Platforms and Power (with Hamilton Helmer and Chenyi Shi)

1. 0:00 – 2:57

   Arena show announcement: CEO of Brooks Running joins live event

   1. BGBen Gilbert0:00

      Hey, Acquired listeners, we have some fun news for you. Following hot on the news that we are doing a freaking arena show-

   2. DRDavid Rosenthal0:07

      Arena show!

   3. BGBen Gilbert0:09

      [laughing] At Climate Pledge Arena in Seattle. We are here tonight to announce the very first guest that will be joining us for that show.

   4. DRDavid Rosenthal0:18

      Ben, who is it?

   5. BGBen Gilbert0:20

      It is fresh off his full-page profile in The New York Times this weekend, Jim Weber, the CEO of Brooks Running. We wanted to have a really fun, local Seattle success story, but I think most people have no idea the magnitude of the success story here, or Jim's personal story. It's just fascinating.

   6. DRDavid Rosenthal0:40

      We want everything we do for this event to, like, literally check all the Acquired boxes. This checks all the Acquired boxes.

   7. BGBen Gilbert0:46

      Berkshire Hathaway.

   8. DRDavid Rosenthal0:48

      Berkshire Hathaway. Uh, people who don't know, Brooks Running is a very successful, now standalone, division of Berkshire Hathaway. Local Seattle story, amazing, amazing journey. What they went from... Under Jim, they went from, like, de minimis small number of millions of revenue to over a billion in revenue a year, competing with Nike and Adidas.

   9. BGBen Gilbert1:09

      They were, like, accidentally bought by Berkshire as part of a Fruit of the Loom roll-up, and they were sort of this bland nothing brand, and by-

   10. DRDavid Rosenthal1:16

       Yes

   11. BGBen Gilbert1:17

       ... unbelievable, maniacal focus on making fantastic running products, that is how they became the billion-dollar business that they are today.

   12. DRDavid Rosenthal1:24

       Not to mention, Jim battled cancer, uh, along the way. Like, so great.

   13. BGBen Gilbert1:29

       And when you say billion, by the way, we should say billion in revenue. Well, like, this is a profitable, over billion-dollar [chuckles] revenue growing company.

   14. DRDavid Rosenthal1:37

       This isn't a billion-dollar valuation. [laughing] That's, that's a billion in, in cash every year. [chuckles] Not cash flow, but revenue.

   15. BGBen Gilbert1:43

       Yes. So we're very excited to have a conversation with Jim at the event. You should totally come join us. It's May 4th. Doors open at five, with plenty of time for drinks and mingling throughout the event. You can go to acquired.fm/arenashow, or click the link in the show notes to RSVP. We've got a few more details in the previous little mini episode that we released to announce the Arena Show. All proceeds will go to Climate Pledge Arena's philanthropy, the One Roof Foundation. It's twenty dollars to attend, and, uh, we hope to see you there. Acquired.fm/arenashow, or click the link in the show notes.

   16. DRDavid Rosenthal2:19

       We're gonna have some more announcements coming over the next couple of weeks, and, uh, it's amazing. People are DM-ing us, saying they're flying in from all over.

   17. BGBen Gilbert2:27

       [chuckles]

   18. DRDavid Rosenthal2:27

       If you live in Seattle, definitely come. If you don't live in Seattle, Alaska Air has great flights-

   19. BGBen Gilbert2:32

       Great flights

   20. DRDavid Rosenthal2:32

       ... to SeaTac. This is gonna be a huge party. We're so excited.

   21. BGBen Gilbert2:36

       [upbeat music] Awesome. Listeners, acquired.fm/arenashow, we'll see you there.

   22. SPSpeaker2:40

       Who got the truth? Is it you? Is it you? Is it you? Who got the truth now? Is it you? Is it you? Is it you? Sit me down, say it straight, another story on the way. Who got the truth?

2. 2:57 – 4:31

   Show setup: Hamilton Helmer returns with a new platform-focused framework

   1. BGBen Gilbert2:57

      Welcome to this special episode of Acquired, the podcast about great technology companies and the stories and playbooks behind them. I'm Ben Gilbert, and I'm the co-founder and managing director of Seattle-based Pioneer Square Labs, and our venture fund, PSL Ventures.

   2. DRDavid Rosenthal3:11

      And I'm David Rosenthal, and I'm an angel investor based in San Francisco.

   3. BGBen Gilbert3:17

      And we are your hosts. Well, today, back by extremely popular demand, we have Hamilton Helmer. We email Hamilton, like, once a quarter or so, David, and ask, "Uh, hey, have you found an eighth power yet?" [laughing] And he always says, "No," but he did finally say, "Hey, my colleague, Chenyi, and I have been developing a new framework for how executives can apply 7 Powers for platform businesses, which are way more complicated." So obviously, we jumped at the chance to get to dig into this with Hamilton, since we later found out that by platform, he means this very broadly, like any business that serves as an intermediary to make transactions. So it probably applies to the technology business that you're working on right now.

   4. DRDavid Rosenthal4:02

      Or investing in.

   5. BGBen Gilbert4:03

      I found it particularly interesting, reflecting after the interview, because it's a framework still in progress, so you can start to see some of the, like, really important principles crystallize for Hamilton and Chenyi as they sort of talk through it. We get to read about these things in business books twenty years after they're finalized and gone through tremendous rigor, and it's just really cool to see it in the infant stage.

   6. DRDavid Rosenthal4:26

      So fun to have Chenyi on, too. She is an incredible rising star.

3. 4:31 – 8:42

   Sponsor segment: Solana stake pools and liquid staking explained

   1. BGBen Gilbert4:31

      For sure. These special episodes are sponsored by the Solana Foundation. As you know, Solana is, uh, a global state machine, and the world's most performant blockchain. It means developers can build applications with super low transaction fees, low latency. They don't have to compromise composability. It's all on a single chain with one global state. Today, we've got a little fun interview with Dan Albert, who is the executive director of the Solana Foundation. So here we go. Well, Dan, you guys are up to something really interesting in the Solana ecosystem with stake pools, or liquid staking. Can you share with us what that is, and how it has some advantages over some of the issues with just regular staking, like the lack of liquidity?

   2. SPSpeaker5:16

      Hey, thanks for having me. The goal of the Solana Foundation is to foster the growth of the Solana network and the Solana community as a whole. The goal really is to have one billion people with self-custody of their keys and the ability to understand what that means, and sign transactions, and do useful things. So in order to get a good chunk of the world's population doing this, we need a whole robust suite of apps and services that are useful to people as humans. To that end, it's one of the reasons why I'm really excited about stake pools, because it provides a great vehicle for ordinary people who want to participate in the crypto ecosystem, the ability to participate, while also fostering the growth of the network and supporting the growth of a larger set of validators.... And so what this is really is a way for people who are interested in crypto and interested in supporting and securing the blockchain networks that they care about through staking, but providing people a liquid means to do so. So what does that mean? So an individual user or users can deposit their SOL into one of these programs and get back a derivative token, and what happens under the hood is the stake pool automatically distributes the underlying tokens to one or many different node operators or validators on the Solana network. So traditionally, on Solana and on other proof of stake networks, when you stake an asset, it's subject to some lockup period or sometimes called the unbonding period, where basically the asset is not liquid. You can't move it or sell it or do anything with it on short notice. And Stake Pools provides really liquid exposure to the same underlying asset while giving the user the ability to earn any potential staking rewards that are earned by the validators who are members of that pool. It really takes a lot of the kind of technical and research overhead away from the user, which can be really intimidating. The Solana network currently has over fifteen hundred validators operating on mainnet beta, and I get this question very often from members of the community that say, "Hey, I'd love to stake. How do I pick a validator? I click the dropdown list, and there's a thousand names." And so by vying to be included in one or multiple stake pools, these validators can earn stake delegations based on performance and based on merit, rather than based on name recognition. So we've got some community-facing resources on the Solana Foundation website around Stake Pools, so that's solana.foundation/stake-pools. There's some information there about existing pools that have been launched and are being successfully managed by different teams in the Solana community. There's also some information if people are interested in potentially launching their own stake pool to support a group of validators or perhaps to implement their own unique staking strategy.

   3. BGBen Gilbert8:25

      Our thanks to Dan and Solana. If you are considering developing on Solana, head on over to solana.com/developers, or click the link in the show notes. All right, with that, David, let's dive into our interview with Hamilton and Chenyi, discussing platforms and power.

