12 Two-sided Platforms 3

Aaron Schiff

ECON 204 2009

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.

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 pA:– 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.

Subscription Pricing

• Solving simultaneously

nA = A – pA / nB and nB = B – pB / nA

gives demand on each side as functions of pA, pB, A and B (but very ugly equations!)

• Profit from subscription pricing at a marginal cost of c per customer:

= nA(pA, pB)(pA – c) + nB(pB, pA)(pB – c)

• As with usage pricing, the profit-maximising prices are interdependent – have to choose prices charged to both sides simultaneously.

The Price Structure Matters

• Return to usage pricing, recall that total usage of the platform is nA × nB = (A – pA)( – pB)

• Instead of the individual prices pA and pB we can think of the price level L = pA + pB and structure s = pA / 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.

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 = pA / L.

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?

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!

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.

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.

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.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?

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.

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?

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.