Growing a Business

How to Build a Two-Sided Platform

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I had just finished lecturing to my technology entrepreneurship class about strategies in networked industries recently when I learned of a young business called Flashnotes.com -- an Internet site that matches students who need academic materials like lecture notes, flashcards, and tutoring assistance with students who provide those materials. The company provides a good example of an entrepreneur who has adopted a strategy that fits his business model.

That’s important. While choosing the right strategy won’t guarantee success, not doing so will assure failure.

These days a lot of new high-tech companies are two-sided platforms based on network effects. That’s econ-speak for a business model in which each side benefits from increases in the number of participants on the other side. The classic example is eBay. The value of selling on eBay increases with the number of buyers on the platform, and the value of buying increases with the number of sellers present.

Industries based on network externalities tend to be winner-take-all. Because the value of using the platform increases with the number of participants, once one platform in the market reaches critical mass, users typically converge on it, and abandon the alternatives.

In this type of market, attracting a large number of people to your platform quickly is central to business success. Therefore, startups in this space tend to follow a grow-huge-fast-or-die strategy.

That brings me back to Flashnotes. Given its business model, the company needs to increase the number of people using its platform quickly.

The company’s strategy is aligned with that goal. It has acquired several other peer-to-peer academic materials websites; used viral marketing to get out the message about its platform to buyers and sellers of academic materials, and partnered with a textbook publisher and professors to drive students to the site.

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When growing a two-sided platform, entrepreneurs must ensure that both sides expand proportionately. Too much growth on the seller side and there won’t be enough buyers, leaving sellers unhappy. Too much growth on the buyer side and there won’t be enough sellers, leaving buyers dissatisfied.

The ease of joining a platform is rarely identical on both sides, requiring the platform owner to subsidize one side’s growth to keep pace with the other. In Flashnotes’ case, any student with a credit card can become a buyer, but only people with good lecture notes can become sellers. Therefore, Flashnotes needs to work harder to attract sellers than buyers. That’s why the company has rewarded sellers of class notes with upfront payments for simply posting their study materials on the site, and has set up the Learning Scholar’s program with publisher partner Cengage to attract more student sellers.

Of course, growing a platform fast is expensive. So it makes sense that the founder of Flashnotes, Mike Matousek, has raised money from venture capitalists, rather than trying to bootstrap the business. Giving up equity to investors isn’t always the right choice, but when you need a lot of capital to grow fast, then tapping VCs makes a lot of sense.

Entrepreneurs’ strategic choices have an asymmetrical effect on their startups’ success. Picking the right strategy won’t guarantee that an entrepreneur will become rich. Too many things (including luck) have to come together for a given start-up to become the next Apple, Google, or Facebook. But picking the wrong strategy will almost certainly ensure failure.

That’s why it’s good to see a young company like Flashnotes following the right strategy for its industry. While the company may not win the entrepreneurial lottery, at least its founder hasn’t thrown away his ticket.

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