4. 8:42 – 10:50

   Why power matters: product-market fit vs. the second step change

   1. HHHamilton Helmer8:42

      7 Powers was an attempt to take an understanding of strategy and make it generally available as sort of pattern recognition, Chenyi, I think, uses that term, which I like a lot, for founders and people that are interested in trying to create great strategies and make their companies successful. And the reason it needed to be decentralized is that there are really two major step changes in the value of a company. The first is product-market fit, and the second is getting power. And they're, they're quite distinct and involve different things, and Peter Thiel gets at it in his book with his X and Y axis. You create X value, but you only get to keep Y percentage of it, and X and Y are independent variables. And the thing is that each of these involves an invention, and so it means there's a creative activity involved. And when you look at something that involves invention and creativity, it means, guess what? It's the inventors that do it, right? And so the idea behind 7 Powers and Strategy 3.0 is to put into the hands of those who are capable of inventing that, a way of looking at the world that gives them a little bit more acuity about what will work and what won't.

   2. BGBen Gilbert10:10

      And specifically, what will work and what won't on developing power. Not finding product-market fit, but the second piece.

   3. HHHamilton Helmer10:16

      Not on product-market fit. That's right. It's very much focused on the second thing, and it should be in those people's hands, and so you have to empower the people that actually can do the invention. So what we've found is that platforms, they often involve different types of power. They're very complicated and idiosyncratic. They're complex. You can look at one, and you... It's hard to tell whether they have power or not, and figuring that out is hard, so pulling that apart is a useful exercise.

5. 10:50 – 14:40

   Defining platforms broadly: intermediaries for transactions across history

   1. BGBen Gilbert10:50

      Chenyi, could you tell us maybe two things? One, from your perspective, for this work that you all have done and are in still in the process of doing, how do you define platforms? And then also, why is this group particularly interesting to y'all?

   2. CSChenyi Shi11:07

      Yeah. I'll address the second question first, which is why platforms are so interesting. I guess it's pretty obvious to us all that platforms are creating tremendous value. There's stats out there that says majority of the most valuable companies today would operate on some form of platform in this model. So for us, it's, you know, both important and, you know, it's just intellectually so intriguing to go into them. And I guess the way we define platform, we think of it very broadly and high level. We think of it as an intermediary for transactions, and that's it. I know sometimes we see people sort of think of platforms as being bounded to digital technologies. People equate the term platform as digital platforms. For us, that's actually limiting the scope of the topic because platforms really is more than that. It's a model with very ancient roots. You know, there's a book that Hamilton and I both really enjoyed reading and learned a lot from. It's called The Matchmakers from Evans and Schmalensee. So both are economists who've thought really deeply about platforms, and they took their title from-... or in reference to the Chinese ancient village matchmakers, who would keep a knowledge base of single men and women in the village and pair them up for dates.

   3. BGBen Gilbert12:15

      [chuckles]

   4. CSChenyi Shi12:15

      I love that example because these are people who existed three thousand years ago. They have no access to our technology, but they operate as platforms. So this is sort of the scope we're going after. If we come up with a framework to understand platforms, they should work as well for an Uber or Airbnb of today, as they should work for the matchmakers three thousand years ago.

   5. BGBen Gilbert12:35

      And so in that example, is the sort of keeper of all of the men and women to matchmake, is that the sort of intermediary of transactions that you're thinking of, so the whoever keeps that database is indeed a platform?

   6. CSChenyi Shi12:49

      Yes. And if you think in their mind, you know, three thousand years ago, they'd be thinking: How do I out-compete, you know, this other matchmaker in my village? And you'll be thinking about, okay, do I have a bigger database, and do I have no better knowledge about these people on my platform? So it's actually not that dissimilar.

   7. BGBen Gilbert13:06

      Yeah. What are the dimensions that are gonna make my platform more successful than another?

   8. CSChenyi Shi13:12

      Exactly.

   9. HHHamilton Helmer13:13

      There's been a revolution in knowledge about this kind of business model, and a lot of that is around the first step, which is product-market fit. You make better matches, right? If you've got mobile phones, all of a sudden it's possible to do a lot of stuff that you couldn't do back in the day. But that question is different than the question of, okay, you've created all this value, how do you get to keep some of it for yourself? Which is what power is about.

   10. BGBen Gilbert13:42

       What you're essentially teeing up here is, just to make sure I understand, platforms under this definition of an intermediary of transactions encompasses a lot of business models that we would otherwise refer to more narrowly as, like, marketplaces or platforms, like what, you know, Windows offered for application developers to build on top of-

   11. HHHamilton Helmer14:02

       Yep

   12. BGBen Gilbert14:02

       ... in the nineties that gave it so much power, could encompass aggregators of sorts, because they're all, in a way, an intermediary of transactions. And I think what you're saying is, there's a whole lot of work that you've done, and there is to do out in the world of applying the 7 Powers framework specifically to platform businesses, because they're different than businesses that aren't platforms. Do I have that right?

   13. HHHamilton Helmer14:27

       Yes, that's well put. David should be interviewing you. [laughing]

   14. BGBen Gilbert14:33

       [laughing]

   15. CSChenyi Shi14:33

       [chuckles]

   16. DRDavid Rosenthal14:33

       Chenyi, can you walk us through your work on how to assess platform power?

6. 14:40 – 17:51

   Technology as the platform catalyst: collapsing transaction costs and creating new markets

   1. CSChenyi Shi14:40

      I guess even before that, we're not trying to understate. I think we just said, you know, platform is not tied to a particular form technology, but there's an important thing to notice that technology is really important. And there's a particular form that gets reflected in the platform, which is technology lowers transaction costs, and it lowers it so radically that what you see is entirely new markets get created that was not existent before. So our way of framing the relationship between platform technology is that platform is not bounded to a form of technology, but technology is the driver for new platforms to emerge, and that's something I guess all the entrepreneurs and inventors out there would have a very clear sense of what is the technology trend they're riding and creating new markets with their platforms.

   2. BGBen Gilbert15:27

      It's fascinating. It's, like, definitionally true, be it by reducing distribution costs or by reducing the friction to make a transaction. Every step change in technology dramatically reduces transaction costs.

   3. DRDavid Rosenthal15:40

      Shoot, I mean, TikTok using AI, that getting cheap enough and good enough to have that drive the algorithm. So many examples.

   4. CSChenyi Shi15:48

      Yeah, exactly. The frictions or transaction costs come in very different tastes, right? It could be the reduced of search cost, the reduced cost to input information, reduced cost to deliver things to your customers, and it's only up to the imagination of the entrepreneurs to create new ways to make them happen.

   5. BGBen Gilbert16:05

      It's a great point. Even thinking about the database of the notebook, to go back to the matchmaking example, 'cause I think it's wonderfully concrete. Somebody has in their head the five single people they know that they can recall that might be good to matchmake someone with, you know, the Yenta of the village back in the day. [laughing]

   6. CSChenyi Shi16:21

      [chuckles]

   7. BGBen Gilbert16:21

      But if you have a big notebook and you can write down everyone, suddenly your cost of storage went down dramatically and your recall got much less expensive and much more scalable. And then, of course, when you fast-forward to today and you have Tinder and Hinge and these sorts of apps, it's all infinitely cheap, not only to store, but to input, to distribute, to incentivize people to load their own information to the database. There's just all these dimensions of cost that sort of collapse to make everything have less friction.

   8. HHHamilton Helmer16:50

      Technology is what opens up whole new potential vistas on product-market fit in just exactly the way you described, Ben. But if so, you think of two step changes in value, that's the first step change. The second step change is, okay, how much of it do I get to keep? That's the power step change. It makes that, in some ways, harder. That's the paradox. Because all these things that reduce friction are easily available to lots of people, and so your very ability to spin up quickly and make something happen, and it seems very powerful, may in fact, be the very thing that makes it easy for a competitor to catch you. So that's one of the paradoxes that you have to be really thoughtful about when you look at power and platforms.

   9. DRDavid Rosenthal17:42

      I love it. Okay, so can you walk us through how you've developed a framework for analyzing power of a platform?

7. 17:51 – 18:58

   Three diagnostic questions to assess platform power (benefit vs. barrier)

   1. CSChenyi Shi17:51

      It's a very complex problem, and the reason for that is each platform we've tried to do a case study on, the industry economics is different. There are so many idiosyncratic characteristics that impact the equilibrium state. So for us, you know, instead of trying to give you a very abstract, high-level framework that's not gonna, you know, relate to the actual situation, it's probably easier to raise a few questions that we think every operator, when they think through, will find some value in it. So I'll throw out the three questions, and we can go through them one by one. So-...Number one, how is economic value created on your platform? And how does that value change as your platform becomes larger or has more participants attending it? The second question is: how does each group of your customer perceive their economic value from your platform, and how does that change as your platform gets larger? And the third question is: what is preventing your competitors from getting to equivalence in that value proposition? So that, to us, is sort of a comprehensive list of questions that you have to think very carefully about, and then after that, you may be able to get some good insights about whether your platform may have power or not.

