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Trade Talk Blog: The Coming Platform Revolution in Financial Markets

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geoff parker

The following is a guest post authored by Geoffrey Parker. He is a professor of engineering at Dartmouth College and a visiting scholar and research fellow at the MIT Initiative for the Digital Economy. Before joining academia, he held positions in engineering and finance at General Electric. He has made significant contributions to the economics of network effects as co-developer of the theory of two-sided networks. He received his BS from Princeton and his MS and PhD from MIT. You can follow Geoff on Twitter at @g2parker.

Given the dramatic change now underway in financial markets and exchanges, it’s tempting to believe that the industry is in uncharted territory. And, as we’ll see below, there is some truth to this view. However, it’s worth remembering that the industry went through a similar phase of change when exchanges such as the CME became electronic instead of physical markets. Floor traders gave way to traders sitting at computer terminals and, increasingly, to algorithmic trading machines. Electronic completion offered a number of immediate advantages that included better price discovery, improved access to markets and a better ability to create customized products that better fit needs. For example, firms that wished to smooth the value of assets such as power plants or pipelines against commodity price volatility were able to tailor their hedging strategies to their exact needs.

Despite the electronic nature of the business today, my co-authors and I would describe the business model of today’s trading and data industry as a pipeline. What we mean by pipeline is that value is created in a linear fashion whereby firms secure inputs and transform those inputs into products and services through a number of value-adding steps. Financial exchanges such as the NYMEX, ICE, NYSE, Nasdaq and many more connect their markets to end users either directly or through intermediaries such as Trading Technologies. These entities complement market price information with other data streams such as weather, world news and the status of physical assets such as ships, ports and power lines in order to help users such as banks, industrial firms and traders to better understand and predict price movements. For the time being, end users are primarily responsible for the integration of data streams and order execution systems with their own internal systems for analytics and decision making. Thus, as in manufacturing systems, value is created in a linear pipeline way.

Going forward, we see change on the scale of the transition from human to computer traders. That change will be facilitated by the adoption of “platform” business models. Platform models underlie the success of many of today’s biggest, fastest-growing and most powerfully disruptive companies — from Google, Amazon and Alibaba to Uber, Airbnb and Tencent. Platforms use technology to connect people, organizations and resources in an interactive ecosystem in which enormous value is created and exchanged. And we believe that they are just beginning to transform a range of other economic and social areas, from health care and education to energy and government, and also to financial services.

In our book “Platform Revolution (Geoffrey Parker, Marshall Van Alstyne, Sangeet Choudary), we explore the escalation of IT-driven platforms over established product leaders. Our research shows that even nimble incumbents need to overhaul many fundamental business concepts or else fall behind. As with supply-chain expertise, product excellence will still be a corporate asset, yet businesses must move away from a pipeline, or product-based strategy, to platform-based networks where value is derived from larger ecosystems. We noted in a recent Harvard Business Review article:

“Platform businesses bring together producers and consumers in high-value exchanges. Their chief assets are information and interactions, which together are also the source of the value they create and their competitive advantage…. Firms that fail to create platforms and don’t learn the new rules of strategy will be unable to compete for long.”

When we say “platform,” what exactly do we mean?

There are four key roles to consider when building a platform. These are based on a two-sided network in developing a platform and the supporting ecosystem around that platform.

Users (demand side): These are the target consumers of the platform solutions and services. They can be individuals, businesses and other organizations.

Figure from Eisenmann, Parker and Van Alstyne, “Opening Platforms: How, When and Why?

Content and applications developers (supply side): They provide the specific items that attract the users to the platform–music, games, information, services, answers.

Providers: This is the point of contact for common components, rules and architecture. The provider is typically the contact point for the users of the platform–both the consumer of the content and the developer of the content. This role can be done by one firm or many firms.

Sponsor: This is the overall designer and IP rights holder. The sponsor sets direction and controls the underlying platform technology. It also provides the overall organizing structure for the platform via rules, governance and ecosystem support. It can help the ecosystem work by helping participants see how they are better off by being part of the system rather than outside of it. This role can be done by one firm or many firms.

In our 2005 Harvard Business Review article “Strategies for Two Sided Markets,” we describe how to organize provider and sponsor roles as these roles form the basis of the platform and ecosystem. The sponsor is critical to success and serves as the overall planner. The sponsor helps to consummate the match between the demand side and the supply side so that both parties are better off.

Pipelines seek to maximize the lifetime value of products and services for individual customers who, in effect, sit at the end of a linear process. By contrast, platforms seek to maximize the total value of an expanding ecosystem in a circular, iterative, feedback-driven process.

In trading and financial services, we are beginning to see more robust analytics from the data providers as well as integrated software providers such as Trading Technologies, which now has analytics such as Greeks built directly into the system. These are early signs that a platform-industry structure might be emerging. However, it is still difficult for the data providers and software firms to observe the use cases their customers have. As a result, the feedback loop that is necessary for improvement is inefficient.

Once the platform transition gets underway, it will be critical for firms to figure out their roles. Are they a provider who works within another firm’s platform? Are they a sponsor whose job is to set standards and act to grow the overall system? Or are they users who will gain access to many more customers as a supply-side user, or a demand-side user that can gain access to far more suppliers than was possible in the past? The answers to these questions will guide firms as they craft their strategies to deal with the emergence of platform opportunities and threats. The rewards to being a platform can be great, as we have seen in the powerhouse Silicon Valley firms such as Google. However, the platform game can be similar to the “Game of Thrones”: “You win or you die.”