This article first appeared in Forum, The Edge Malaysia Weekly on April 9, 2018 - April 15, 2018
I needed a portable charger the other day, so my husband and I headed to the neighbourhood electronic store. When we were there, we quickly realised that there were not very many options despite the flashy signs and cluttered aisles. We ended up finding one that seemed all right but paid way too much money for it relative to what we thought was fair. “Once Lazada gets better, we won’t have to come here anymore,” remarked my husband. “Stores like these won’t be able to survive.”
He is right. Ten years from now, we will likely be buying most things from a e-commerce platform like Lazada. Are you comfortable with a world where most of your purchases are from one company?
Platforms rely heavily on network effects — the phenomenon where the value-add of a good or service to consumers increases with the number of people who use it. For example, in the market for portable chargers, there are two sides — people who need portable chargers because their phone does not hold a charge well (me) and people who want to sell portable chargers (Sony).
Lazada greatly lessens my search cost — I don’t have to leave the comfort of my house to shop and can easily filter items according to various traits. Companies like Sony, meanwhile, rely on platforms for easy access to consumers and targeted advertising opportunities. Both sides of the market are generally better off when there are more people on the opposite side.
Once a platform has a “thick” market — a sufficient number of users on each side — the trajectory of the business is relatively straightforward. The problem is that getting past this stage is very difficult. The main complication is figuring out how to accumulate enough existing users to attract new users to join. The solution used by many early-stage platforms is to behave very aggressively to establish market dominance. This usually takes the form of subsidising users and taking losses to gain a solid consumer base.
Think Facebook — once upon a time, you could consume a variety of media on it with no advertisements. Think Grab and Uber — consumers love it that they are cheap and easy to use. Unfortunately, all of these benefits that consumers enjoy will go away over time. It is already happening in the case of Grab and Uber. Grab’s purchase of Uber Southeast Asia is an example of enveloping, which happens when a successful platform subsumes a competitor. This is something that happens quite a lot in markets with platforms.
Because of networks effects, platforms tend to become monopolists once they have reached a “critical mass” of consumers. We all know that monopolies are bad for consumers. Economists think of the availability of substitute goods as a limiting force against increased market power — if prices go up for a can of Coke, consumers buy Pepsi instead. As long as there is a degree of substitutability between Coke and Pepsi, neither companies can afford to exorbitantly raise prices without losing most of their consumers.
This view of the world, however, does not take into account the existence of powerful market intermediaries. Consider a world where you can only buy Coke through a platform (say, Lazada). If Lazada raises its prices, you still have the option of buying Pepsi. But what if you can only buy Pepsi through Lazada? Successful platforms have the ability to be monopolists in multiple markets — a fact that will harm consumers greatly through high prices. It is really quite frightening.
Lazada, which is headquartered in Singapore, was founded on the goal of becoming “Asean’s Amazon”. If you have used both services, you would know that the two platforms are not yet comparable. For example, Amazon Prime gets your package to your front door in two days at most. Lazada’s delivery can take up to a month. Do not worry, though — Lazada will get there.
Alibaba, the immensely successful Chinese multinational conglomerate, very recently doubled its investment in Lazada to US$4 billion. Its statement to the media was: “The investment underscores Alibaba’s confidence in the future success of Lazada’s business and the growth prospect of the Southeast Asian market, a region that is a key part of Alibaba’s global growth strategy.” This is as strong and loud a signal as it gets. Alibaba would not be investing this much in Lazada if it were not sure it would make a lot of money later.
Since successful platforms tend to accumulate a lot of profit, it matters whether they are foreign or domestic. Is monopoly power over Malaysian consumers something we want to give away?
The press coverage of platforms has not carefully considered the consequences of a world governed by powerful foreign platforms in countries like ours. Yes, I will eventually be able to rely on Lazada for most of my shopping, but at what cost? Most Malaysian platforms will not be able to compete with successful foreign platforms due to network effects. Where does that leave us?
Dr Melati Nungsari is an Assistant Professor of Economics at Asia School of Business and Research Affiliate at the Massachusetts Institute of Technology’s Sloan School of Management. The views expressed here are her own and do not necessarily reflect those of Asia School of Business, Bank Negara Malaysia or MIT Sloan.
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