8. 18:58 – 27:13

   Uber/Lyft case study: density economics, diminishing returns, and multi-homing risks

   1. HHHamilton Helmer18:58

      So the first question is: what's going on here economically? Who's gaining, and where's the money, right? And so I, I'll give you an example in Uber. So what's going on is you have two sides, drivers and passengers, and they're trying to match, and they're highly heterogeneous because each driver-passenger is time and location stamped. And by having more drivers and more passengers, it makes it possible for Uber to develop more efficient route structures. And what more efficient route structures do, essentially, is to minimize driver downtime. It doesn't change how long it takes to do the drive. That's baked in to who it is and where they want to get to, but it does change how much time you have to wait before you get the next ride. And then you look at both sides of this and say, "Okay, why does greater density create an opportunity for value here?" And the answer is that it's a better fit. You can pick a driver that's nearer a passenger, and this fit notion is something that's the nature of platforms. So you're looking at both sides must be highly heterogeneous, and you're trying to get a better fit, and that's the nature of the economic value. And then the question is: okay, how does that value that you deliver vary as the participants grow? Because that's the characteristic of platforms, is that's often how they're differentiated, by different levels of participation on both sides. And what happens there is that as you are more dense in a specific region, so this is a very geographically bounded economic proposition in the Bay Area, for example, as that density increases, you can decrease the amount of wait time for drivers. However, I'd argue, all the people at Uber and Lyft that know this much better than we do, I'd argue that's not a linear function, right?

   2. BGBen Gilbert21:12

      Right, it has diminishing marginal utility.

   3. HHHamilton Helmer21:14

      Right, so it's a negative second derivative. And so what that means is that the curve flattens, and so n- now if you ask the question, "How does one provider compare to the other?" which is the power question, which is the third thing Chenyi was getting at-

   4. BGBen Gilbert21:33

      And just to set that up for one moment, so the first two questions are more about understanding the lay of the land, and then the third question of what prevents competitors from getting to equivalence, that's the power question. Is that fair?

   5. CSChenyi Shi21:47

      So it's about both how much value you can create and then how much you can capture from it. So the second question is not worth asking if you're not creating much value in the first place.

   6. BGBen Gilbert21:57

      Mm.

   7. CSChenyi Shi21:57

      So you actually have to go through all of them pretty carefully.

   8. BGBen Gilbert22:00

      Just for my benefit, and I think maybe listeners, you know, be- because we went through the questions kind of quickly, can you just remind us of the questions again so we know what we're referring to in the first, second, and third?

   9. CSChenyi Shi22:10

      Yes. Question number one is: how is economic value being created on your platform, and how does that value change as your platform starts to get more participants? Number two is: how does each group of the customers perceive their economic value from your platform, and how does that change as your platform scales? And lastly, how do you prevent your competitors from getting to equivalence?

   10. BGBen Gilbert22:31

       I see. So the first one's really about quantifying value creation and obviously understanding how that changes over time. The second one is about perception of that value creation by different participants, and then the third one's really about value capture and defending the castle over time.

   11. HHHamilton Helmer22:46

       And so Chenyi said that sort of the power question involved more than just the last one, and so if you remember that power involves two things, a benefit and a barrier, right?

   12. BGBen Gilbert22:58

       Mm.

   13. HHHamilton Helmer22:58

       So the first question is the benefit, and the third question's the barrier.

   14. BGBen Gilbert23:02

       Yeah. Well, actually, maybe first, can we finish Uber and talk about that third question for Uber? 'Cause that sort of feels like, for Uber, at least, and Lyft, that's where the rubber hits the road on [chuckles] how valuable are they.

   15. CSChenyi Shi23:13

       Yeah. I think a very challenging characteristic of platforms overall is you don't own your customers. Your customer choose to patronize your platform, and they can choose to do the same with another platform. So this is a scenario that we call multi-homing, and essentially, what we're saying is a lot of the differential value a platform can generate is a result of differential scale they have with their participants. And multi-homing is what arbitrage out all of that differential value if those platform don't make profits out of their operations. The result of that is you're creating so much value, but all of those gets arbitraged, and your customers get it, but not the owner of the platform itself. So in the case of, you know, ride-sharing business, particularly, the things you really want to ask yourself is: what is preventing my customers from also accessing the other platform that's competing with me? And, and your customers, referring to both your riders and your drivers. So it doesn't matter if my platform is right now larger, if technically both groups of my customers can frictionlessly multi-home on the other platform. So if you always open two apps and look for whichever one that happens to have that ride that's closest to you, and you always have open two apps to see whichever one gives me the closest rider that I can get matched with, then relative scale does not matter because you're contributing to the same pool of density in your local area.

   16. BGBen Gilbert24:38

       Makes total sense.

   17. DRDavid Rosenthal24:39

       ... deep-lung listeners of Acquired will know this hits very close to Ben's heart [chuckles] with your, one of your early startup weekend projects, right?

   18. BGBen Gilbert24:47

       That's true. At one point, I started a startup that actually got killed by Uber not willing to play ball with us and cutting off our API, but it's effectively a meta search for ride-sharing to be able to find the fastest, closest ride to you, independent of who's actually providing the ride.

   19. CSChenyi Shi25:00

       Wow! [chuckles]

   20. BGBen Gilbert25:01

       Yeah. It's an undifferentiated experience to hop in one or the other.

   21. HHHamilton Helmer25:05

       Yeah, and, and it's interesting, the whole meta search idea is a friction reducer, so if you can get an overlay that compares two, then it's not hard to see what that does in terms of disin- intermediating power, right?

   22. BGBen Gilbert25:21

       Meta search as a category enables your customers to arbitrage away your power with less friction. [chuckles]

   23. HHHamilton Helmer25:28

       That's right. Think of Snowflake or something, right?

   24. DRDavid Rosenthal25:31

       Okay, so ride-sharing is an example platform where you get to the end of the questions, and maybe there's still kind of a question mark [chuckles] about the industry and the companies within it. Could we walk through an example of a company or an industry where you get to the end, and you conclude, "Oh, wow, this company, this platform has a lot of power?"

   25. HHHamilton Helmer25:51

       So David, before we leave rideshare, think of the moving parts here. One of the moving parts is what does that ride efficiency curve look like? So as you scale, how quickly does it start to slope down? 'Cause that's gonna be critical. If it's a straight line and you're two times relative market share, you're home free. If it tails off pretty quickly at an early stage with two times relative market share, you could be an attractive relative cost position, and once the business is scaled, it's no longer true, 'cause you're into the flat part of the curve, right? So it's the shape of that curve. It's your size relative to somebody else. Let's say you have that advantage. What's to keep it from not being arbitraged out? So you want to turn to people like Ben and say, "Don't offer that app!" [laughing] Right?

   26. BGBen Gilbert26:43

       Which they did.

   27. HHHamilton Helmer26:43

       Right. Right.

   28. DRDavid Rosenthal26:44

       Which they did.

   29. HHHamilton Helmer26:45

       [chuckles] Yeah, so you can fully understand their motivation. You're the enemy, right?

   30. DRDavid Rosenthal26:50

       So I think what you're saying is, take this example of a market where there is diminishing returns to density. If the diminishing return curve is steep, then it's very unlikely that any individual company can develop power. But if it's gradual or linear, then, yes, you still can develop power, even within a market with diminishing returns to scale.

9. 27:13 – 32:30

   When platforms do have power: heterogeneity of preferences and the YouTube example

   1. CSChenyi Shi27:13

      There's this concept that we call heterogeneity of preferences that matters. So what it means is returns to scale is always diminishing, but how quickly it diminishes depends on the space you operate in. So the case of Uber and Lyft, we are... Ben, as you said, the drive is undifferentiated. All I care about is how far away my driver is or my rider is. So what they're doing is literally putting dots on the 2D geographical map, and the minute you get to enough density, you're good enough. So if you think about maybe something with high levels of heterogeneity, think about YouTube. The content you watch has so many dimensions that you care about: the language, the theme, the music, the production quality, and that is a space where, in order to get to a scale where I'm good enough that this additional piece of content is not going to appeal to my users anymore, that's a much higher level of requirement of critical mass or of scale of content. So this is something that we think operators should also think through, like, what is the level of heterogeneity that your transactions have? And that determines how important scale is to you.

