Aggregation Theory [Alex Lieberman]

Audio source: https://art19.com/shows/the-founders-journal/episodes/a77afe33-236f-44b6-a2e8-55b6ff5c8e02

Ben Thompson's own writing on Aggregation Theory

Transcript

swyx: [00:00:00] I generally think that Ben Thompson's aggregation theory is the most important tech strategy concept of our time. It explains a lot. But Ben Thompson himself doesn't really have a good explainer on his own site. So I really appreciated this. Summary by Alex Lieberman of aggregation theory. I thought it was the clearest explainer, with some examples, that I've ever heard. So enjoy.

Alex Lieberman: [00:00:23] Aggregation theory says that some of the most dominant companies in the world became dominant by doing three things. 

First, they have a direct relationship with their customer. 

Two, there is zero marginal cost to serve their customer 

and three, they have network effects. 

I'm going to unpack each of these qualities. 

Own The Relationship [00:00:43] 

The first quality that I mentioned was having a direct relationship with the user. 

Google is the most trafficked site on planet earth. There are 63,000 searches that happen every second on the site. By the end of this episode, there will have been 50 million searches that happen on the platform. Since you started listening. Google's power is in its relationship with you.

The user, when you search something on Google, you are Google's customer. You're not the customer of the website that you end up going to Google captures your data. They monetize you. They recommend the most relevant content for you to click on. And Google is the website that you go to when you want to find an answer.

And so just so you have a comparison around like what it looks like to own your relationship versus not own it take most retail companies that sell through brick and mortar, which many of them do? So let's say you're Patagonia and let's say you sell pullovers through Bloomingdale's. You don't own the customer relationship as Patagonia Bloomingdale's does.

Bloomingdale's has your information as the customer. They know what you bought and they can market to you moving forward, because they have things like your email address or your credit card information beyond getting the sale. If you're Patagonia, you haven't learned anything about your customer.

That's the first characteristic of aggregators. You own the user relationship. 

Zero Marginal Cost [00:02:08]

Now, number two, the second relationship of aggregators is that there is zero marginal cost for serving users. Let me explain what that means. If you're an aggregator, you don't incur any of the marginal costs that most businesses have to.

So take Airbnb. All Airbnb does is provide a great user experience for the customer or the renter to find homes or apartments for rental Airbnb. Doesn't have to worry about the normal costs that most businesses do in serving their customers, because they're not the supplier of the product. There's no such thing as cost of goods sold for Airbnb because they are simply aggregating supply or homes or apartments.

And they're playing matchmaker for demand, which are the people who want to. Rent homes or apartments, whereas let's say your t-shirt business, you have to incur the cost of each additional t-shirt to serve each customer. Airbnb doesn't have any marginal costs for adding another customer on the platform, because if someone decides to find a place to stay on their platform, Airbnb isn't paying for it.

They're simply just connecting that person with the home or the apartment that they were looking for. On top of that, Airbnb also doesn't have to deal with distribution costs because their business exists on the internet. Unlike say a fulfillment based business like Amazon, which literally has to ship physical goods everywhere across the world.

Airbnb is built on the internet and the internet has made delivering goods. Zero cost. That's the second quality of aggregators. 

Network Effects [00:03:41] 

The third and final characteristic of an aggregator are network effects. Basically all that, this means is an aggregator gets more valuable over time for the user and aggregators. Find that the cost of acquiring new customers goes down over time as well, which is completely opposite from what most businesses experience for most businesses.

When you start your company, when you achieve product market fit, your initial customers are generally your most passionate, your most loyal and your perfect fit customers. As you grow your company, you find that the quality of your customer goes down because it isn't a perfect fit. Aggregators are different in that regard, it actually costs less to get good customers moving forward.

Whereas for normal businesses, as you expand, you have to pay more to convince. Less perfect customers to join your company or buy your product. What that also means is aggregators generally operate in a winner, take all fashion because it becomes increasingly difficult for any companies in the industry that an aggregator plays into compete at scale, if not only does the product get more valuable for users, but it also gets cheaper to acquire users.