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The Emergence of Platform Companies
Our work on platform companies has led us to some simple conclusions that we will briefly reiterate:
Platform companies have fractionalized their production process, keeping knowledge-intensive activities like design and distribution in-house, while outsourcing low-value added physical production. For those companies that still have significant manufacturing assets, they are devoted to complex processes or products, where knowledge is embedded in the fixed capital.
Platform companies have worked furiously to develop new products, new markets, and new products for new markets. The US in particular has been very aggressive about investing in foreign countries. Foreign direct investment accounts
for some 10% of total nonfinancial corporate assets and generates some $4.7 trillion a year in sales and some $700 billion a year in earnings.
Platform companies have piled up huge cash hoards as they optimize supply chains and monetize productivity. Due to the backward tax laws, US multinationals have hundreds of billions of dollars stored up in overseas bank accounts.
It is estimated that the nine largest US pharmaceutical companies alone have $113 billion stashed abroad. US companies have so much money squirreled away that Allen Sinai of Decision Economics concluded that, if the US loweredtax rates temporarily on repatriated earnings (as is being discussed), companies would repatriate US$545 billion.There is a precedent for this: we saw US companies bring home $360 billion in 2004 as a result of the temporary 5% tax rate contained in the American Jobs Creation Act.
The net result of all this is that platform companies are productivity passthrough vehicles that monetize the continuous evolution of the global production possibility frontier. In other words, platform companies are the beneficiaries of both Ricardian and Schumpeterian growth.
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The platform model came to the fore a little over a decade ago as: 1) information and communications prices plummeted, 2) global trade soared and 3) global capital flows surged. This convergence of factors enabled emerging economies to specialize, accumulate capital, and establish new comparative advantages, leading to a dramatic increase in the efficiency of global production. This process also triggered an accelerating pace of creative destruction among the world’s developed countries, raising the stakes on the achievement of multi-factor productivity.
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The current financial crisis is the first real test of the twin Ricardian and Schumpeterian growth dynamics that gave rise to the platform business model and the growth trends that we have witnessed in recent years. And today, most of our clients seem to believe that the crisis actually marks the death-knell of the model; the coming years are bound to be marked by growing protectionism, collapsing productivity and consequent economic misery.
We disagree and instead believe that recent evidence suggests that, far from being the beginning of the end for the platform-company model, we are simply going through the end of the beginning. With every day that goes by bringing another spate of earnings disappointments, bankruptcies, and examples of mismanagement, it would seem intuitive to expect corporate behavior to reflect these grim times, with companies retreating, retrenching and regressing. But, in recent weeks, we have started to pick up on examples of the exact opposite, as the well-capitalized platform companies have used this period of turbulence to position themselves for the next phase of growth.
Our bet is thus that the platform model itself will emerge stronger from the current crisis, and play a larger role in future global economic development than most investors currently believe. Globalization is far from dead and the companies that are positioning themselves today to reap its rewards will be the winners of tomorrow.
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