   2. HHHamilton Helmer28:21

      Right.

   3. BGBen Gilbert28:22

      That makes so much sense that basically YouTube will continue to compound the economic value of their lead because even though there's... I'm gonna make up some numbers that seem big, but a hundred billion hours on YouTube and only ten billion hours on competing platforms, the thing I wanna watch is so unique to me as a person, how I feel at that moment, if the personality of the creator is interesting to me, that the fact that there's always going to be slightly better content market fit for me on YouTube than that other platform just means that that curve diminishes very, very slowly.

   4. CSChenyi Shi29:00

      Exactly, and there's a favorable by-product of that, which is for something like YouTube's content, it's actually really hard to describe what I'm looking for, right? How can I, in text, search for the exact content I want? So YouTube accumulates this unique set of knowledge about both what you like and watch time of others that attest to the quality of the video, so that makes the search so much easier on YouTube compared to a competitive platform, even if it's a complete copycat to YouTube.

   5. BGBen Gilbert29:32

      So YouTube is a good example where the value they provide to me is high. I perceive that value to be high, and then when you think about other constituents, also, I mean, the creators perceive the value to be high, advertisers perceive the value to be high, and then when you get all the way to that third question of: how are they better than competitors? There's lots of ways that they're better than competitors. I'm curious, as you think about YouTube as a platform, what are the ways that they have power versus other video platforms?

   6. HHHamilton Helmer30:01

      Because of what Chenyi was talking about in terms of heterogeneity, if edge cases matter, there's a pretty good chance there's an opportunity for power.

   7. BGBen Gilbert30:11

      Hmm.

   8. HHHamilton Helmer30:12

      And because when you say edge cases matter, what you're really saying is that curve doesn't flatten out very quickly. Right?

   9. BGBen Gilbert30:20

      Right.

   10. HHHamilton Helmer30:20

       And so it says that even... that differences in one of the sides' scale remain material in terms of the other side's appreciation of the value being provided. When you go on YouTube, your tastes are extremely idiosyncratic.... I'm looking for the latest climbing send or something on general relativity or, you know, the weird stuff, right? Or the latest performance car or something.

   11. CSChenyi Shi30:53

       Yeah, definitely. So there's a lot of work in economics that states there could be an equilibrium pricing schema, where you charge one side, and you pay the other side, and that still contributes to a very powerful platform in the long run. So it's an interesting state about YouTube. It's very complicated, but extremely intriguing, which is they have accumulated so much heterogeneous content that they are able to charge enough mind share from their users, and they monetize that mind share with advertising dollars, which they then pay their creators. So it's a position of power that creates enough firepower to keep maintaining and enlarging that lead in this particular user-generated video content market. So that's why you keep seeing YouTube gets larger and larger, and that's because there's one source that provides them with that benefit that they can maintain in the long run.

   12. BGBen Gilbert31:48

       Yeah, it's interesting that there's no real scale that seems to have been reached with YouTube, where anything starts getting compressed, any margin starts getting compressed. There doesn't seem to be any place where a meaningful number of creators are going direct and, like, publishing to their own video platform that's not YouTube. That doesn't seem like YouTube is having to pay out a smaller and smaller percent of its profits to creators. It doesn't seem like advertisers are trying to get more bang for their buck. They're happy with the bang for the buck. The margins are not getting compressed there. It's kind of remarkable that as that business continues to grow and grow and grow, there is not margin compression in any corner of the business.

10. 32:30 – 36:39

    Why YouTube stays dominant: search costs, expectations, and different user segments

    1. CSChenyi Shi32:30

       Yeah, and the cost of multi-homing on the creator side is actually not huge. You take a catalog, you upload to another platform, it shouldn't be theoretically impossible.

    2. BGBen Gilbert32:39

       We will multi-home this episode on both Spotify and YouTube.

    3. CSChenyi Shi32:43

       Exactly. So the real question really you should focus on is what's binding all the viewers? Why do people keep coming back to YouTube? And a good thought experiment to go through is, let's say, there is a copycat version of YouTube stood up tomorrow, which carried over every single video YouTube has today, would you move? Would viewers suddenly start to go to the other platform? And this sort of goes back to my earlier point about this is such a heterogeneous space that the cost of search is not immaterial. For me to, you know, over time, accumulate the set of influencers I follow and tell YouTube which ones are the content I love to watch, then YouTube knows the watch time, which is a very important input into their algorithm of, you know, what are the high-quality content, as proved by all my other users. So those information dramatically reduces my search cost that the other platform, even if they have the whole suite of content, cannot really match. So there's frictions right there on the viewer end that I think is protecting YouTube's business.

    4. HHHamilton Helmer33:44

       Chenyi and I argue about this. [laughing]

    5. BGBen Gilbert33:47

       Yes. [laughing] Do you have a different opinion?

    6. HHHamilton Helmer33:50

       For me, the reason I go back to YouTube is an expectation that exactly the content that I want is there, and it's not the efficacy of the search, and so that's the dispute.

    7. BGBen Gilbert34:03

       There seems to be some sort of buried thing in my brain that is aware of their network economy power, where at first I thought it was brand, but it's more like I have the assumption that the latest SNL skit is going to be there because everyone uploads their stuff there. 'Cause I'm with you, Hamilton, I have the same... I'm gonna go to YouTube every time because I have the absolute most confidence that the thing that I'm looking for is there because of their network economy power.

    8. CSChenyi Shi34:30

       Oh, I'm so excited here.

    9. HHHamilton Helmer34:31

       And when you say network economies, what you're referring to is that a network effect is when somebody uploads something, it makes the whole site more valuable to everybody else for all these reasons. It makes matching more efficient and more likely to result in a good thing happening in terms of value. So yeah.

    10. BGBen Gilbert34:53

        Okay. I totally disagree. I'm with Chenyi on this one. [laughing]

    11. CSChenyi Shi34:56

        [laughing] There you go.

    12. HHHamilton Helmer34:57

        That is perfect. Two for two, right?

    13. BGBen Gilbert35:00

        David's a real YouTube user. You spend hours a day.

    14. DRDavid Rosenthal35:03

        I've become a real YouTube user. I think there is a baked-in assumption, Hamilton and Ben, in the way you think about YouTube, and you represent a large class of people, but I think there's also another class of people that m- I'm guessing Chenyi and I may be part of.

    15. HHHamilton Helmer35:15

        We won't get into age demographics here, but [laughing]

    16. DRDavid Rosenthal35:18

        [laughing] The assumption is you both think you are going to YouTube with intent to look for something. I don't go to YouTube with intent to look for something. I go to YouTube with intent for YouTube to surface for me, without me doing anything, things that I will enjoy.

    17. HHHamilton Helmer35:33

        Interesting. Different use case, yeah. I hate to say it, but probably, uh, you know, history is on the side of the younger demographic. Although, I guess, Ben, [laughing] uh, y- I, I hate to group you with me.

    18. DRDavid Rosenthal35:45

        Ben's younger than me.

    19. HHHamilton Helmer35:45

        That's-

    20. BGBen Gilbert35:45

        Yeah

    21. HHHamilton Helmer35:45

        ... that's a dangerous- [chuckles]

    22. BGBen Gilbert35:46

        No, no. I use YouTube the way that one might speculate older generations use YouTube, and David is a little Gen Z in that respect. [laughing]

    23. DRDavid Rosenthal35:54

        [laughing]

    24. CSChenyi Shi35:54

        There you go, Dave. Now we've classified you appropriately.

    25. DRDavid Rosenthal35:56

        Amazing. Oh, I'm so happy. I can retire now. [chuckles]

    26. CSChenyi Shi36:00

        [chuckles] But that's a good point for, like, all parties to think through, 'cause without being YouTube, you won't know exactly how your customers split between people who search and people who just look for enjoyment on your platform, and every platform should have a clear sense of how their customers are split into those groups.

    27. DRDavid Rosenthal36:14

        Yeah, both of those segments exist for YouTube.

    28. BGBen Gilbert36:17

        This is what I loved about how specific you were, Chenyi, in your second question of: how do different customer segments perceive value? Because in analyzing the value created by YouTube to me, but also the power that YouTube as a business has for me as a specific customer, is totally dependent on my use case of it.

