X Marks the Spot

8 min readJan 24, 2021

A case study in business strategy and two sided networks

On Dec 10, 2020, mere months after a pandemic rocked the global travel industry, Airbnb grabbed headlines with a smashing public stock offering(IPO). The market price of airbnb at the end of opening day; over 100 billion dollars. That company market value represented over three times the market capitalization of travel industry stalwart Hilton Hotels. How could a company which neither owns nor manages guest rooms nor controls any meaningful physical assets command such a lofty sum? By contrast, Hilton Hotels controlled almost a million rooms worldwide:

6,110 properties comprising 971,780 rooms in 119 countries and territories as of December 31, 2019

airbnb, my friends, knows the power of owning a two sided network.

When it comes to designing a two sided network, X marks the spot.

In response to my recent article introducing the concept of two sided networks: hyperscale and the betamax, a few astute readers questioned whether two sided network effects are really anything special. They wondered if a two sided network is not a feature of every business and whether such a concept can usefully inform a business strategy. One such question was :

“Isn’t every business just a two sided network? Consider any manufactured product, say a Ford truck, isn’t Ford really just a two sided network because consumers benefit when Ford can source from many parts producers and parts producers benefit when more consumers drive Ford trucks?”

An excellent question. Consider a classic value chain. Most companies, whether they have an interest in automobiles, hotels, or potatoes are classically thought of as one entity in a value chain flow terminating with the consumer:

Classically, winning enterprises built their empires by owning some position in this flow of value to consumers. No doubt, countless business school case study debates have explored company fortunes made on the backs of an optimized position in the value chain.

Clearly the model is a vast simplification. In fact, as Leonard Reed’s classic essay argued, supply chains are so complex, “no single person on the face of this earth knows how to make [even a pencil]” . If you never read the essay I, Pencil, you really should. I will post a link at the end. Regardless, the point is, generally, value flows one direction.

Here is a slightly more detailed value chain for the hotel business:

A vertically integrated hotel will own the property, manage the property, and market the property. Hilton was actually started as a vertically integrated hotel in Cisco, Texas by Conrad Hilton.

It might surprise you to learn, today Hilton actually manages very few properties, and owns even fewer. Here is a breakdown

5287 Hilton Hotels Franchised
703 Hilton Managed Hotels
57 Hotels Wholly Owned

So if Hilton does not own massive buildings and does not manage the staff who clean up your room after a stay, why is Hilton a thirty billion dollar business? Hilton owns the customer relationship. The components of the value chain are largely masked to the consumer. Crack open Hilton’s annual report, their strategy is:

focused on the growth of our business by expanding our share in the global hospitality industry through our development pipeline.

I’m going to call this the Y strategy.

Essentially, the Y strategy focuses on owning the customer relationship and controlling the supply chain sitting behind the good or service. Elements of the chain might be directly owned or outsourced, but the consumer only sees one brand. Apple computers followed a similar Y strategy by exerting more vertical control over the pc hardware supply chain and tightly coupling the hardware with their operating system. A clear contrast to Microsoft’s relatively open ecosystem.

As you can see, Hilton is focused on a model where value flows in the traditional way. Even in such a strategy one will inevitably find weak two sided effects. For example, hotel real estate owners benefit from more Hilton guests and vice versa. There is at least one specific two sided network strategy built into Hilton’s business model, can you spot it?

Any two sided network effect is likely secondary to the overarching Y strategy. From the Hilton Annual Report(10K),

In addition to our current hotel portfolio, we are focused on the growth of our business by expanding our share in the global hospitality industry through our development pipeline…
Overall, we believe that our experience in the hospitality industry, which spans more than a century of customer service and entrepreneurship, and continues to evolve for the tastes, preferences and demands of our hotel guests; our strong, well-defined brands that operate throughout the hospitality industry chain scales; and our commercial service offerings will continue to drive customer loyalty, including participation in our Hilton Honors guest loyalty program. We believe that satisfied customers will continue to provide strong overall hotel performance for us and our hotel owners and encourage further development of additional hotels under our brands with both existing and new hotel owners, which further supports our growth and future financial performance.

Stated another way, Hilton’s business is all about integrating together the vast elements of the hotel supply chain together into a compelling customer value proposition.

