Aggregation Theory

The last several articles on Stratechery have formed an unintentional series:
•    Airbnb and the Internet Revolution described how Airbnb and the sharing economy have commoditized trust, enabling a new business model based on aggregating resources and managing the customer relationship
•    Netflix and the Conservation of Attractive Profits placed this commodification/aggregation concept into Clay Christensen’s Conservation of Attractive Profits framework, which states that profits are earned by the integrated provider in a value chain, and that profits shift when another company successfully modularizes the incumbent and integrates another part of the value chain
•    Why Web Pages Suck was primarily about the effect of programmatic advertising on web page performance, but in the conclusion I noted that the way in which ad networks were commoditizing publishers also fit the “Conservation of Attractive Profits” framework

In retrospect, there is a clear thread. In fact, I believe this thread runs through nearly every post on Stratechery, not just the last three. I am calling that thread Aggregation Theory.

The value chain for any given consumer market is divided into three parts: suppliers, distributors, and consumers/users. The best way to make outsize profits in any of these markets is to either gain a horizontal monopoly in one of the three parts or to integrate two of the parts such that you have a competitive advantage in delivering a vertical solution. In the pre-Internet era the latter depended on controlling distribution.

For example, printed newspapers were the primary means of delivering content to consumers in a given geographic region, so newspapers integrated backwards into content creation (i.e. supplier) and earned outsized profits through the delivery of advertising. A similar dynamic existed in all kinds of industries, such as book publishers (distribution capabilities integrated with control of authors), video (broadcast availability integrated with purchasing content), taxis (dispatch capabilities integrated with medallions and car ownership), hotels (brand trust integrated with vacant rooms), and more. Note how the distributors in all of these industries integrated backwards into supply: there have always been far more users/consumers than suppliers, which means that in a world where transactions are costly owning the supplier relationship provides significantly more leverage.

The fundamental disruption of the Internet has been to turn this dynamic on its head. First, the Internet has made distribution (of digital goods) free, neutralizing the advantage that pre-Internet distributors leveraged to integrate with suppliers. Secondly, the Internet has made transaction costs zero, making it viable for a distributor to integrate forward with end users/consumers at scale.