TWO SIDED MARKETS
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TWO SIDED MARKETS. Bruno Jullien. IDEI and GREMAQ, Toulouse. ESNIE - CARGESE. GETTING MULTIPLE SIDES ON BOARD. platform. buyers. sellers. B2C website. buyers. B2B platform. suppliers. gam e rs. videogame platform. game developers. "eyeballs". portals, newspapers, TV. advertisers.

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TWO SIDED MARKETS

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Two sided markets

TWO SIDED MARKETS

Bruno Jullien

IDEI and GREMAQ, Toulouse

ESNIE - CARGESE


Two sided markets

GETTING MULTIPLE SIDES ON BOARD

platform

buyers

sellers

B2C website

buyers

B2B platform

suppliers

gamers

videogame platform

game developers

"eyeballs"

portals, newspapers, TV

advertisers

cardholders

debit & credit cards

merchants

Chicken and egg problem. Must get both sides on board/court each side while making money overall.


Two sided markets

Organization of lecture

1INTRODUCTION

2 MONOPOLY

3 COMPETITION

4USAGE FEES

5COMPETITION POLICY


Two sided markets

Platform enables or facilitates interaction between "buyers" and "sellers"

Platform

usage charge

usage charge

+ membership charge

Buyer

+ membership charge

Seller


Two sided markets

Some 2SPs:

Exchanges

 Exchanges/auctions (eBay, Amazon).

 B2B.

 Employment agencies.

 Dating services.

 Real-estate agencies.

 Futures and securities exchanges

Communications

 Telecoms.

 Internet backbone services.

But also...

 Academic journals.

 Shopping malls.


What are two sided markets

What are two-sided markets?

  • Externality: Participants on one side care about the level of participation and usage of the other side

  • Differentiated treatment of each side

  • The profit and the allocation depends on the structure of price not only on the total price.

  • Not all platforms are 2SM

Example: electricity

Buyer

GRID

Producer

Bilateral contract

Only the total price charged on the two sides matters, as they negotiate

how to share it: similar to tax neutrality


Two sided markets

A « classical » industry may become a 2SMs

Example 1 : computers / video games

(vertical desintegration)

Hardware producers

Operating system

users

developers

Example 2 : TV operators

Content

(cinema, sport…)

operator

users

Advertisers


Two sided markets

Illustration : Encoding vs. reading

• Adobe Acrobat, Text Processors: free reader, charge or royalties for encoding.

• Contrast: books.

Illustration :why did credit cards and debit cards adopt so markedly different business models?

• Credit (Visa, MasterCard, Amex):high merchant discount, low (negative) cardholder price.

• On-line debit:low merchant discount.

Illustration :Videogame platforms.

  • Sell console at or below cost, royalties on games

Often results in very skewed pricing pattern


Two sided markets

2.1 MONOPOLY WITH SUBSCRIPTION

Registration

Registration

sellers

buyers

Platform

Access cost

For the moment no transaction fee/ cost

Network size

externalities

demand

functions


Two sided markets

MONOPOLY PRICES

Profit:

Volume / margin trade-off

Adjusted margin

Demand elasticity

for fixed participation of the other side


Two sided markets

  • Standard formula for profit maximization:

Elasticity = % variation in demand for 1% decrease in price.

  • Example: price to buyers.

Cost = opportunity cost, smaller than cost incurred in serving buyer

[attracting extra buyers generates revenue on seller side either through usage charges or by being able to increase sellers' membership fees.]

Price will be low/zero/negative if presence of buyer generates substantial revenue on seller side, buyer side reluctant to get on board (elastic demand).


Two sided markets

  • Comments :

    • The non adjusted margin is lower on the side where the elasticity is the highest and/or the externality created is larger.

    • In some cases prices may be negative (if possible, otherwise gifts, tying…) or null (free newspapers)

    • If one side is captive, the price is higher on this side and smaller on the other side (debit cards).


