Platform Transformation Risk and the Role of Hosting Rivals

This paper studies the decision of traditional firms to transform into digital platforms. While digital transformation enhances value through externalizing value creation, it also entails investment risk. We show that when investments entail high risk and the value of network effects is low, firms should avoid transforming into a platform and retain their traditional form. By contrast, low transformation risk or high value of network effects make digital transformation profitable. Interestingly, when firms choose to transform, we show that inviting rivals onto the platform can raise profits. Indeed, the platform may even pay rivals to join its platform in certain cases. The benefit of enhancing network effects through demand aggregation can be more profitable than competing as separate platforms. Further, inviting rivals onto a proprietary platform lowers the rival's competitive aggressiveness. This is a novel strategic rationale for inviting rivals on to the platform elicited in this paper. Yet, when the value of network effects is very high and investments are near certain, the platform chooses not to invite rivals. We provide clear managerial and policy implications from these results and use real world examples to illustrate our theory.