11. 36:39 – 38:44

    Customer value perception varies: Amazon seller vs. eBay seller mental models

    1. CSChenyi Shi36:39

       Yeah, exactly, and I would like to give some example that's kind of a more stark contrast between, you know, different modes of how customers might perceive the value. So I think we often hear like, "Oh, more buyers will attract more sellers, and more sellers gonna attract more buyers." Like, this is oftentimes true, but it's so general that it's oftentimes missing the actual granularity that matters to you.... So the example I give is, think about an Amazon seller and how does he optimize his economic value from a platform? So these sellers typically have a built-out supply chain. They more or less sell around the market price. So what they're trying to do is to, "I wanna sell more units at that single price, and whether or not I'm going to go to a different platform," the question he's gonna ask is, "How many more units am I going to sell? And is that going to cover my cost of going on to the other platform?" Now, this rationale, if you take it onto an eBay seller who's trying to auction his antique watch, it's going to be very different, right? He has only one watch to sell, but the equation going in his mind is, "How can I sell this watch for the highest price possible?" And again, this just depends on the better matching thing that we talked about before, because the more participants you have on this platform, you're gonna have better matching. It's more likely for you to have a buyer who values this watch much more than others. So the question he's gonna ask when thinking about this alternative platform is, "What is the likelihood that a buyer with more willingness to pay is gonna appear on the other platform, and by how much? And how do I compare that with the cost I have to manage this other platform that I may wanna hop on?" So you have to understand what's the equation going on in your customer's mind very carefully, 'cause sometimes they could be really different, and that determines the equilibrium of the competition.

    2. DRDavid Rosenthal38:21

       Yeah, the Amazon seller doesn't care about finding people who will pay a higher price for their product. They want to find as many people as possible who will pay the market price for their product, right?

    3. CSChenyi Shi38:31

       Exactly.

    4. BGBen Gilbert38:32

       Assuming their margin is roughly comparable, and also putting aside the question of: Is it strategically a good idea for my business to sell through Amazon versus selling direct? We're, I think, intentionally not diving into that, 'cause it's a whole bag of worms.

12. 38:44 – 49:25

    When to turn on monetization: surplus leader margin and the share-vs-margin tradeoff

    1. DRDavid Rosenthal38:44

       Right. Right. [laughing] Okay, so one question I wanna ask you all... Maybe YouTube is the right one to go back to. I think we can all agree that YouTube has a large power opportunity. When and how is the right time for a company that finds themselves with a large power opportunity as a platform to start capturing that value? Famously, everybody thought that Google was nuts with YouTube, because it lost billions of dollars [chuckles] for more than a decade, and in retrospect now, perhaps that was a brilliant strategic decision by Google. [laughing] Uh, how do you all think an operator should think about that?

    2. HHHamilton Helmer39:25

       For me, the key thing here is to remember that the product-market fit and power questions are different questions, and one doesn't necessarily answer the other, in fact, often doesn't, and that it may be that when you have a business model that gets you to product-market fit, there may be a power opportunity embedded in that, and there may not be. And so those are two very different problems. One is the problem of capitalizing on an inherent potential for power, and the other is trying to figure out what are you gonna do that will get you power in something that currently doesn't have it, and that second is a very hard problem, right? It's a second invent that's every bit as hard as the product-market fit invent. So think of Steve Jobs trying to figure out where to take Apple when the PC business turned out to not have any power, right? Um, here's the most brilliant innovator of our generation, and yet, uh, he couldn't solve the problem, and he ended up losing his job.

    3. BGBen Gilbert40:32

       It's actually worth drilling in on that Steve Jobs comment for a minute, and then, of course, you, like, tempt me with, uh, Apple history catnip. [laughing] I have to jump on it.

    4. CSChenyi Shi40:41

       [laughing]

    5. BGBen Gilbert40:42

       It's interesting that he tried. The power computing-- I don't know if the macOS running on other hardware devices was a, an initiative that started while Steve was still there, but it's interesting how obsessed Steve was with, "We control the whole stack." You know, "We're the software and the hardware, and our software only runs on our hardware, and our hardware can only run our software." And with power computing and all these sort of Mac clones that Apple authorized and said, "We're gonna enable our OS to run on these other PCs..." I actually owned one, and it was a cheaper Mac, and it did not save the company, because they had no ability to take the profit dollars that they earned from that and build something defensible with it. And it's fascinating, that, Hamilton, exactly to your point, they did try things, and also, there was no power opportunity that they or anyone really found to be a very profitable PC manufacturer.

    6. HHHamilton Helmer41:38

       Yeah, I mean, I think if they hadn't completely flubbed the Mac 3, I think they might have ended up in a very attractive power position, because they did own the stack, and they did own the operating system, and they didn't yet own the processor, but they could eventually. And if you think of the PC business, the two nodes of power were the OS and the CPU, but you needed to have superior scale and get everybody signed up to have that work, and the Mac 3 was such a complete flub that it made it possible for the IBM PC to just take over the world, basically.

    7. BGBen Gilbert42:16

       Right.

    8. HHHamilton Helmer42:16

       Of course, the IBM PC didn't have power either, and so that ended up being an, a long-term, not that attractive a business.

    9. BGBen Gilbert42:24

       Well, it's funny, 'cause the Mac, just the desktop line, has a lot of power today. It is remarkable-

    10. HHHamilton Helmer42:31

        Yes

    11. BGBen Gilbert42:31

        ... amount that people will pay in dollars they wouldn't pay to a different manufacturer with a different operating system for an Apple computer, and now they bundle in proprietary chips that are the best on the market, so they have dramatically lower cost structure. So it's just margins everywhere.

    12. HHHamilton Helmer42:46

        Right. As you might guess, I'm a huge fan of Steve Jobs, and-

    13. BGBen Gilbert42:49

        [chuckles]

    14. HHHamilton Helmer42:49

        ... I think his impulse to control the stack was not based on sort of power, but aesthetics almost. He wanted to control the experience.... and had this sense of the aesthetics of the experience. He was a genius at that kind of stuff, right? And it could have aligned with power had their execution been better-

    15. DRDavid Rosenthal43:12

        Hmm.

    16. HHHamilton Helmer43:12

        -but it was a failed opportunity, unfortunately. This will really date me, but I remember when IBM entered the PC business, Apple took out a, a full-page ad in, what was it? The Wall Street Journal or something-

    17. DRDavid Rosenthal43:23

        Welcome!

    18. HHHamilton Helmer43:23

        -welcoming them to the business. And, and that's sort of a common trap that you sometimes see, which is people that are just amazing at innovation, which I have a huge admiration for. That is to say, getting product-market fit, think that they can just out-invent the competition forever, and that story usually doesn't end well, I don't think. When... The things you're in, you have to solve the power equation, or, uh, or else you end up competing in a commodity way on your base business.

    19. DRDavid Rosenthal43:54

        So obviously, the answer is different for every company, but what are some ways to think about when you can feel comfortable enough in your power position to start dialing up your profitability, which I guess would equate to dialing back your subsidies on the platform?

    20. HHHamilton Helmer44:15

        In the early stage of a platform with product-market fit, what that means is there are a lot of people who want this stuff, right? And so you scale like crazy, and you're rewarded for that. Your B round and your C round, all of a sudden, the numbers start to look pretty darn good. But then later on, you face the power question, which is: Is that a profitable proposition, or have you just acquired a lot of customers? So I, I think it's an idiosyncratic tactical question, that as a business progresses, you have to make a decision about when you start increasing prices, and it's not that you would eliminate the subsidy. And I think, like all decisions like that, you have to look at sort of the immediate effects and the long-term effects. But I have to say that in general, and, uh, you s- see this in my book, there's this difference in businesses between the takeoff phase and the later phase. Takeoff phase, when there's enormously rapid growth, and in that phase, the acquisition price of a customer, it's not priced properly, and so it's a good time to get customers, and later on, you sort of can tighten the screws a little bit.

    21. DRDavid Rosenthal45:25

        Well, like I... The YouTube example is interesting, right? Like in their case, dialing down the subsidy and dialing up profitability means increasing ad loads to users. And for years and years and years, ad loads were very low. It was comical. Users were getting so much value for very little ads on YouTube. And then in recent years, they've been dialing it up quite a bit, and they don't seem to be bleeding customers in doing so.

    22. CSChenyi Shi45:50

        I'm going to supplement Hamilton with his own book, so Hamilton, don't feel awkward.

