Platform firms — businesses that enable transactions between two parties — constantly struggle to prevent those partners from taking their deals off-platform. The technical term for this is “disintermediation,” and examples of it include readers buying online rather than from bookstores, Upwork and ZBJ (China’s Zhu Bajie) programmers contracting directly with clients, and Airbnb struggling not only with guests contracting directly with hosts, but also with some of its biggest professional hosts reportedly competing against it on new platforms. Disintermediation — and the failure to understand and address it — killed once thriving businesses like Borders books, Blockbuster movies, and Tower records. It’s easy to understand why platform companies worry so much about being cut out of the loop.
Here’s the thing, though: True disintermediation is rare. Most buyers and sellers don’t cut out the middleman entirely, but rather find a new provider that cuts transaction costs or adds more value so that switching is a natural choice. Readers buy from Amazon, not authors directly. Movie watchers and song listeners don’t buy from Hollywood studios or musicians but from Netflix and Spotify. Simply put, these are not atomic markets of many-to-many interactions. New centers of attraction (Amazon, Netflix, and Spotify) have re-intermediated the old ones (Borders, Blockbuster, and Tower).
The issue is that companies often misunderstand the problem: Disintermediation is a sign that your customers don’t think you are adding as much value as you think you are. Just because you enabled the first transaction doesn’t mean you’re entitled to take all the value from the second, the third, and subsequent transactions. The good news, however, is that firms that appear to be struggling with disintermediation can take simple steps to stop the bleeding before it’s too late — if they understand what’s really taking place.
How can a firm know when deals are sticky and when they will go somewhere else? At least six factors contribute to partners taking deals off your platform.
First, urgency reflects the need to solve a problem now, which helps keep the deal. A large platform that can address a need quickly is more valuable when urgency is high, in contrast to a single off-platform source that is high-quality but unavailable. For instance, the delivery app Drizzly provides on-demand alcohol for parties. A trip to the liquor store might cost less, but it requires advance planning or someone stepping out mid-party.
Rake is what a platform charges for facilitating a deal. The higher this fee, the more partners want to avoid it. Groupon’s rake of nearly 50% contributed to its plunge and plateau in stock value.
Risk is the danger that a deal goes badly. If a project is risky, then both buyers and suppliers prefer having the benefit of reputation systems, insurance, and mediation services the platform provides. Uber covers driver costs and holds riders accountable if riders throw up in the car.
Skill is the level of expertise required to perform the task. For low-skill jobs, the main issue is usually price, and a large pool of suppliers helps customers secure the best deal. That means platforms offer the best value for both the first and subsequent deals, as with E-Trade for example. But when a job requires high skill, platforms often only add value to the first deal, where the benefits of reputation systems truly matter. After that, buyers can cut out gatekeepers once they find a reliable supplier. For instance, Rocket Lawyer connects people with expert attorneys to help with legal issues. But once someone has found a reliable attorney, they no longer need the platform. And, they don’t want to explain their situation all over again.
Subsequent deals highlight related factors, interaction frequency, or how often partners must communicate to complete the task, and project modularity, or the degree to which a task can be divided into smaller, independent components. If a task requires repeated communication or it can be broken easily into separate parts, then buyers and sellers have multiple opportunities to establish a relationship independent of the platform. On Upwork, for example, working through stages of website deployment — specification, design, coding, backend, test, etc. — gives parties a chance to reduce the rake on each stage. Then later stages can happen off-platform.
Broadly speaking, these six factors tell companies how to reduce the costs of search, negotiation, risk, or delivery associated with getting the deal to happen as distinct from producing the work itself. In economic terms, these are known as “transaction costs.” The platform’s role is to lower them compared to the next best alternative. Understanding this principle gives executives control over the outcome even if the superficial attributes change. The platform helps orchestrate the deal, but the supplier actually produces the result, and if the buyer and supplier can handle the transaction costs more efficiently without the platform, then they will disintermediate the deal. Interestingly, the Chief Strategy Officer for Alibaba even defined a test for successful platforms as achieving “the nexus of lowest transaction costs.” Understanding disintermediation in this way then gives you the tools to prevent it.
