Smaller technology firms are on the rise, proving there is space in the sector for tier-two firms, especially those that have built their own platforms.

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There are hundreds of large, listed technology firms in the U.S. outside the elite ranks of GAFAM – Google and parent company Alphabet, Apple, Facebook, Amazon and Microsoft. Those in the tier-two category, defined by The Economist as having a market value of at least $20 billion, incorporated in 2000 or later, form an important group. Ranging from ecommerce and streaming services to travel firms and corporate apps, they are worth $2.4 trillion combined and have been growing rapidly.

Snap, the maker of social media app Snapchat, offers a textbook example. The first few years after its 2017 IPO were rocky, to say the least, but Snap has since mounted a highly successful turnaround. In the first quarter of this year, its revenue grew by 66% from the previous year. Snap also added more than 50 million daily users in the same period, bringing its total to 280 million. Chief Financial Officer Derek Andersen said he expects year-over-year revenue growth of 80% to 85% for the second quarter.

Technological advancements, particularly in cloud computing, are one contributing factor to the growth of these firms, enabling them to expand within their specialties and find bigger markets. Twilio, for example, is a cloud communications platform as a service (CPaaS) that provides text, voice and video to thousands of other firms such as Airbnb and Zendesk. It was founded in 2008, and in the past few years has grown its annual revenue to nearly $2 billion. Its market capitalisation is over $50 billion.

Of course, the pandemic has played a major role in the recent growth of tier-two technology firms, notably Zoom, driving digital demand to all-time highs and creating more space for competition. “Covid has been the great digital accelerator,” says Jeff Lawson, CEO of Twilio. But other factors have been at play at well, and these companies were already trending upwards before the pandemic. On the eve of it, in February 2020, their joint market cap reached 22% of GAFAM’s, up from 14% three years earlier.

The second tier have made inroads mainly by creating protected space for themselves to grow, says Mark Mahaney of investment bank Evercore ISI. This is best exemplified by firms that have built platforms, which tend to have strong “network effects” that enable them to flourish. Snap has done this, as has Shopify, which President Harley Finkelstein describes as “a piece of software that powers other brands.” It provides tools for virtual stores, complete with web hosting, payments and the like, and allows third parties to offer added services such as delivery.

Such successes could propel tier-two firms to catch up with GAFAM – or at least come close. But for the smaller, younger tech firms to become true contenders, the titans will need to become less innovative, and the second-tier firms may need to consider mergers. Critics and regulators, which have been threatening the dominance of GAFAM, could play a decisive role. Dan Ives of Wedbush Securities emphasizes this point, saying, “Unless the regulatory environment really changes, this is going to be the status quo for the foreseeable future.”

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