1. 12 Two-sided Platforms 3 Aaron Schiff ECON 204 2009

2. Introduction Objectives of this lecture: More analysis of two-sided platform pricing, plus issues related to understanding two-sided market outcomes, and other platform design issues.

3. Subscription Pricing With subscription pricing, the demand for subscriptions on either side of the market depends on the prices charged on both sides. For example, increasing p A : –Reduces the number of A-types that subscribe to the platform. –The smaller number of A-types makes the platform less valuable to B-types, and reduces the number of B-type subscriptions.

4. Subscription Pricing Solving simultaneously n A =  A – p A / n B and n B =  B – p B / n A gives demand on each side as functions of p A, p B,  A and  B (but very ugly equations!) Profit from subscription pricing at a marginal cost of c per customer:  = n A (p A, p B )(p A – c) + n B (p B, p A )(p B – c) As with usage pricing, the profit-maximising prices are interdependent – have to choose prices charged to both sides simultaneously.

5. The Price Structure Matters Return to usage pricing, recall that total usage of the platform is n A × n B = (  A – p A )(   – p B ) Instead of the individual prices p A and p B we can think of the price level L = p A + p B and structure s = p A / L, where s is between 0 and 1. Then total platform usage is (  A – sL)(   – (1 – s)L) Holding L constant, changing s affects total usage of the platform (and hence profits). –This is a key feature of two-sided markets.

6. Example 1 In the usage pricing model suppose  A = 1 and  B = ½ and the price level is L = 1. Derive and plot total usage of the platform as a function of the price structure s = p A / L.

7. Pricing Principles Key point: To maximise profits, prices on both sides of the market must be set jointly and effects on both sides must be considered when setting the price on either side. Typically, one side pays a relatively high price and the other side pays a relatively low price. How to choose which side to charge the higher price?

8. Pricing Principles Charge the higher price to the side which: –Has less elastic demand. –Has higher willingness to pay. –Generates less benefits to consumers on the other side of the platform. –Prefers quantity over quality (charging a high price excludes ‘low quality’ consumers). Example: Why do nightclubs charge a high price to men and a low price to women? –Answer: Men prefer quantity, women prefer quality!

9. Pricing Principles The platform may also find it beneficial to offer special deals to ‘marquee’ buyers. –Consumers on one side of the market who bring a lot of benefits to consumers on the other side by belonging to the platform. –Example: A major game development studio brings a lot of benefits for game console buyers. –Especially when trying to get the platform off the ground, attracting key users on either side can be crucial.

10. Analysing Two-Sided Markets In a ‘normal’ market: –Higher marginal costs generate higher prices. –More intense competition reduces prices towards marginal cost. In a two-sided market: –Higher marginal costs increase the price level but the profit- maximising price structure may still have a low price on one side. –More intense competition reduces the price level but the price structure may still be highly asymmetric. In a two-sided market we cannot reach conclusions about a firm’s behaviour or the intensity of competition by looking at once side of the market in isolation.

11. Example 2 Google’s “Ad Manager” platform: –Two sides: Advertisers (banner ads) and website publishers. –See http://googleblog.blogspot.com/2008/03/our-solutions-for-ad- serving.htmlhttp://googleblog.blogspot.com/2008/03/our-solutions-for-ad- serving.html Google charges a zero price to website publishers who belong to the Ad Manager platform. Other ad platforms offer similar services but charge a positive price to website publishers. Questions: –Pricing below marginal cost is often thought of as anticompetitive behaviour (“predatory pricing”). –Should Google be prevented from offering its service for free to website publishers?

12. Compatibility As with other networks, two-sided platforms can be compatible or incompatible with other platforms. –Compatible: Adobe PDF –Incompatible: iPod/iTunes, eBay. The same basic issues and results that we discussed before arise. –Compatibility softens competition. –Fight for the market or share the platform? –Network effects as a barrier to entry. –Compatibility makes it easier to establish new platforms.

13. Platform Design Issues Key things a platform must decide / know: –Who exactly are the two consumer groups and what are their characteristics? –Should the platform integrate into one side of the market and become a one-sided business? What is the structure of the platform’s “ecosystem”. –Make the platform compatible with other platforms? –Subscription or usage fees? –What price level and structure?

14. Platform Design Issues Sometimes platforms choose to ‘integrate’ themselves into one side of the market and supply that side themselves rather than relying on outsiders. –Examples: Videogame platform makers sometimes produce their own games; Apple produces some of its own software. Fully or partially integrating into one side of the market makes getting the platform off the ground easier. –Can help to eliminate the expectations problem by guaranteeing a source of content or value for the platform. Integrating also makes it easier for the platform to control quality. But this is more expensive and possibly more risky for the platform.