive” place to transact, you want industry leading VALUE. Competing on low prices or low rakes is sure way to dilute the overall value of the profit potential of the market you serve in. I know Bill uses the terms “excessive”, “greedy” and “overzealous” at times in his post, but depending on your business objectives and exit goals . . . profitability is critical to the timing , level and sustainability of your market success. If it is truly excessive the market decides and they won’t pay/stay or not enough will pay/stay (part of Bill’s overall point). It not about the price or size of rake, it is about the value you deliver and your value advantages over alternatives.
    ***
    EXCERPT 4:
    High volume combined with a modest rake is the perfect formula for a true organic marketplace and a sustainable competitive advantage. A sustainable platform or marketplace is one where the value of being in the network clearly outshines the transactional costs charged for being in the network. This way, suppliers will feel obliged to stay on the platform, and consumers will not see prices that are overly burdened by the network provider. Everyone wins in this scenario, but particularly the platform provider. A high rake will allow you to achieve larger revenues faster, but it will eventually represent a strategic red flag – a pricing umbrella that can be exploited by others in the ecosystem, perhaps by someone with a more disruptive business model. As Jeff Bezos is fond of saying, “your margin is my opportunity.”

    QUICK THOUGHT: Much I could comment on just his excerpt alone, but two quick thoughts . . . (1) Bill speaks to the critical balance that must be achieved with a marketplace / platform business. Focus on communicating the value, benefits and advantages of your marketplace or platform. If you focus on price or rake, so will they. (2) Your willingness to race to the bottom on low prices or rakes is not a sustainable strategy. Creating value is hard and creating sustainable value is even harder . . . lowering your price or rake is easy . . . and as Bill notes, easy for everyone . . . it doesn’t make it smart though and is the source of many regrets throughout history. Hopefully, not for you.
    ***
    EXCERPT 5:
    Most venture capitalists encourage entrepreneurs to price-maximize, to extract as much rent as they possibly can from their ecosystem on each transaction. This is likely short-sighted. There is a big difference between what you can extract versus what you should extract. Water runs downhill.

    QUICK THOUGHT: Again, be very clear and honest with yourself about (1) what your business objectives are, (2) the stage in the value lifecycle your particular market is in, (3) your value advantages today and your value roadmap for the short and long term future. This will better prepare you to determine how much of Bill’s kind post applies to you or is more a commentary on the examples he covers.

    FINAL THOUGHTS:
    I have slightly modified a common reminder I offer to businesses . . .

    ** It’s not the price [rake] they don’t like, but what they understand they are (or are not) getting for that price [rake].

    Thanks again to Bill for the excellent post and to others for their thoughtful comments.

    Think of all the time and dollars you have invested into your business, products, services and solutions . . . I encourage you to best position yourself, your team and all your shareholders/stakeholders to discover your full market potential on an every day, every transaction basis.

    If you are a marketplace or platform business, take the time to understand your customers and what will generate the highest possible Return On Value or Return On Rake for all participants. Bill has helped you get started with this thinking.

    Be better than the rest,

    Chris Hopf
    PricingWire
    @pricing

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