Stratechery: Defining Aggregators

Aggregation Theory was first coined in this eponymously-titled 2015 article. That article followed on the heels of a series of posts about Airbnb, Netflix, and web publishing that, I realized, fit together into a broader framework that was applicable to a range of Internet-enabled companies.

The Characteristics of Aggregators

Direct Relationship with Users

Zero Marginal Costs For Serving Users

This characteristic means that businesses like Apple hardware and Amazon’s traditional retail operations are not aggregators; both bear significant costs in serving the marginal customer (and, in the case of Amazon in particular, have achieved such scale that the service’s relative cost of distribution is actually a moat).

Demand-driven Multi-sided Networks with Decreasing Acquisition Costs

Because aggregators deal with digital goods, there is an abundance of supply; that means users reap value through discovery and curation, and most aggregators get started by delivering superior discovery.

Then, once an aggregator has gained some number of end users, suppliers will come onto the aggregator’s platform on the aggregator’s terms, effectively commoditizing and modularizing themselves.

This means that for aggregators, customer acquisition costs decrease over time; marginal customers are attracted to the platform by virtue of the increasing number of suppliers.

This is in contrast to non-aggregator and non-platform companies that face increasing customer acquisition costs as their user base grows. That is because initial customers are often a perfect product-market fit; however, as that fit decreases, the surplus value from the product decreases as well and quickly turns negative.

One additional note: the aforementioned Apple and Amazon do have businesses that qualify as aggregators, at least to a degree: for Apple, it is the App Store

Amazon, meanwhile, has Amazon Merchant Services, which is a two-sided network where Amazon owns the end user and passes all marginal costs to merchants (i.e. suppliers).

Classifying Aggregators

Level 1 Aggregators: Supply Acquisition Level 1 Aggregators acquire their supply; their market power springs from their relationship with users, but is primarily manifested through superior buying power. That means these aggregators take longer to build and are more precarious in the short-term. The best example of a Level 1 Aggregator is Netflix.

Level 1 aggregators typically operate in industries where supply is highly differentiated, and are susceptible to competitors with deeper pockets or orthogonal business models.

Level 2 Aggregators: Supply Transaction Costs Level 2 Aggregators do not own their supply; however, they do incur transaction costs in bringing suppliers onto their platform. That limits the growth rate of Level 2 aggregators absent the incursion of significant supplier acquisition costs.

Uber is a Level 2 Aggregator (and Airbnb in some jurisdictions due to local regulations). Uber owns the user relationship and bears no marginal costs in terms of COGS, distribution costs, or transaction costs. Moreover, Uber does not own cars; those are supplied by drivers who sign up for the platform directly. At that point, though Uber needs to undertake steps like background checks, vehicle verification, etc. that incur transaction costs both in terms of money as well as time. This limits supply growth which ultimately limits demand growth.

Level 2 aggregators typically operate in industries with significant regulatory concerns that apply to the quality and safety of suppliers.

Level 3 Aggregators do not own their supply and incur no supplier acquisition costs (either in terms of attracting suppliers or on-boarding them).

Google is the prototypical Level 3 Aggregator: suppliers (that is, websites) are not only accessible by Google by default, but in fact actively make themselves more easily searchable and discoverable (indeed, there is an entire industry — search engine optimization (SEO) — that is predicated on suppliers paying to get themselves onto Google more effectively).

Social networks are also Level 3 Aggregators

Level 3 aggregators are predicated on massive numbers of users, which means they are usually advertising-based (which means they are free to users).

The Super-Aggregators Super-Aggregators operate multi-sided markets with at least three sides — users, suppliers, and advertisers — and have zero marginal costs on all of them. The only two examples are Facebook and Google, which in addition to attracting users and suppliers for free, also have self-serve advertising models that generate revenue without corresponding variable costs (other social networks like Twitter and Snapchat rely to a much greater degree on sales-force driven ad sales).

Regulating Aggregators Given the winner-take-all nature of Aggregators, there is, at least in theory, a clear relationship between Antitrust and Aggregation. However, traditional jurisprudence is limited by three factors:

The key characteristic of Aggregators is that they own the user relationship. Critically, the user chooses this relationship because the aggregator offers a superior service.

The nature of digital markets is such that aggregators may be inevitable; traditional regulatory relief, like breaking companies up or limiting their addressable markets will likely result in a new aggregator simply taking their place.

Aggregators make it dramatically simpler and cheaper for suppliers to reach customers (which is why suppliers work so hard to be on their platform). This increases the types of new businesses that can be created by virtue of the aggregators existing (YouTube creators, Amazon merchants, small publications, etc.); regulators should take care to preserve these new opportunities (and even protect them).