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Why Platforms might want to welcome Regulators

I’ve had an “aha” moment yesterday reading Laetitia Vitaud’s “Why Taylorism cannot apply to the cleaning craft” before reading their joint newsletter with Nicolas Colin for this week’s edition of The Exponential View that azeem curates.

Out of personal interest but also spending some time looking at marketplaces at Point Nine — we’re seed investors in Helpling, the leading cleaning marketplace in Germany— I have tried to make sure I understood their reasoning.

Trying to make it more visual, I also started drawing a few graphs to seize the different dynamics at play in markets where a few (digital) platforms are dominating. I will never be able to do a better job than they do in their post, so if you have 15min, you should go read it (it’s awesome). The goal of this post is not to try to reinvent a new macroeconomic theory but rather to explain theirs with three graphs. The post ends with an illustration of how the theory would apply in the context of digital marketplaces.

Macroeconomy is a (very) complex topic (one of the most prominent VC also says it’s useless) and I am (very) far from trying to pretend that what follows explains well all the dynamics at play in markets with digital platforms. Many of the them are eminently debatable.
Feel free to reach out via email or on Twitter if you want to start debating!

I. Market equilibrium in a traditional economy

In a traditional economy, without digital platforms and without winner-takes-all/most dynamics, the two main dynamics at play are the following:

(1) Free market: competition dictates prices. The higher the competition intensity, the lower will be market prices (and margins). This leads liberals to think that markets regulate themselves and that market equilibria are optimal.

(2) Cost structure: the cost structure of a business dictates how much they can pay their workers. In extreme cases, companies sometimes go against this principle according to a phenomenon that economists call “Wars of Attrition”. Market players try to out beat competition by lowering prices, sometimes at the expense of their own profitability. VC money is actually often used to fund these wars of attrition with marketplaces having negative margins until they reach market leading positions.

This leads to a third dynamic, which they call (3) Ford’s Epiphany”, that tampers dynamics (1) and (2). By increasing wages, companies increase retention rates of workers and eventually their own competitiveness. See Ford’s reasoning here.

(1) + (2) + (3) probably explains the current market equilibrium in most markets.

Now, the very interesting point they make is that companies should actually welcome regulators because by forcing all market players to implement social protection mechanisms, they increase employee retention and eventually reduce the competition intensity. This potentially leads to a market equilibrium with higher wages for employees and a higher level of profitability for companies.

In the graph above, I have tried to explain why.

If you’re wondering how to read these graphs, the end of the post should help⬇.

Extending this rationale in the next two parts, I’ll try to explain why mandatory social protection could actually be beneficial to digital platforms.

II. Market equilibrium in the platform economy without regulation (a.k.a what’s currently happening)

The first two dynamics are also at play in the platform economy.

The third one remains a big question mark. Why?

On the one hand, Laetitia Vitaud is right when she mentions that workers’ retention is one of the biggest challenges of cleaning marketplaces. It’s also one of any ride-sharing platforms (Uber, Lyft and others). Therefore, by increasing wages, platforms should be able to increase retention and decrease the competition intensity (or just start competing). Case in point here is that despite being late entrants to the ride-sharing market, companies such as Taxify and Cabify asking drivers for a lower commission are now worth over a billion although they had much less funding than their US competitor.

But, on the other hand, network effects at play in marketplaces i) force companies to win market share as fast as possible early on and ii) eventually create winner takes all/most dynamics that eventually decrease the level of competition. Before market leaders emerge and because of i), it’s a multi-player game and a single competitor will be afraid to be less competitive on price if he ever decides to increase wages. And due to ii), companies in market leading positions do not have to retain employees/workers as these have no other choices than working for the leading one. Hence, we can legitimately wonder if the third loop, which we called earlier “Ford’s epiphany” , has any impact here and if the economy does not look as such in the end:

The problem of this reasoning is that markets are impermeable and workers will eventually change job or not rely on platforms. This is, admittedly, what’s happening in many cleaning marketplaces.

III. Market equilibrium in the platform economy with regulation

Now, interestingly, and this was my “aha” moment yesterday, if we combine I + II, we could argue that social protection will eventually force marketplaces to increase wages, which will in return increase employee retention and decrease the competition intensity.

As counter intuitive as this might seem, forcing platform to offer faire wages and social protection to their workers could actually strengthen their position of market leaders.

See the graph below (or click here):

Ok, it might be hard to understand how each parameters interact with another with some many arrows. If you want to try it yourself, and separate the impact of each parameter, just click here

Mandatory social protection for platform workers forces platform to increase wages, which in return will reactivate the “Ford’s epiphany” loop. It could therefore increase employee retention and lower the competition intensity.

So, assuming that this reasoning holds, German regulator, please go ahead, increase the level of social protection required to hire cleaning workers on cleaning marketplaces in Germany ;)!

And, reader, please take this post with a big grain of salt, it’s just an argument from a French socialist Venture Capitalist for digital marketplace regulation!

Want to play around with the system that explains this mechanics? Check this link!

If you’re wondering how to read these graphs, these two loops should be helpful:

The War of Attrition loop is self-reinforcing. If a company decides to decrease wages to lower prices, it will enter a price war and will need to keep on decreasing prices.
The Free Market loop is a balancing loop. An increase in the level of competition intensity will incentivise companies to lower prices, which will limit the willingness of new entrants to start competing.

A huge THANKS to the professor who invented the discipline of System Dynamics (it’s helpful almost everyday), to Nicky Case for designing Loopy, to Point Nine’s marketplace expert Pawel Chudzinski for reviewing my post and to my 🇫🇷 mate Clement Vouillon for helping me review the mechanics of the graph several times — the economy was completely upside down before.

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Louis Coppey

Louis Coppey

4.4K Followers

VC @pointninecap, @MIT grad, writing about #VC, #SaaS, and #Automation.