James Phang

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How Did The Tech Giants Become Powerful?

The likes of Amazon, Google, Facebook, Netflix, and other big technology companies have dominated the market and have some kind of hold on our lives. They affect how we access, consume, and purchase products. Over the past couple of months, a lot of attention has been drawn towards these tech giants due to their dominance in their respective sectors but also the power they have over consumers. To understand why these tech giants dominate their respective sectors and don’t look to fall at any point, Stratechery has developed a theory called Aggregation Theory which provides an understanding of how they became so powerful.  

Before the Internet

In the era before the internet, traditionally businesses would need to reach their consumers. For example, newspaper outlets would write and print their newspaper and distribute them to areas where they believe their consumers are located. The problem is that this way it needs a lot of investment and facilities to print and transport the newspaper. There are typically three types of players in any given chain: suppliers/producers, distributors, and consumers. While there could be unlimited amounts of customers there are only a certain amount of factories, printing presses, and trucks. To make it profitable companies would integrate the supply and distribution within a company and optimise those processes. The company could optimise their processes as much as they like but they need consumers to buy its product, the problem would still be getting the product to the customer. These consumers would be served the same content and would be catered to for their needs.

The Internet Era

The introduction of the internet allowed businesses to have a further reach and consumers were not too confined to what they were being served, they could now go out on the internet and locate the information they desired. The problem that the internet platform gave was that it was dense and busy, a consumer only has 24 hours a day to consume information on the internet. The biggest problem now is to capture the end-user’s limited attention. The answer to this problem is aggregators.

What Are Aggregators?

There are 3 main characteristics an aggregator must have:

Direct relations with their users

The aggregator represents a destination that consumers interact with. Consumers don’t interact with the product via a third party but an aggregator just owns the online customer relationship. Consumers would visit the aggregator’s app and website directly and the app or website shows the results customers demand in one destination.  For example, Google Search and Airbnb.

Zero marginal costs for serving new users

When an aggregator is serving millions of users it mustn't incur new costs for serving new customers. The newspaper would incur production costs when demand is on the rise. Unlike Facebook, they incur no cost for serving a new customer or new area. Amazon is also an aggregator but incurs marginal costs when they ship physical goods to the customer's doorstep.

Demand-Drive Multi-Sided Network With Decreasing Acquisition Cost

When an aggregator facilitates interaction between two or more other parties (Multi-Sided), this drives up demand to consumers as there are bigger supply and demand options. In turn, this makes it more appealing for suppliers to be on the destination which in turn increases demands from suppliers to be located on the aggregator's platform. This decreases acquisition costs and becomes a never-ending cycle.

Types of aggregators

Supply Acquisition Costs

Netflix falls into this bracket, Netflix acquires their supply but they are the aggregator because they own the customer relationship and can serve new customers without any transaction costs. They have a network effect that the more users they have, the more money they can spend on content and every new piece of content decreases the acquisition costs for future Netflix subscribers. Produced content is a fixed content for all users that has value for all Netflix subscribers. Unlike traditional TV where they cannot show their entire backlog of content as they can only show 24 hours of TV a day.

Supply Transactions Cost

The companies incur a marginal cost when a new supplier enters their marketplace. In this category, you will find Uber and Airbnb where they have to do a background check on drivers/hosts and adhere to local regulations. These aggregators usually operate in a regulated environment where safety is a concern.

Zero Supply Costs

Companies do not incur any new costs when new users use the platform/service. An example of this would be Snapchat and Twitter as it doesn’t cost them anything when users create a new user account.

Super Aggregators

You must be wondering where Facebook and Google fall into this. They fall under ‘Super Aggregators’ as they have a well-balanced business model. They allow advertisers to advertise with a self-serve solution, they rely on their large sales force to grow their revenue. Advertisers on Google and Facebook mostly do not speak directly with zero human interaction while spending money on their platforms.

Summary

Aggregation Theory explains how these companies became so powerful that they set themselves apart from other companies. They control the end-user demand and commoditising suppliers. While questions will continue to be asked whether these companies power is dominating consumer behaviour and restricting new business flourishing, Aggregation Theory helps understand how they operate in a way that they incur small costs or none at all but continue to become more powerful.

Video: The Wild Power Of Aggregation Theory by The Verge

Resources

https://stratechery.com/concept/aggregation-theory/