Lets turn to airbnb. Clearly airbnb focused their business on building a two sided network and owning the control point. From airbnb’s S1 (an S1 is a document similar to an annual report required when companies first list their stock):

Our Long-Term Growth Strategy
Our strategy is to continue to invest in our key strengths:
• Unlock more hosting. In order to have enough selection for guests booking on our platform, we will continue to invest in growing the size and quality of our host community. We believe that we have just scratched the surface of the opportunities that hosting can provide.
• Grow and engage our guest community. We intend to attract new guests to Airbnb and convert more of them into brand advocates. We will continue to focus on engaging our existing guests to return to book and to use Airbnb with more frequency.

Order is important. You can see the first most important stated element is the host(supplier) not the guest(customer)! Every business acknowledges the importance of the customer, but airbnb recognizes explicitly their maniacal focus on adding value both up and down the value chain. They want to kick open wide the bottom and top parts of the X. This is the X marks the spot strategy. They sit in the middle and own the control point.

So what makes a winning X marks the spot strategy? I dove into many past winners (Microsoft, airnbnb, Ebay, and VHS) and indeed some of the losers (beta). Four key characteristics which I have found to be common among the most compelling businesses with a winning two sided network strategy are they:

Focus on creating value for both sides of the network.

The winning two sided networks have a clear strategy to create value for stakeholders on both sides of the network. This attention to bidirectional value flow contrasts sharply with the traditional one way value flow of a classic value chain. Here is an easy litmus test to check how focused your company strategy is on harnessing a two sided network effect. Do connected businesses on each side of your gateway know and value each other as distinct entities. Can they even identify each other? Here is an example, who makes the brakes in a Ford vehicle? Unless you are into cars, I doubt you know or care. That brake manufacturer is masked from you the consumer because Ford is the intermediary controlling all the upstream members of the chain. Until this article, you might not have known Hilton does not not actually own or manage most of their hotels. Compare this with airnb: again from the s1

Why do guests choose Airbnb?
Guests can be hosted. Whether guests stay with a host or have a home all to themselves, they can experience the cities they visit the same way locals do.

Airbnb promotes a direct connection between host and guest. Look at ebay, many small businesses were built upon a distinct reputation intermediated through ebay’s platform. Sellers were able to build differentiated value propositions from other sellers in the market. Again consider the microsoft windows domination story: NVIDIA, Intel, Asus, AMD, Dell, Adobe, and many other brands were built largely via their participation in the windows two sided network ecosystem.

2. Surrender control of the 4 Ps

In Marketing 101 we learn about the 4 Ps. These Ps define interactions with the consumer: the product (the good or service); the price (what the consumer pays); the place (the location where a product is marketed); and promotion (the advertising). In the Y strategy, a company like Hilton exerts great control over the 4 ps. In contrast, airbnb “hosts” control their own destiny. Hosts largely control three of the Ps- the price, the product, and the place. A real estate company leasing a property involved in a Hilton operation, in contrast, assumes little control over any of the Ps toward a Hilton customer.

3. Re-imagine the market opportunity

In the 1980s, the IBM pc business model was enshrined in selling hardware. In accordance with this model IBM decided to outsource to Microsoft the role of providing the operating system to ship with the hardware. In that flawed market strategy, the operating system was considered a value add to compliment the value proposition of the hardware. Bill Gates’s key insight was imagining the operating system as the control point between and ecosystem of hardware makers and software developers. He re-imagined the market and built Microsoft around this winning two sided network effect.

4. The gateway commands a steep switching cost

Further on the Microsoft example. Consider the needs of a software developer. The Windows Application Programming Interface(API) helped developers become incredibly productive. Using the API, programmers transformed innovative ideas into friendly graphical user interfaces. They built with Windows. They built in a fraction of the time required from scratch or on an alternative operating system. Therefore, as companies developed applications on Windows, the switching cost to a different “gateway” such as Mac or OS2 was far from negligible. airbnb builds in all kinds of “free” handy guest management tools on their app to make the lives of hosts and guests easier. Each of these also conveniently helps increase the switching cost and thus magnifies the two sided network effect.

Companies whose business model is not built on a pure X marks the spot strategy, can still find ways to leverage the powerful effects. Hilton enjoys a very strong two sided network effect. Can you guess what it is? Their guest rewards points program. The guest point program creates a loyalty. Customer loyalty is very attractive to potential management and owners looking to join the Hilton franchise. Guests value the increased number of properties where they can spend their points. Even Hilton realizes, X marks the spot.

X Marks the Spot

A case study in business strategy and two sided networks

Written by Brad Anderson