Two sided markets

Other examples of skewed pricing patterns:


Two sided markets

Sellers

Marquee buyers

Other buyers

Mind the cross-group externalities

 More complex story: within-side externality

Platform

attracts

large fee (because marquee buyers)

good deal

Illustrations:Amex corporate card.Killer application/game.Key store in shopping mall.


Welfare optimal prices

Welfare: Optimal prices

  • Unrestricted :

  • Price equal to the net opportunity cost

    • → marginal cost net of the value created for the members of the other side


Optimal prices

Optimal prices

  • Budget constraint

  • Ramsey-Boiteux prices depend on elasticity and on externalities (λ is determined by the budget constraint or cost of public funds)


Budget balanced allocation

Budget balanced allocation

  • Ramsey prices with respect to the net opportunity cost

    → marginal cost net of the value created for the members of the other sides

  • Low or negative price if

    • participation generates a relatively higher externality on the other group, and

      ii) the own price demand elasticity is high


Monopoly summary

Monopoly, summary

  • Competitive access (marginal cost pricing) is not efficient

  • One price should be below access cost (if no fixed cost), it may be negative.

  • Similar pattern of price skewness with unregulated monopoly and Ramsey pricing

  • Monopoly may be more efficient than competitive access

    → Optimal market structure?


Two sided markets

3 COMPETITION

Variant 1 : single-homing bilateral

Platform 1

  • price smaller on both sides

  • expectations of users play an important role

  • (multiplicity of possible equilibria)

  • "divide and et conquer"

Platform 2

buyers

sellers


Two sided markets

Single-homing and competition

  • Two identical platforms

  • Participants register with only one

  • Competitive benchmark

    • If usages can be fully taxed in a non-distortionary way and negative registration prices are feasible, then in equilibrium

      • Only one platform is active

      • Zero profit

    • But conditions are very restrictive!

  • In general a positive profit equilibrium is possible, unless there is enough homogeneity within sides and coordination between sides


Divide and conquer

Divide and Conquer

  • Divide and conquer strategies

    • Divide: subsidies one side

    • Conquer: charge participation of the other side

  • Competition generates “cross-subsidies”

    • From the high externality group to the low externality

  • There is some scope for positive profit, but much less than in the case of standard network goods uniformly priced

  • Raise dynamic contestability by limiting the ‘first-mover advantage”


Divide and conquer example

Divide and Conquer: example

  • 1 buyer and 1 seller: νB = νS= ν

  • Platform 1 charges pB and pS>0

  • Platform 2 charges:

    • pB - νto buyer and ν to seller

    • Profit pB- cB -cS

  • Eq. prices if small cost (total cost less than ν)

    • pB= pS= cB +cS (if less than ν)

    • Profit = cB +cS


Two sided markets

Variant 2 : competitive bottleneck

Platform 1

Platform 2

buyers

(single-homing)

sellers

(multi-homing)

  • lower prices for buyers

  • higher prices for sellers


Two sided markets

Multi-homing and competition

  • Charge « monopoly prices » in multi-homing market High profits on the multi-homing side but dissipation of these profits through to the single-homing side Illustration:advertisers multi-home. Eyeballs don't (and even if they do, rehearsal effect). Subsidy eyeballs

  • Endogeneous MH: Easy to divide but difficult to conquer

  • Limits tipping by facilitating coexistence


4 usage fees

4 USAGE FEES

  • Fees per transaction / interaction

    • One-sided : only one sided is taxed or tax neutrality

    • Two-sided : Non-commercial transaction, restrictive rules (payment cards)

  • Usage fee affects : the probability of “trade”; the net benefits from “trade” (νB, νS ); the platform revenue

  • Balancing fees: set transaction fees to maximize total surplus from trade, use registration fees for coordination / revenue

    • Same limits as for two-part tariffs: heterogeneity, risk aversion, incentive

    • Mature platforms rely more on registration fees

  • Two-sided (no registration fees) : same analysis adjusting for the opportunity cost


Two sided markets

Regulation of interactions between end-users

The platform as a competition authority.

