1) The document presents a "Moat Map" that plots companies on two spectrums based on their business models: the degree of supplier differentiation and the extent to which network effects are internalized or externalized. 2) Facebook and Google are shown to have highly internalized network effects and commoditized suppliers, while Apple and Microsoft have more differentiated suppliers and externalized network effects. 3) The map is used to analyze companies' strategic positions and potential "moats" based on where they fall within these two dimensions. Being outside the map, like Uber, makes defending market position more difficult.

1. The Moat Map
May 15, 2018, Ben Thompson
A subtext to last week’s article, Tech’s Two Philosophies, was the idea
that there is a difference between Aggregators and Platforms; this was
the key section:
It is no accident that Apple and Microsoft, the two “bicycle of the mind”
companies, were founded only a year apart, and for decades had broadly
similar business models: sure, Microsoft licensed software, while Apple sold
software-differentiated hardware, but both were and are at their core
personal computer companies and, by extension, platforms…
Google and Facebook, on the other hand, are products of the Internet, and
the Internet leads not to platforms but to aggregators. While platforms need
3rd parties to make them useful and build their moat through the creation of
ecosystems, aggregators attract end users by virtue of their inherent
usefulness and, over time, leave suppliers no choice but to follow the
aggregators’ dictates if they wish to reach end users.
The distinction wasn’t entirely satisfying; first and foremost the power of
both aggregators and platforms, however defined, ultimately rests on the
size and strength of their userbase. Moreover, Google and Facebook have
platform-type aspects to their business, and Apple has aggregator
characteristics when it comes to its control of the App Store (that Microsoft
does not is a symbol of the company’s mobile failure).
Moreover, what of companies like Amazon, or Netflix? In a follow-up Daily
Update I classified the former as a platform and the latter as an aggregator,
but clearly both have very different businesses — and supplier relationships
— than either Google and Facebook on one side or Apple and Microsoft on
the other, even as they both derive their power from owning the customer
relationship.
Make no mistake, that bit about owning the customer relationship remains
critical: that is the critical insight of Aggregation Theory. How that ownership
of the customer translates into an enduring moat, though, depends on the
interaction of two distinct attributes: supplier differentiation and network
effects.

2. The Supplier Differentiation Spectrum
Consider the six companies I mentioned above: Facebook, Google,
Amazon, Netflix, Apple, and Microsoft.
These companies exist on a spectrum in terms of supplier differentiation
(and, by extension, supplier power):
• Facebook has commoditized suppliers more than anyone: an article
from the New York Times is treated no differently from a BuzzFeed
quiz or the latest picture of your niece or an advertisement.
• Google gives slightly more deference to established content
providers, but not much; search results are presented the same
regardless of their source (although Google increasingly presents
results differently depending on the type of content).
• Amazon is a little harder to classify — that’s kind of entailed in the
name The Everything Store — but generally brands are much less
important than they are in a world of limited shelf space, and few
people even realize they are buying from the 3rd party merchants that
make up over half of Amazon’s sales.
• Differentiation matters more for Netflix, particularly when it comes to
acquiring new users; still, users are transacting with Netflix and, the
longer they stick with the streaming service, first opening Netflix and
then looking for something to watch, as opposed to the other way
around.
• Apple first and foremost attracts and retains users through its
integrated experience, but that experience would quickly be
abandoned were there not third party apps.
• Microsoft traditionally succeeded entirely because of its ecosystem,
not just applications but also the entire universe of value-added
resellers, systems integrators, etc.
The extremes make the point: Facebook could lose all of its third party
content providers overnight and still be a compelling service; Microsoft
without third parties would be, well, we already saw with Windows Phone.

3. The Network Effect Spectrum
Another way to consider this spectrum is in terms of user-related network
effects. The idea of a network effect is that an additional user increases the
value of a good or service, and indeed all of these companies depend on
network effects. However, the type of network effect differs considerably, as
well as the extent to which the network effect directly improves a company’s
core product (what I am calling an “internalized” versus “externalized”
network effect):
Again there is a spectrum:
• For Facebook the network effect that matters is users — a social
network’s most important feature is whether your friends and family
are using it. This network — given it is the product! — is completely
internal to Facebook.
• Google has network effects of its own, but they are less about users
and more about data: more people searching makes for better search
results, because of the system Google has built to relentlessly
harvest, analyze, and iterate on data. Like Facebook, Google’s
network effect is largely internal to Google.
• Amazon’s network effect is more subtle: there is an aspect where
your shopping on Amazon improves my experience through things
like rankings, reviews, and data feedback loops. Just as important,
though, are two additional effects: first, the more people that shop on
Amazon, the more likely suppliers are to come onto Amazon’s
platform, increasing price and selection for everyone. In other words,
Amazon, particularly as it transitions to being more of a commerce
platform and less of a retailer, is a two-sided network. There is one
more factor though: Amazon’s incredible service rests on hundreds of
billions of dollars in investments; that fixed cost investment has to be
born by customers at some point, which means the more customers
there are the less any one customer is responsible for those fixed
costs (this manifests indirectly through lower prices and better
service).