    23. DRDavid Rosenthal45:54

        [laughing]

    24. HHHamilton Helmer45:54

        [laughing]

    25. CSChenyi Shi45:56

        So I think there are two parts to this. So number one is, if they're readers of 7 Powers, and you're patient enough to flip to the appendix, uh, after each chapter, there is this concept that we call surplus leader margin, which is the maximum price you can charge more than a competitor while still maintaining your competitive position. So this is essentially what we are talking about here, is: How much can I charge while maintaining the leadership I have today? And that number is not dynamic. That number is dependent on the differential scale you have against the other platform. So that's one of the high level, like, you know, what's the overall thing you wanna achieve, but at the same time, we recognize the difficulty. And power is both market share and differential margin. And Hamilton always says, you know, it's, it's an active trade-off between both. Entrepreneurs do it because when you see such, so large greenfield you can penetrate, you should grab that and sacrifice short-term margin for a larger market share, and that's still power because you can realize those profits in the future. So it's hard to tell people the one-size-fit-all, this is exact point, but understanding what is your surplus leader margin, how much is the maximum you can charge, given the best alternative out there, and dial up the tune when it's the right time.

    26. DRDavid Rosenthal47:11

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    27. BGBen Gilbert48:31

        Crazy. And the team is so freaking talented. Like, it was fun hanging out with the team when I was down in San Francisco, what, a few weeks ago now, and just a real all-star group they've built there.

    28. DRDavid Rosenthal48:40

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13. 49:25 – 1:06:17

    Ecosystem extractiveness: TSMC vs. Apple and the logic of pricing for long-term advantage

    1. BGBen Gilbert49:25

       Thanks, Modern Treasury. There's something that I've been thinking about that I wanna ask you. So we had, months ago, after our TSMC episode, a couple of the investors from NZS Capital on, and one of the points that they made is, we actually don't like to hold Apple in our portfolio right now because our view is that they're being overly extractive to their customers or over the whole ecosystem. You know, it's the thirty percent stuff with the App Store. They are realizing their market leadership, and they are squeezing as much as they possibly can. And you contrast that against a TSMC, which does not charge the very most they possibly can to the customers to manufacture their chips, and it's a very intentional strategy, and they believe that that's sort of a long-term view that they have in order to do that. I'm curious, as investors, how you think about from the perspective of maximizing enterprise value for a firm, what should a company do? Should they be maximally extractive to their ecosystem, or should they leave some surplus on the table?

    2. HHHamilton Helmer50:29

       Yeah, it's a great question. Before commenting specifically on TSMC, one of their primary competitive interfaces, obviously, in terms of fab technology and getting ahead in that, is Intel. And I just-- just to caveat about, both those businesses are amazing and well-managed and successful, and the fact that TSMC seems to be gaining ground is also a reminder to everybody that power is not forever. [chuckles] 'Cause I use Intel in my book, and that's the way life is. You know, technology's changing, competition changes, and for me, you know, one of the longest term power things I've ever observed is that of elite universities and being able to maintain, and which is ironic that it's not even in the private sector.

    3. BGBen Gilbert51:17

       [chuckles]

    4. HHHamilton Helmer51:18

       So I think on a pricing question like that, pricing may well be tied to a strategic goal, but it's tactically available to anyone, so its justification has to be tied to underlying fundamentals. And essentially what you're doing is, in this case of TSMC, what you've cited, is they're sort of giving up current profits for something in the future, right? And presumably, it's sort of future revenues. So they either get retention through customer loyalty or acquiring new customers. So that leads you to ask, will more customers, more revenue in the future, give you more differential returns? And that gets you down to ask about scale economies. Do they have it? And I would argue yes, but it's pretty unusual type of scale economy. So there are some very strange industry characteristics here. So really large, lumpy capital. I don't know, what's a new fab now? Is it ten billion or something?

    5. DRDavid Rosenthal52:17

       Oh, I think it's ten billion plus, yeah, if I remember right from our episode.

    6. HHHamilton Helmer52:21

       Yeah, huge, huge number. There are kinda quote, unquote "predictable" material performance advances, i.e., Moore's law, so that life isn't usually like that. [chuckles] You don't think that, well, I've got a fairly high assurance that if I make the right technology choices, that I'll have a ten X improvement in eighteen months or something. Uh, you know, that-- life isn't usually like that, and so this is very unusual, and it's driven by the correct technology choices. And the other thing is that the tech advantages are driven by upstream suppliers.

    7. DRDavid Rosenthal52:59

       Right, ASML and others in this case.

    8. HHHamilton Helmer53:02

       And that's a hard choice, actually. I don't know if you, if you go back a ways, there is a long discussion in semiconductor companies of whether to go through with x-ray lithography, and it turned out there's a lot of money invested in thinking about that.

    9. BGBen Gilbert53:17

       It was very contrarian. In the early 2000s, even Intel, I think, funded ASML's development, a big industry consortium, including Intel, of the EUV, and then thought the technology was gonna die, and so I think three or four years in, divested.

    10. HHHamilton Helmer53:33

        Right.

    11. BGBen Gilbert53:33

        Whereas obviously now that's the dominant way that we have these three and five nanometer processes, and TSMC's to benefit.

    12. HHHamilton Helmer53:41

        Right. So under those sort of really odd industry conditions, it means that if you're quite comfortable with forward guarantees of customers, you can make a capital commitment, this huge capital commitment. It wouldn't matter much if there weren't those big material performance advances, and it wouldn't matter much if it was not all that lumpy. You could do it in small increments, and it wouldn't matter if it was relatively small amounts, and it wouldn't matter if it was all vertically integrated. So that allows a scale company to get to the newer technology first, and that has profound implications for sorta continuing that cycle, but it means that they're lower cost per transistor, and they also, uh, can do higher performance products, which probably are higher margin. Before TSMC, the companies that crossed that threshold of enough comfort with forward guarantees were the companies that sold the products. So back in the day when... You guys are too young to remember this, but there was a time when IBM controlled the computer industry. There's nothing like that today. People talk about tech dominance, but IBM just was a force that was just so far and above everybody else, and they backward integrated into fabs, right? And they were the fab leader 'cause they could do this stuff, and then Intel.

    13. BGBen Gilbert55:09

        That's right.

    14. HHHamilton Helmer55:10

        So we've moved from a vertical-... to a horizontal organization of this. So I may be too reductive about this, but to me, their pricing makes perfect sense, even from a purely Machiavellian, shareholder value kind of perspective, is that that allows them to get a customer... Lock-in is too strong a word, but a, a comfort with future customer-

    15. DRDavid Rosenthal55:39

        Comfort that NVIDIA is gonna stay with them for generations to come and be paying them billions of dollars to allow them to.

    16. HHHamilton Helmer55:46

        Right. And remember, for the really tricky upstream suppliers, what's the-- Is it the Dutch company that does... You, you guys know who does-

    17. BGBen Gilbert55:55

        Yeah, ASML.

    18. HHHamilton Helmer55:56

        Yeah, ASML. You have to make a long forward commitment. It's not just the amount, and so it allows them to do that. And then, of course, if they had that advantage and didn't make the right choices about technology, and I don't know if that's luck or skill, then it also doesn't work. But they've made the right technology choices, and they have enough guarantee of future business that they can now be the leader in technology. And this is a business where that performance frontier is moving in sort of a predictable way. And so being a leader in technology means that you are a, a cost and performance leader in the business. And so it makes a lot of sense to me to kind of give up current profits to guarantee that ability. Uh, does that make sense to you guys?

    19. BGBen Gilbert56:47

        Yeah, I had not previously thought of the notion that... You know, of course, I thought, "Well, maybe it's not actually benevolent, that they're not maximally extractive," but I couldn't quite put my finger on why.

    20. DRDavid Rosenthal56:58

        Morris seems like a nice guy, but, [chuckles] you know.

    21. BGBen Gilbert57:00

        Yeah, and the why is so interesting that, well, to the extent that they can massively increase the probability that their customers stick around for a while, they can spend this ten to fifty billion dollars of CapEx to build these new fabs. They can be one of the very few customers in the world that's guaranteed to, over the next three to five years, get these machines from ASML and other suppliers, like Trumpf, the laser company, et cetera. And so because those are scarce resources to be the customers of those companies, and because it's so expensive to build these leading-edge fabs, to the extent you make the right technology choices, there is this sort of self-fulfilling prophecy of guaranteeing all of those future profits if you have that magic ingredient of being certain that your customers are gonna stick around.

    22. HHHamilton Helmer57:47

        Yeah, it's gonna be very interesting. TSMC is just s- such an amazing story. So they've been able to take what, in all prior generations, had been a vertically organized business and made it horizontal. And the thing that makes horizontal organization work is typically a scale economy, so that you pick up more scale. The strange industry characteristics means that predictability of future customers is profoundly important in terms of creating company value.

    23. DRDavid Rosenthal58:22

        So when we contrast that, kind of back to Ben's original question, with Apple's situation today, I guess it is quite different. I mean, I think a lot of people feel that Apple's thirty percent rake that they charge developers to be in the App Store is-

    24. BGBen Gilbert58:38

        Is maximally extractive.