2SP performs balancing act through other instruments than membership and usage fees:

The platform as a price regulator.

(illustration: no surcharge for payments with card)

The platform as a licensing/certification authority

(illustrations: exchanges: solvency requirements, prohibition of front-running; dating clubs; Nintendo's mid 80s decision to control quality of third-party games)

The platform as a supplier of information and enforcement.

(illustrations: auto auctions arbitration processes, eBay’s feedback forum)


5 competition policy

5 COMPETITION POLICY

  • The issue is the lack of clear benchmark

  • Efficiency is not achieved at price equal marginal cost (or TLIC)

  • Efficiency may require cross-subsidies, or direct subsidy

    • Two violations of anti-trust: “dumping” on one side, excessive price on the other side


Market definition

Market definition

  • Changing the tariff on one side affects the demand and the profit generated on the other side:

    • SNIP test?

    • Estimation of demand elasticity must account for the presence of the other side : due to feedback effects, the elasticity at fixed participation of the other side is not equal to the apparent elasticity

  • One or two markets ?

    • Change the evaluation under dominance criterion

    • Yellow pages , medias : two markets, readers and advertising

    • M2M termination charges: two markets (origination, termination) + regulation of termination (one market should lead to no regulation under EC rules)

    • Credit cards: one market with 2 sides


Price abuse

Priceabuse

  • High price-cost margins do not imply market power even if they are low-fixed costs.

  • Competitive cross-subsidy

    • Competition leads to more cross-subsidy

    • Competition leads to more price-discrimination

  • Another efficiency defence for price below costs

  • Predation tests: accounting for both sides→ Measure of “total price”→ Switch to effect based approach?


Tying as coordination device

Tying as coordination device

  • Divide and Conquer strategy

    • Subsidy one side

  • Negative prices may be not feasible

    • Targeted offers

    • Tie a good with registration so that registration has a value even with no participation of the other side.


Indirect network effect

Indirect network effect

Possibility of coordination failure and multiple equilibria:

Solving the problem may require negative prices and price skewness


Coordination failure positive price

Coordination failure: positive price

N

N


Solving coordination failure one negative price

Solving coordination failure: one negative price

N

N


Competition policy

COMPETITION POLICY

  • Should we regulate?

    • No clear distortion

    • No clear guidelines for regulation

    • No rational for cost based regulated price

    • Large informational requirement

  • The regulatory response may be worse than the (imperfect) market response

  • Partial regulation (platform neutrality, reciprocal termination charge, …) ?


Two sided markets

Some References

Non-technical :

  • Jullien, B (2005): “Pricing and other Business Strategies for e-Procurement Platforms”, IDEI working paper, forthcoming “Handbook of Procurement”

David Evans (2003) "Some Empirical Aspects of Multi-Sided Platform Industries," Review of Network Economics, 2: 191-209.

  • D. Evans, D. et R. Schmalensee (2005) “The Industrial Organisation of Markets with Two-Sided Paltforms”, NBER working paper.

  • Rochet, J.C. et J. Tirole (2005). "Competition Policy in 2 SMs", mimeo IDEI,forthcoming "Advances in the Economics of Competition Policy".


Two sided markets

Some References

Technical:

  • Rochet, J.C. et J. Tirole(2006) "Two-Sided Markets: A Progress Report", forthcoming, Rand J. Ec.

Armstrong, M. (2006) "Competition in Two-Sided Markets,“ forthcoming, Rand J. Ec.

Jullien, B.(2005) "Two-Sided Markets and Electronic Intermediaries," CESifo Economic Studies, 51.

Caillaud B. et Jullien B. (2003) “Chicken and Egg: Competition between Intermediation Service Provider“, Rand J. Ec., 34.

  • Rochet, J.C. et J. Tirole(2003) “Paltform Competition in Two-Sided Markets”, Journal of the European Economic Association


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