Three economical models that rule modern tech giants
On-Demand Economy, Economies of scale and Customer-Centric Economy
In this post, I am going to present you my views on the On-Demand Economy, Economies of Scale and Customer-Centric Economy, by giving real examples of how giants like Amazon, Netflix and Uber got where they are today. You don’t require any technical background to go through this post.
The On-Demand Economy is defined as the economic activity created by technology companies that fulfil consumer demand via the immediate provisioning of goods and services.
— Business Insider
This trend started with software companies like Amazon, who allowed any customer, either small startups or large companies and federal governments like the United States Government, to request computing capacity for exactly the amount they need and only for as long as needed.
In the past, these companies had to provision their own servers, by acquiring in advance computing capacity that they might need in the foreseeable future. This led to having to pay for resources that would not be used during most of the time and that would not sustain huge peaks in demand without high investments and accurate forecasts. Amazon revolutionized the market of IaaS (Infrastructure as a Service) with this on-demand approach.
Now, you can see this being adopted by all other types of business. Take transportation with Uber, housing with AirBnB, offices rental with WeWork and entertainment with Netflix. Netflix allows you to have the content you want to see when you want to see. You don’t wait for the next week to see the next episode, you don’t have commercial breaks showing you publicity, you get what you want when you want. Another example, WeWork, which allows small companies and big ones (e.g. General Motors and Samsung) to quickly set up offices in 70+ cities worldwide without having to build their own, saving both time and money.
Economies of Scale
Economies of scale refer to reduced costs per unit that arise from increased total output of a product. —Investopedia
WeWork brings us to the subject of Economies of Scale. Their model is based on having a large portfolio of offices locations (250 as of the moment of this writing) which allows them to rent them for a lower price than any company could get if it had to build all the infrastructure, security and maintenance. And the more they grow the more the customers benefit, as a result their cost per desk has been decreasing over the past years.
From $10,888 per desk in 2015 to $5,631 per desk in 2017, and is expected to reach roughly $4,000 per desk this year.— The Economist
Although this is not at all a new business model, Amazon Web Services has been decreasing the price of their services since its launch in 2006. Their constant growth as resulted cheaper services. Putting it simply, imagine having the costs of security, maintenance, power and cooling of 10 servers compared to a million servers, it is easy to understand that the price per server is cheaper the more servers you have.
This model has led to the exponential growth of companies such as Uber and Netflix that, sometimes aggressively, try to take over the monopoly for a specific market. They present a service that is cheaper and of higher quality than the ones existing at the moment. But that is not sustainable in its current form, they required rounds of great investment to keep expanding until they model becomes viable by scale. It’s a very risky all in play that requires the constant convincing of the shareholders that they should keep investing in an unprofitable business for the sake of long-term profitability.
To better understand a well designed long-term profitability model I highly advise reading Jeff Bezos 1997 letter to shareholders.
Customer Centric Economies
We start with the customer and we work backwards. — Jeff Bezos
The two previous economic models are quite simple, to grasp and understand, and even envision. They can be seen being applied to a large set of companies. But the one model that I believe that has the most long-term benifits is Amazon’s Customer-Centric vision. At first, it seems just a normal company slogan but after seeing Jeff Bezos famous napkin model it struck me that by focusing on the customers and their needs is how you maintain a long-term standing that will directly benefit the company in the long run.
When amazon.com opened their website to other retailers to sell on their website, they probably were called crazy. “Are they just going to let the competition products being sold right next to their products?” Some thought that allowing other retailers to sell would just crumble Amazon’s business, they could sell the same products at cheaper prices on Amazon’s platform, who would want that?
This is a short-term vision of the play. By allowing others to sell on their platform, Amazon increased the variety of products they were selling. A customer that can get everything is looking for in the same platform, is a happy and a returning customer. This leads to more sellers on the platform, which results on more selection, leading to an increase in customer satisfaction, that then again creates more traffic and consequently more sellers. We can see here a spiral effect that in the end results on the growth of the platform. And as we’ve seen from economies of scale the bigger the platform the cheaper the prices and therefore an increase in customer satisfaction.
Another example is AWS, Amazon Web Services. It was born from the fact that the company had already made large investments in development and research for the underlying infrastructure that supported amazon.com website retail business. By opening their services to the public, and allowing other customers to use them for a fee, their services grew exponentially. By listening to their customers’ needs they now have the infrastructure that supports their website tested and deployed globally as the biggest and more advanced and with more services than any other cloud infrastructure while making money out of it.
This three models are extremely coupled. The scale of your business impacts directly your ability to serve your customers on-demand and by consulting your customers and therefore achieving a customer centric relation the more you attract new customers and grow. Nevertheless, to achieve such scale you require large amounts of investment and most importantly a clear vision of your long-term goals.