    25. DRDavid Rosenthal58:39

        It's maximally extractive. Yes, that's a good way to put it. [chuckles] But they're not in a situation like that. They're a vertically integrated company. They control the whole stack, and they're able to fund their also quite large capital expenditures, but they fund that through hardware sales in a very different manner than TSMC.

    26. HHHamilton Helmer58:55

        Yeah, it's not clear to me that sort of giving that money back to customers or suppliers would benefit them a lot. I have an iPhone, and I really like it. I realize that every time I turn around, it's trying to get me to buy, you know, the iCloud or something, you know, and they're, of course, trying to take advantage of me.

    27. DRDavid Rosenthal59:17

        [chuckles]

    28. HHHamilton Helmer59:17

        But I really love the product.

    29. DRDavid Rosenthal59:19

        [laughing]

    30. HHHamilton Helmer59:19

        And there are, of course, very high switching costs. I was on a plane and, and unfortunately ruined my iPhone, and, uh, landed in Hawaii and had to get another one. And it was a very easy choice to get another iPhone as opposed to another product. So I don't think people are terribly dissatisfied with the situation, and so they're not risking a lot, so it doesn't seem insensible to me. I mean, there, there are regulatory issues they're gonna face, and they'll be constrained in certain ways and all that, but it makes sense to me. So I've-- maybe I'm too cynical in my old age.
14. 1:06:17 – 1:16:41

    Network effects vs. network economies, and why “flywheels” can be misleading

    1. BGBen Gilbert1:06:17

       We teased earlier that we were gonna talk about the difference between network effects and network economies, and this is something that David and I have flubbed on a few episodes, where I think I've conflated them in our power section. And I'm curious, what are some telltale signs of a company that has network effects but did not develop network economies power?

    2. HHHamilton Helmer1:06:38

       So I think network effects in the types of things that we've been talking about in this episode are common. You know, it's when a driver joins Uber, he makes the platform more valuable to passengers because more efficient route structures are now enabled, right? And that's a network effect. So the things that happen there are somebody joins the network, that's the network part, that's a new driver joining, and something happens to somebody else in it that has a value implication. That's the effect. That's a network effect. So the question is: What would you like to call network economies? That sounds like an odd thing to say, but that's really the question. And you could say-... anything that there are network effects and there's power, you could call, that might be one choice, and Chenyi and I are currently debating this. And so there's another choice, which is the one that I'm currently going down, which is that it's when there's power from direct network effects. And a direct network effect is where your joining has an immediate value impact on somebody that's sort of on the same side. So I join Facebook because I'm your friend, and those effects are strong because they're additive. So another friend's join, it doesn't substitute for the one that just joins, it adds to it. So and it's those kind of effects that do more lead to winner-take-all kinds of situations. So my naming choice right now is, if there's power as a result of direct network effects, then that's a network economy, and those aren't very common. I'd say indirect network effects, like the one in, in Uber, are much more common. It's just a value impact, but that's the benefit side, right? But as you two well know-

    3. BGBen Gilbert1:08:31

       Is it arbitragable?

    4. HHHamilton Helmer1:08:33

       - you need both the benefit and a barrier side, so is it arbitragable? So then you have to get to the much rarer set of cases where there's a benefit, it's material, right, and also it's barriered, and then that's a much, much narrower set of things. So do you wanna add something?

    5. CSChenyi Shi1:08:52

       I'm hesitant to drag David and Ben into our whole debate, but-

    6. BGBen Gilbert1:08:55

       Please.

    7. CSChenyi Shi1:08:55

       I think the short version of things here is network effects describes only the value creation, and it's a statement without consideration about competition, which the latter is all power is about. So regardless of how we end up defining network economies, it is the type of platform that we believe has power, and that's differentiating from network effects on its own.

    8. HHHamilton Helmer1:09:17

       Gee, I wish I had said that. You can edit out my comments and put Chenyi in. [laughing]

    9. BGBen Gilbert1:09:21

       [laughing] For our final sponsor of this episode, this is just one of the most fun sponsor reads to do. Mystery! You all know about this company by now, as they really have grown up in the Acquired community. They have a new offer to really sweeten the deal for Acquired listeners today, too-

    10. DRDavid Rosenthal1:09:40

        Ooh.

    11. BGBen Gilbert1:09:40

        - which I'm excited to tell you about.

    12. DRDavid Rosenthal1:09:42

        Leave it to the Mystery guys to be coming up with new stuff.

    13. BGBen Gilbert1:09:45

        Of course, mid-season. You might remember the Mystery founders, they came on the LP show back in April twenty twenty to talk about pivoting from facilitating, you know, these magical nights out for consumers pre-COVID to magical virtual experiences in the home while we were all in lockdown. Well, there was another twist yet to come. It turns out a bunch of consumers who did these virtual in-home experiences in April twenty twenty worked at places like Amazon, and Microsoft, and Apple, and McKinsey, and Uber, and Twitter, and Autodesk, and a bunch of other great now customers.

    14. DRDavid Rosenthal1:10:17

        Including Modern Treasury.

    15. BGBen Gilbert1:10:19

        Very true. While their virtual experiences with their friends was great, they really needed to upgrade that virtual experience with their team, 'cause, you know, after you log into Zoom seventeen times in that single day, and you're trying to have fun with each other and make it feel different, it's hard to make it feel super different without-

    16. DRDavid Rosenthal1:10:36

        The beatings will continue until morale improves. [chuckles]

    17. BGBen Gilbert1:10:40

        [chuckles] Yes, yes. Uh, thanks for quoting me from last episode. Well, so enter Mystery. They take over all those terrible team happy hours from scheduling and planning and executing. They even do all that and track engagement and employee retention and impact afterwards, so you know where that budget is going, and it makes those just really fun, great experiences. So flash forward to today, they've executed tens of thousands of events. I love startup pace. How crazy is it that in April twenty twenty, they had done zero of these, and now they've done tens of thousands, not just for those huge companies, but also startups of all sizes? David, like you mentioned, Modern Treasury, Convoy, lots of other startups. They just raised a giant Series A from Greylock to really blow this out of the water. It's been so fun following their journey. So here's how they're upping the ante: We were like, "You know what? Should we change this around? You know, we really appreciate the great tidbits we've been able to share so far, but, like, what else can we do together?" And they were like, "Oh, for Acquired listeners, we'll do three events for the price of one," which I think that makes it the best offer any sponsor has ever had on the show, which, of course, they are doing this. So they wanna plan a series of three experiences for your team and find out your preferences, what the team likes to do, what they don't like to do, and sort of make each event get better than the last. So they wanna do this three-event thing so that you can kind of experience what the sort of ongoing, changing craftsmanship of the journey is. So if your company could use someone to take all the headache and event planning off your plate and turn them into something that people really love, go over to trymystery.com/acquired, or click the link in the show notes and go get that crazy deal to get three Mystery events for the price of one.

    18. DRDavid Rosenthal1:12:25

        Thank you, Mystery. So when we were emailing before this, Hamilton, you wrote something that I know is gonna be provocative. You wrote: "When you see a flywheel, run for the hills." [chuckles]

    19. HHHamilton Helmer1:12:39

        Right, right, right, right.

    20. BGBen Gilbert1:12:40

        [laughing]

    21. HHHamilton Helmer1:12:40

        I did say that.

    22. DRDavid Rosenthal1:12:41

        The number of decks that I see that have flywheels these days is about a hundred percent. So [chuckles] this is gonna be a new way of thinking for folks. What is the concern about flywheels?

    23. HHHamilton Helmer1:12:52

        So flywheels are a sign of product market fit and tell you absolutely nothing about power. And it's not easy to get a flywheel, and that is how these platforms do find life, and so you get into issues of critical mass and ignition and all that stuff, but that's product market fit. And it doesn't say that if one company has benefited from this, that another... As I mentioned before, often the very technology that enables that happening quickly enables multi-homing as well. And so-... the benefits are usually from a differential size on one or both sides of the platform, and so you have to somehow prevent that.

    24. CSChenyi Shi1:13:36

        Anecdotally, there's one exercise we did, which is really simple but surprisingly interesting, which is we took a flywheel of a company that's really popular, I won't name which one, but we swapped that logo with their competitor's logo in the middle of that flywheel, and it still works. So, [laughing]

    25. DRDavid Rosenthal1:13:51

        [laughing]

    26. CSChenyi Shi1:13:51

        that's exactly what we were looking for.