The solution for disintermediation is quite simple: Create more value than you take. Stop playing the role of toll-taking gatekeeper and start playing the role of value-adding partner. Either decrease transaction costs or increase value for buyers or suppliers, or both.
Every platform interaction has a producer side and a consumer side. This is true regardless of whether the activity is a ride, a tweet, a stay, a product, a service, or a piece of art. The trick is to design appropriate carrots and sticks for both sides, with a heavy emphasis on carrots. Why are carrots better than sticks? Carrots add value for keeping interactions on-platform, while sticks add costs for taking interactions off-platform.
Many platforms choose sticks because they are easier to implement or because they feel entitled to a certain level of profit. Sticks, however, do not engender goodwill among customers, service providers, freelancers, or developers. They include:
- Hiding supplier contact information to prevent direct communication. For years, Angies List (now Angi) hid home service provider contact information, which limited interactions and growth.
- Bounties paid to buyers and suppliers who rat on the other side for proposing disintermediation.
- Secret shoppers and secret sellers who make such proposals to test partner loyalty. ZBJ used both bounties and secret shoppers when freelancers did not want to share large commissions with the platform.
- Deplatforming, public shaming, and eventually legal action, which Apple tried when Fortnite tried to use its own system to facilitate payments rather than use Apple’s system with its exorbitant 30% tax.
Carrots are far better because they show a commitment to creating value, which is the only real basis for capturing value. They include:
- Giving users software tools to enhance the production, delivery, quality, or consumption of the product or service. Instagram and Vimeo offer filters and image editing tools that not only reduce costs for producers but also help them create value for consumers.
- A variant of this strategy is to offer value-adding services. The freelance platform Upwork will provide project management for large contracts by partitioning it and farming out components to different subcontractors. 99Designs, a design contest platform, helps designers automate their billing, track their progress, and pay their taxes.
- Frequent buyer or frequent seller rewards. OpenTable gives buyers dining points that they can spend on restaurant meals, while CoachUp gives professional coaches volume discounts. Etsy rewards artists’ loyalty by showcasing their work.
- Shifting monetization to the point where the platform adds the most value. ZBJ introduced an optional pricing model that shifts from a transaction fee to a subscription fee. Once the fee is paid for the first deal, suppliers’ costs for each new deal are zero. When further use of the platform is free, sellers prefer the benefits of automated tracking and billing that happens on-platform.
- Insurance, which is one of the most successful benefits to both sellers and buyers. On the seller side, Airbnb insures hosts against fire, theft, and property damage. On the buyer side, Amazon offers free returns and money back guarantees.
- Basic safety. Uber introduced a rider emergency help button that most taxis do not offer. When a freelance contract is based on an hourly rate, Upwork has provided monitoring software so that a client knows a programmer is coding and not perusing Facebook.
- Introducing buyer and seller rating systems. Almost every major platform now uses some form of review to reduce the adverse selection of finding bad providers and the moral hazard that, having been paid, they might not deliver.
Ironically, these strategies do come with a challenge — a “disintermediation dilemma.” Strategies intended to add value can inadvertently lead to leakage. This occurs when tactics do add value but only to the first interaction and not the second. Consider a five-star rating on a home cleaner or landscaper. Once contact is made and trust established, a platform that adds no further value will be disintermediated. This problem doomed Homejoy within a few years of launch. Groupon, likewise, adds value to a first sale by providing group buying discounts for buyers and discovery for merchants. But then deals conclude off-platform at the merchant and its “leaky bucket” adds little value to later deals. Buyers just visit the merchants. By contrast, Meituan, a Chinese successor to Groupon, handles delivery through the platform, generates frequent buyer rewards, and helps merchants design new products and situate new stores. Increased volume increases benefits.
Disintermediation is a signal. What it really tells you is that you don’t provide enough value after an initial match. You’re taking more than your fair share. Disintermediation simply means someone else provides more value than you do. Instead, if you create more value than you take, you will attract deals rather than repel them.