4. • Netflix is a hybrid much like Amazon: there are certainly data network
effects when it comes to what shows are made, what are cancelled,
recommendations, ratings, etc. An essential part of Netflix’s
competitive advantage going forward, though, rests on its
differentiated ability to invest in new shows; this investment capability
is driven by the company’s huge and still-growing user base, which is
the biggest way that additional users benefit users already on the
service.
• Apple certainly benefits from a large user base over which to spread
the significant fixed costs of its products, but on this end of the
spectrum it is the two-sided network of developers and users that is
most important. The more users that are on a platform, the more
developers there will be, which increases the value of the platform for
everyone.
• Microsoft, befitting the point I made above about the expansiveness
of its ecosystem, has the most “externalized” network effect of all:
there is very little about Windows, for example, that produces a
network effect (Office is another story), but the ecosystem on top of
Windows produced one of the greatest network effects ever.
At this point, you may have noticed that these two spectrums run in roughly
the same order: I don’t think that is a coincidence.

5. The Moat Map
Here are these two spectrums laid out on two orthogonal axis:
This relationship between the differentiation of the supplier base and the
degree of externalization of the network effect forms a map of effective
moats; to again take these six companies in order:
• Facebook has completely internalized its network and commoditized
its content supplier base, and has no motivation to, for example,
share its advertising proceeds. Google similarly has internalized its
network effects and commoditized its supplier base; however, given
that its supply is from 3rd parties, the company does have more of a
motivation to sustain those third parties (this helps explain, for
example, why Google’s off-site advertising products have always
been far superior to Facebook’s).
• Netflix and Amazon’s network effects are partially internalized and
partially externalized, and similarly, both have differentiated suppliers
that remain very much subordinate to the Amazon and Netflix
customer relationship.

6. • Apple and Microsoft, meanwhile, have the most differentiated
suppliers on their platforms, which makes sense given that both
depend on largely externalized network effects. “Must-have” apps
ultimately accrue to the platform’s benefit.
It is just as useful to think about what happens when companies find
themselves outside of the Moat Map.
Missing Moats
Start with Apple and apps: in August 1997, Steve Jobs, having just returned
to Apple, took the stage at Macworld Boston and proceeded to humble
himself: first, he talked about how much Apple needed Adobe, and then he
announced a settlement with Microsoft that entailed Microsoft investing in
Apple and developing Office for Mac for at least five years. That was
followed by Bill Gates’ grinning visage appearing via satellite over Jobs’
head:
I wrote in 2013 that I believe this experience resulted in Apple making poor
strategic choices with the iPhone and iPad: the company never again
wanted to have its suppliers become too powerful. The way this played out,
though, is that Apple for years neglected the business model needs of

7. developers building robust productivity apps that could have meaningfully
differentiated iOS devices from Android.
To be sure, the company has been more than fine: its developer ecosystem
is plenty strong enough to allow the company’s product chops to come to
the fore. I continue to believe, though, that Apple’s moat could be even
deeper had the company considered the above Moat Map: the network
effects of a platform like iOS are mostly externalized,
which means that highly differentiated suppliers are the best means to
deepen the moat; unfortunately Apple for too long didn’t allow for suitable
business models.
Another example is Uber: on the one hand, Uber’s suppliers are completely
commoditized. This might seem like a good thing! The problem, though, is
that Uber’s network effects are completely externalized: drivers come on to
the platform to serve riders, which in turn makes the network more
attractive to riders. This leaves Uber outside the Moat Map. The result is
that Uber’s position is very difficult to defend; it is easier to imagine a
successful company that has internalized large parts of its network (by
owning its own fleet, for example), or done more to differentiate its

8. suppliers. The company may very well succeed thanks to the power from
owning the customer relationship, but it will be a slog.
On the opposite side of the map are phone carriers in a post-iPhone world:
carriers have strong network effects, both in terms of service as well as in
the allocation of fixed costs. Their profit potential, though, was severely
curtailed by the emergence of the iPhone as a highly differentiated supplier.
Suddenly, for the first time, customers chose their carrier on the basis of
whether or not their preferred phone worked there; today, every carrier has
the iPhone, but the process of reaching that point meant the complete
destruction of carrier dreams of value-added services, and a lot more
competition on capital-intensive factors like coverage and price.
Direction or Context?
It’s worth noting that maps can take two forms: some give direction, and
others provide context for what has already happened; I’m not entirely sure
which best describes the Moat Map. In the case of Apple and apps, for
example, I absolutely believe the company could have made different
strategic choices had it fully appreciated the interaction between supplier
differentiation and network effects.
On the other hand, one could make a very strong case that the degree of
supplier differentiation possible flows from the network effect involved:
perhaps it was inevitable that Facebook and Google commoditized
suppliers, for example, or that Amazon and Netflix would have to
simultaneously pursue differentiated suppliers even as they sought to
suppress them. What is always certain, though, is that there is no one
perfect strategy: as always, it depends.