Throughout CEE, we can see that the monopolistic nature of digital hubs such as eMag, Allegro, Vinted and OLX are creating information bottlenecks that are concentrating value in the hands of a small number of firms.
What is really interesting about the digital economy is not the opportunities that it might create for efficiencies or cost reductions, but its basis in a network.
Value creation is shifting beyond the boundaries of the firm into network hubs like Amazon, Allegro and eMag.
Because digital disruption bends markets towards the domination of a maximum of three major players, whoever controls these hubs is able to capture more value from each transaction.
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Metcalf’s law states that a network’s value increases with the number of nodes. Just like your phone network, it is not each piece of digital hardware that is valuable. Rather it is their ability to interact with one another that makes them useful to you and in doing so creates value.
Network effects exist when the value of a product or service increases according to the number of others using it. Platforms like Facebook, WhatsApp, TikTok and other social media are based upon the idea that as the number of users increases, the value to each increases.
Importantly, as the network grows, its value to each user and to owners of networks increases exponentially.
Shifting the source if value creation
Whilst in many ways obvious, this simple insight has had profound ramifications. As more of the economy becomes digitally networked, it is shifting the source of value creation out of business products and linear processes that are controlled by producers and into networks and those who control them.
In Managing Our Hub Economy, business school professors Marco Iansiti and Karim Lakhani reveal this happens because, “traffic begets more traffic, and as certain nodes become more heavily used, they attract additional attachments, which further increases their importance”.
Thus “while value is being created for everyone, value capture is getting more skewed and concentrated”.
Amazon provides a prescient example of why it is so important for companies to get this right. Amazon’s use of its five-star rating scheme has been so successful that it has effectively defined how to overcome customer resistance to e-commerce.
The Amazon rating scheme was so effective because it aggregated trust between consumers, rather than trying to build trust directly in Amazon.
In the early days of ecommerce potential customers struggled to trust websites enough to take their credit cards out. However, allowing customers to provide feedback on products and sellers, we learnt to trust other customers’ reviews. In short, Amazon was the first major player to embrace its role as a hub, a facilitator of globally anonymous relationships.
Amazon’s ability to create and capture value flows directly from its ability to add value to its network connections. The combination of its peer-based rating system with secure payment systems is the basis of its global retail empire.
The ability to bridge their networks into new marketplaces has, so far, proved highly successful and continues to grow apace. Amazon itself doesn’t manufacture products. It simply coordinates the connections between buyers and sellers that sometimes requires an active role for themselves in the supply chain.
Monetising groove-in
Widely copied, peer-to-peer aggregation of trust has proved transformational in monetising groove-in and the Amazon rating scheme has been successfully imitated, as the basis of hub-based value creation by the likes of eMag, Allegro, OLX, eJobs and many others across Central and Eastern Europe.
As economist and former Greek finance minister Yanis Varoufakis pointedly notes in Techno Feudalism: What Killed Capitalism, digital hubs have not only enabled peer to peer interactions without the limitations of scale or geography. They have persuaded users to work for them for nothing. Users are quite literally reproducing capital for tech firms.
Furthermore, by contributing content users are creating network platforms that are clearly monopolistic. It is monopoly power that enables Amazon to take the largest share of the cover price of many books, for example. Thus, leaving as little as four per cent royalties for academic writers, such as myself!
So powerful are network effects in the digital economy that Varoufakis claims that we are all becoming ‘techno serfs’ and creating a world of ‘techno feudalism’.
However, the work of Iansati and Lakhani reveals that not only are network effects changing markets, they are enabling digital hubs, such as Amazon, Google and Microsoft to take control over the architecture of whole marketplaces rather than simply being dominant actors within them.
A license to print money?
In CEE we can clearly see that the monopolistic nature of digital hubs such as eMag, Allegro, Vinted and OLX are creating information bottlenecks that are concentrating value in the hands of a small number of firms.
Capture of network effects by network hubs is why technology companies are experiencing heavy losses and yet seem to attract inflated valuations.
In short, it is because, as I wrote back in 2019, there exist feedback loops which are encouraging and pushing markets towards monopolistic, rather than perfect, competition. When investors believe that they are seeing signs of groove-in emerging, current earnings are seen as a poor predictor of future monopolistic earnings and valuations soar.
The lesson is that if you are trying to build a digital business try to develop groove-in to capture network effects. If you are successful you will have a licence to pretty much print money. Good luck.
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