    27. DRDavid Rosenthal1:13:52

        That is a brilliant thought exercise. [chuckles]

    28. BGBen Gilbert1:13:55

        Assuming that they have more scale than their nearest competitor, is there some way that you could draw the XY axis where they're growing in a way that's N cubed, and their competitor is either further down the N cubed because it's a time series axis, or perhaps they're only growing in a way that's like N squared, so there's no way that they could ever catch up? That seems to be the thing that you're trying to tease out.

    29. HHHamilton Helmer1:14:17

        Yeah, I mean, so typically, these things do depend on differential scale on one or more or both of the sides, right? And the way you've asked that question, Ben, you've just sort of assumed the critical thing, which is you've said it can scale three times as fast. So then the question is why?

    30. BGBen Gilbert1:14:34

        'Cause it's a flywheel. You know, it's a lot of stuff feeding into each other. [laughing]
15. 1:16:41 – 1:26:03

    Closing synthesis: why platforms are valuable, complex, and paradoxical for power

    1. HHHamilton Helmer1:16:41

       I thought it might be useful for me to do a quick take of kind of a summary of some of the points that we've talked about, and platforms is such an important topic. They're sort of like markets that are way of exchanging, and that's what business is about in a certain way, and so it's-- there's a lot of value there. And the tech frontier that's been advancing has made many, many more platform plays viable. If you think of processors, and displays, and, and mobile distribution, and all that, basically, we all have this little computer that we carry around with us that makes a lot of stuff possible that just wasn't possible before. And we see that in that many of the largest market cap companies in the world are platform plays. So the first reason is lots of value there. The second reason it's an important topic is it's really complicated.

    2. DRDavid Rosenthal1:17:33

       [chuckles]

    3. HHHamilton Helmer1:17:33

       And so it kind of strays into multi-sided market territory, which economists have spent a couple of decades trying to sort out, and I find, uh, personally, to understand really what's going on is very intellectually challenging. So lots of value, it's very complicated, and then the third reason is that we talked earlier in this podcast about there are two-step changes in value in a company: product-market fit and then power. And in the case of platforms, one of the things that's really odd but very important is that those signals go in opposite directions often, that you can have tremendous product-market fit traction. Something can scale really fast and be a big market, but the very thing that allows it to scale also allows, uh, lowers barriers, allows easy competition, multi-homing. And so you might see something where there's huge value created, but if you ask the question of is there power, a completely different issue and may be at odds with the very thing that's driving all the value. So those are the three reasons. So then getting into the nature of the platform, value facilitates an exchange between heterogeneous buyers and heterogeneous sellers, and so it's exchange is what creates value, matching typically.

    4. BGBen Gilbert1:18:56

       And to your point on the first component here, technology is really such a huge lever because technology lowers friction, and so it makes possible much, much, much more efficient making of these transactions and making of these matches, and so that's why it seems to play such a huge role.

    5. HHHamilton Helmer1:19:13

       Yeah, utterly. Think of matching. There has to be discovery, and then there has to be the mechanics of the transaction itself. And think of discovery without mobile.

    6. BGBen Gilbert1:19:25

       Hmm. Right.

    7. HHHamilton Helmer1:19:26

       Let's say I wanted a ride in the San Francisco area.... Would I just call a lot of people to see, do you have a car and time to give me a ride somewhere? I mean, that's really what we're talking about here, right? Having a computer that sits with you all the time, that you pay a lot of attention to, is a tremendous advance in availability. And then, and then on the transaction side, all of a sudden you can push a button, and you don't have to negotiate price, or payment information is already in there. I mean, we all take this stuff for granted, but this just enables all kinds of essentially markets that didn't exist before. So the value comes from matching a buyer and a seller, but power in these things is really different. It comes from one platform doing this materially better than another platform, and that the thing that drives that difference in performance is sustainable. Typically, that the difference in performance is driven by, uh, differences in the size of at least one side of the platform. So the New York Stock Exchange is more attractive than the London Stock Exchange 'cause the liquidity's better. There are more buyers than sellers, and you get lower bid-ask spreads, right? But if all the parties involved had easy multi-homing, that would go away. But in fact, it's maintained by contractual arrangements, and it's really a pain to switch from one, [chuckles] one to the other.

    8. DRDavid Rosenthal1:21:18

       Yeah, the easy, obvious example of this that has been discussed much in the past decade is Airbnb versus Uber, right? Like, Airbnb has so much unique supply that you're not gonna find on booking.com or HomeAway or any other platform. Whereas, you know, Uber, it's like, yeah, I can get a car on Uber or Lyft or DiDi or whatever. [chuckles]

    9. HHHamilton Helmer1:21:36

       So the question often is, first, so you have to meet two conditions: the value that one platform delivers has to be materially better than the other, and remember, this is a matching situation. And I won't get into the technical aspects of it, but basically, it's equivalent to sort of a distance formulation. Even in multidimensional spaces, a square root function, which means the second derivative is negative, which means that it flattens out after a point. And when it flattens out and whether there are two competitors that are both in the flat region is a critical element there. And then even if that is true, that it isn't flat enough between the two of them and there is a real material difference in deliverables, then the thing that maintains that difference, which is different scale on at least one side, has to be maintained. And so the degree to which multi-homing is frictionless is critical.

    10. DRDavid Rosenthal1:22:37

        Well, and we just see that play out so frequently in the startup and technology and, you know, venture investing space. I have on my mind, 'cause we're researching right now at NVIDIA, and, you know, they were the first computer graphics chip company, the first in Silicon Valley, and they thought that was gonna be so great. They had such a great team and so much funding from Sequoia and Sutter Hill, and it was gonna be great.

    11. HHHamilton Helmer1:23:02

        Sutter Hill, wow, that's going back a ways.

    12. DRDavid Rosenthal1:23:04

        Yeah, and then the, you know, they wake up, uh, six, 12 months later, and there's 90 other companies [chuckles] that have all been funded doing the same thing. Uh, you know, there's no power there, and NVIDIA, of course, had to develop power in other ways.

    13. HHHamilton Helmer1:23:16

        Their segue of their business from one thing to the other is... That'll be a wonderful thing for you to explore. You gotta see what really does drive value, and is there a real difference between competitors, and is there some lock-in of some sort of one side, uh, volume so, or on count, so that you maintain that superiority?

    14. DRDavid Rosenthal1:23:41

        I love it.

    15. HHHamilton Helmer1:23:42

        So anyway, this has really been enjoyable. As always, thank you both.

    16. BGBen Gilbert1:23:46

        Thank you so much, Hamilton.

    17. DRDavid Rosenthal1:23:47

        Yeah. Thank you both. This is a real treat, and a treat to have both of you. Welcome, Chenyi, and to Acquired on the first time, I'm sure not the last time. And yeah, we can't wait to do this again.

    18. BGBen Gilbert1:23:59

        All right, listeners, thank you for joining us on this journey with, uh, Hamilton and Chenyi. I learned some stuff. David, I know you learned some stuff. We wanna hang out with you, so come join us in the Slack. We've got over 11,000 members. We'll be discussing news of the day, this episode, dropping some hints for next episode. We've got a limited partner show that you should go check out. We've got three, I think, David recorded that we've released only for LPs or will release soon. So if you're a paid limited partner at acquired.fm/lp, you'll get access to those. Otherwise, after two weeks, all the episodes become public, and you can search Acquired LP Show in the podcast player of your choice to get access to those public episodes, like discussing what's next in fintech with a partner from Bain Capital, Christina Melas Curiazi. Or what else have we released recently? Probably the Composer episode will become public here soon.

    19. DRDavid Rosenthal1:24:54

        Not boring portfolio company number one.

    20. BGBen Gilbert1:24:56

        That's right, with Ben Rolert.

    21. DRDavid Rosenthal1:24:58

        Oh, the other thing on the LP show, now with it being public, literally the number one most requested thing that we got for anything ever at Acquired was, "Can I get the LP show on Spotify?" And now, thanks to doing this, you can.

    22. BGBen Gilbert1:25:13

        We've got a job board. These are, uh, jobs that David and I, and head of special projects at Acquired, Sani, research and curate personally. So if you're looking for that next great career move, head to acquired.fm/jobs, and share this episode with a friend. We love social media, of course, but we love that strong one-to-one communication even more. So thank you so much for listening. We'll see you next time, and our thanks to Solana Foundation, Modern Treasury, and Mystery. Later, listeners.

    23. DRDavid Rosenthal1:25:42

        We'll see you next time.

    24. SPSpeaker1:25:44

        [singing] Who got the truth? Is it you? Is it you? Is it you? Who got the truth now? Huh! [upbeat music]

Episode duration: 1:26:03