How ‘Aggregation Theory’ is Fueling a Multi-Trillion Dollar Technology Revolution
The Great Commoditization of Distribution
Tom Goodwin made the following observation in his March 2015 article in Techcrunch titled The Battle Is For The Customer Interface and it went really viral on social media last year:
Uber, the world’s largest taxi company, owns no vehicles. Facebook, the world’s most popular media owner, creates no content. Alibaba, the most valuable retailer, has no inventory. And Airbnb, the world’s largest accommodation provider, owns no real estate. Something interesting is happening.
In his July 2015 post, Ben Thompson of Stratechery introduced the term ‘Aggregation Theory’ which I believe effectively describes the phenomenon in Goodwin’s quote on a macro level. Ben Thompson describes how a significant number of the most influential technology companies of the past two decades have grown by effectively commoditizing distributors in product/service/content supply chains across a number of verticals including publishing, transportation, hospitality, commerce, media etc.
Ben Thompson says the following about the value chain for consumer markets in a pre-internet era:
The value chain for any given consumer market is divided into three parts: suppliers, distributors, and consumers/users. The best way to make outsize profits in any of these markets is to either gain a horizontal monopoly in one of the three parts or to integrate two of the parts such that you have a competitive advantage in delivering a vertical solution. In the pre-Internet era the latter depended on controlling distribution.
Before the internet, distributors were kings in any industry due to the fact that offline distribution of any good or service from the ‘makers’ to the subsets of global consumers that were willing to pay for said good or service was a particularly complex task, as I illustrate in the table below:
Over the last two decades, the distribution chain for most goods and services have been redefined end-to-end. The distributor’s role in the chain has been commoditized. ‘Makers’ can now bring their goods and services direct to consumers.
This turned out to be both good and bad.
- Good in the sense that makers can essentially become their own distributors by creating their own websites and distributing to consumers directly through their own channels. They get to choose what, when, where and how to distribute.
- Bad in the sense that because all makers were given the ability to create independent outlets for distribution, discovery became exponentially more complex for the demand side of the equation i.e. consumers would effectively have to navigate millions of independent outlets to find goods, services and content.
Enter the ‘aggregators’.
The best aggregators effectively connect supply with demand in the most effective way possible. They bring value to the suppliers by removing the overhead of direct internet distribution, making supply much more discoverable while also giving suppliers significant control over the manner in which goods, services or content is surfaced to end consumers. The value for the end consumer is a simplified UX, designed with a primary goal of reducing the net number of steps it takes a consumer to discover the specific goods, services or content that they seek on a platform.
The following graph from statistica shows the 10 most valuable public consumer internet companies by market cap as of August 2015.
All of the companies above were founded in the 12 year window between 1994 and 2006, but the most interesting thing about the companies above is the fact that every single one of them is an online aggregator. Every single one.
That’s over 1 trillion dollars in value across just the top 10 web aggregators (with over 900 billion just from the top 3) all created within the last 22 years, and for the most part, these companies don’t create the goods, services and content that they surface to consumers. Of course you have Netflix creating a few dozen of the tens of thousand of movies and TV Shows on their site, and you have Amazon distributing their own devices like the Kindle and Echo alongside millions of items on the site, but 99.999% of the value in these services is derived from the goods, services and content that is created by third party makers.
Vertical domination for all aggregator platforms comes down to a battle to delight consumers. All marketplaces usually have three major steps on the path to becoming indispensable parts of any industry’s distribution chain.
- The first step usually involves convincing a small set of suppliers to distribute on a proposed platform with a sparse or non-existent demand side. Amazon did this by initially partnering with book suppliers to distribute books through the site, with the suppliers maintaining all the inventory overhead.
- The second step is really about fine tuning the user experience to effectively delight consumers in ways that offline distribution channels cannot. In the case of Amazon and books, consumers could sift through a catalog of over a million titles to find a specific book of interest to them. In an offline retail world, the search for a single title could involve hours or days of painstaking visits to dozens of retail outlets.
- The third step is where vertical domination sets in. This is the point at which consumers are sufficiently delighted so much so that the platform becomes an indispensable part of their interaction with an entire industry. At this point, suppliers not on the platform feel somewhat isolated. In some cases suppliers complain about the platform but still continue to distribute via the platform because pulling out from the dominant platform in a vertical could very easily lead to reduction in top line growth. This is why hollywood complains above Netflix, but still distributes content via the platform and why some publishers complain about Google’s policies but still either have to comply with the platform’s rules or effectively face expulsion from the internet, as was the case with Rap Genius in 2013 and why Uber drivers continue to offer their services on the platform, despite the fact that a lot of Uber drivers despise the platform on ethical ground.
Offline incumbents can kick and scratch, as we are seeing with the taxi industry’s reaction to Uber’s aggregation of drivers on its intuitive platform, but kicking and scratching will not win consumers in the internet age, great UX does and that is what the best and most valuable internet aggregators are mostly focused on.
The consumer, not the distributor, is king in the 21st century.
The last several articles on Stratechery have formed an unintentional series: Airbnb and the Internet Revolution…stratechery.com