Aggregation Theory: The Most Powerful Economics Theory You Didn’t Learn at University
The internet has fundamentally shifted power from the supplier to the consumer by changing scarcity into abundance.
The internet has undeniably changed everything by freeing information. Exponential growth and enormous scale is now possible and is even a common occurrence with internet businesses like Amazon, Google, Facebook, Netflix, Alibaba and Uber changing the way we work, socialise and even think. Ben Thompson, the now famed Technology-focused Strategy Analyst who runs Stratechery, coined the phrase ‘Aggregation Theory’ to explain how and why these companies are replacing the pre-internet elite at an increasing rate.
The theory postulates that the internet has fundamentally changed the economic assumptions of the supply chain in three key ways:
1. Zero transaction costs = easily acquire customers
2. Zero distribution costs = abundant content
3. Zero marginal costs = exponential scalability
These three fundamentals explain how content changed from scarcity, only available through traditional media such as newspapers, magazines, books and TV, to abundance available on every person’s blog, social feed and YouTube channel. This transition is most obvious in text-based media which was easily put on the web through coding and then later built out its capabilities to enable audio and, later still, video onto the web. This changing paradigm moves the ‘bottle-neck’ in the value chain from distribution to the customer relationship. This leads companies to focus on customer retention and satisfaction whilst modularising and aggregating suppliers for the easy use of the customer. This strategy allows the firms to focus exclusively on offering the best possible customer service in order to attract more customers to offer up to the separate suppliers. For example, Google has organised a web of content suppliers in its searches, aiding discovery of abundant modular content without any special supplier relations but instead focusing on customer relations. Previously, when content was scarce, newspapers focused on suppliers i.e. editors and reporters by integrating backwards. Another example of an aggregator how Uber has created a platform to aggregate individual drivers and for a collection of Uber users .
A virtuous cycle is created as the suppliers benefit from more consumers, the consumers benefit from more supplier meaning that the consumers benefit from more consumers. Thinking back to Uber, the more people are using the system the more drivers will join the app and thus the better the service becomes because wait times will be slashed and service improved. This is obviously a fantastic business model because it progressively attracts customers with higher willingness to pay for the service, solving the age-old problem of how to increase revenue without losing revenue from existing customers. Netflix is another easy example of this, its a back catalogue of shows and movies increase year on year offering a higher value for the same price and thus attracting customers with a higher willingness to pay than existing customers. This is a classic example of a network effect that the platform economy benefits from. This network effect builds like a snowball, collecting consumers and suppliers in equal measure at exponential rates enabled by zero marginal costs. This will continue until singularity/monopoly is reached.