The Chinese taxi hailing apps Didi Dache and Kuaidi Dache brought significant innovations to the country’s taxi industry when they launched in 2012. By leveraging mobile Internet technology to create platforms where drivers and passengers can communicate and trade directly with each other the apps created a new type of ecosystem that corrected weaknesses in the traditional taxi industry, such as long waiting times and profiteering by taxi companies. The resulting improvements in efficiency have been a win-win for both drivers and passengers. Since their launch, the two companies have been engaged in an epic battle for market share backed by the two largest Internet companies in China—Alibaba and Tencent. So their announcement of a merger early this year was quite a surprise. What’s behind this rapid about face that’s taken them from being foes to friends? What lessons can other businesses with platform features take away from their merger? What will this collaboration mean for China’s taxi industry? Chen Weiru, CEIBS Associate Professor of Strategy and author of the bestselling book Platform Strategy: Business Model in Revolution has the answers:

Arch-rival Internet giants Tencent and Alibaba back the taxi-hailing apps Didi Dache and Kuaidi Dache, respectively, and were operating them on the assumption that they follow the “winner take all” principle of the Platform Business Model. Hoping to knock their competitor out of business, each company tried to buy the loyalty of users by throwing billions of RMB at passengers and drivers as a reward for each ride booked through their app.

But as it turns out, taxi-hailing apps don’t follow the “winner take all” principle. There are three criteria for  a “winner take all” market: Strong cross-side network effect, Positive same-side network effect and High switching cost. In the taxi app market, increasing the number of passengers using the platform certainly attracts more drivers to join; and vice versa. This strong cross-side network effect supports the first criterion for a platform market in which one winner can take all. However as more drivers join the platform, the more these drivers will compete with one another for passengers. Similarly, as more passengers use the platform there is more competition for finding an available taxi driver. This means there is very low, and occasionally a negative, same-side network effect. A strong same-side network effect, the second criterion for a “winner take all” market, does not hold here. Since it’s easy for both passengers and drivers to download and use any other similar app at the same time, the third criterion of high switching cost doesn’t apply here either. With no same-side network effect and a low switching cost there is no possibility for “winner-take-all”, therefore it does not make sense for the two companies to continue spending money to try and buy market share.

Kuaidi CEO Lv Chuanwei acknowledged this in an internal letter to staff about the merger. “The cutthroat competition that burns money is not durable,” he said. Lv admitted that both investors and entrepreneurs no longer had the stomach for continuing to pay subsidies to users. The Didi-Kuaidi merger will create the largest travel-related app in China, which analysts estimate could be worth more than US$ 6 billion. The merger will save both time and opportunity costs, and it will combine the two company’s technical advantages, products and talents, which will accelerate expansion and development of new services, and promote the development of the entire industry. Didi Dache CEO Cheng Weizhan was quoted in media reports saying that the merger, along with the rapid development of China’s mobile travel apps, will help conserve resources and solve congestion problems in cities. What’s more important, through these platforms, users experience a mutual trust relationship, which contributes to the broader establishment of a social trust environment in China.

Many have speculated that the Didi-Kuaidi merger is also an attempt to stave off competition from Uber, the US-based ride share app that entered the China market last December in a partnership with Baidu. Uber has announced plans to invest US$500 million to expand in China, and said it will enter a new city every three months. However I don’t believe that Didi and Kuaidi are that concerned about Uber’s entry into China. The market for taxi apps and commercial car hailing apps like Uber is a very local one, and so far Uber’s performance in China is barely satisfactory. However, again, because the commercial car hailing app market does not enjoy the “winner take all” feature, Uber has time to learn.

Even with their evident advantages such as high volume and expansive coverage, Didi and Kuaidi have not yet been very profitable. The companies are now shifting their focus towards a new area of business with higher-end cars for higher-end urban professionals, the same market segment being focused on by Uber, yongche.com, zuche.com and other companies. Though this type of specialty car service has no market prospect for being “winner-takes-all”, once their merger is complete Didi and Kuaidi would do well to develop value-added services such as carpooling. This would increase passengers’ same-side network effect and make the newly merged company even more invincible. In the face of such increased competition in the specialty car market, I expect that there will be more consolidation among the smaller players.

Ultimately the future success or failure of the merger between Didi and Kuaidi will depend on how well the two companies can integrate their resources, including senior management, operations and technology. This is the most difficult part of every business merger. Since the two companies used to be arch enemies, if their competitive spirit remains and the two sides continue acting aggressively, a smooth and effective integration may not be possible.

As the Didi-Kuaidi merger shows, not all platform businesses are “winner-takes-all”. However there are still many other online industries with platform features, such as group-buying, take-out services and tourism that are following the same “winner-takes-all” thinking and throwing money at users in an attempt to drive out their rivals. I expect this merger will cause many of these businesses to finally realize that they cannot buy market share for long, and instead some will begin to pursue a more rational strategy like developing strategic alliances with rivals that can lead to a long-term win-win co-existence.”