TOPIC 11: MARKET DEFINITION FOR MULTISIDED PLATFORMS

Topic 11| Part 2 3 October 2013

ANTITRUST ECONOMICS 2013David S. EvansUniversity of Chicago, Global Economics Group

Elisa MariscalCIDE, Global Economics Group

2Overview

Part 2

Competitive Constraints and

Two-Sided Market Definition

Using Single-Sided Market Definition in a Two-Sided World

Market Definition with Additive Prices

Pragmatic Approaches to the Analysis of Two-

Sided Market

Part 1

Overview of Market Definition

General Principles of

Market Definition

Hypothetical Monopolist Test

Critical Loss Analysis

3A Shopping Mall Merger Example

Four malls in very small country owned by different operators

Five High Streets with shops

Mall 1 and Mall 3 propose to merge into Mall 1+3

1

2

3

4

What are the relevant market(s)? Can we use traditional SSNIP-based tools to answer that? How do we assess market power? Would the merger result in a “substantial lessening of competition” in those

markets?

4Shopping Mall Platforms

Two sides are shoppers and retail stores

Shoppers pay price of zero usually

Retail stores pay rent plus sometimes a percent of sales

Shopping malls have one or more “anchor stores” which usually pay very low rents

Incremental profit on the money-making side of the platform comes mainly from non-anchor stores

5Shopping Malls and Anchor Stores

Anchor Store

6 Competitive Constraints and Two-Sided Market Definition

7Refresher on Economics of Two-Sided Platforms

• Shoppers like retail stores and vice versa

Each side is a complement to the other side

• Fewer amenities for shoppers reduces prices and profits from retailers. Higher prices to retailers reduces variety and raises cost to shoppers which has feedback on prices retailers are willing to pay.

Prices and profits for the two sides are interlinked

• Shopping mall gets one profit from shoppers+retailers which is earned from the joint costs of building and operating the mall.

Profit maximization decisions are based on a “system of interlinked sides” rather than individual sides

8The “Other” Side Acts as a Price Constraint

If a platform increases the price on side A that will not only reduce demand on side A but also—through the indirect network effects— demand on side B.

The loss of demand on side B degrades the value of the platform to side A, leading to a further reduction in demand by side A customers.

The complementary side B therefore magnifies the effect of a price increase on side A.

Demand on side A is more elastic after taking the cross effect into account.

9

Accounting for Two-Sided Effects Makes Demand More Elastic

$1

$3$2

$8

$7

$6$5$4

1 32 4 5 76 8 9 10 11

Space in a Shopping MallFor a price change around this point the flatter curve reflects the feedback effects on the shopper side resulting from fewer or less interesting stores

Pric

e pe

r m

eter

Thousands of meters rented

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The magnifying effect of the complementary side on demand response to price increase

As a result of positive feedback effects a 5% increase in the price on side A leads in this example to a 30% decrease in the quantity on side

A and a 10% decrease in the quantity on side B. True demand elasticity with feedback effects of 6 rather than 4.

PA ↑5% ⇒ QA ↓20% ⇒ QB ↓5% (demand elasticity=20%/5%=4)

QB ↓5% ⇒ QA ↓3% ⇒ QB ↓2%

…….. (so the feedback loop continues) Ending up at: QA ↓30%, QB ↓10% (demand elasticity= (30%/5%)=6

Accounting for Two-Sided Effects Makes Demand More Elastic

11

The Cross-Effects for the Shopping Mall Merger Reduce the Ability to Raise Prices

How much this matters in practice depends on how big the cross-effects are. They may be small enough to ignore safely, or so big they

must be considered.

Suppose independent malls 1 and 3 merge to form merged mall 1+3.

After the merger the merged mall 1+3 will have an incentive to raise prices to the extent that the two malls constrained each other pre-merger.The ability of the merged mall 1+3 to raise price to either side depends on the cross-effects. If it raises prices to retailers then the quality of the mall will decline and fewer shoppers will come; if they reduce amenities for shoppers retailers will want to pay less.The complementary side therefore constrains the ability to profitably raise price.

12Other Platforms Serve as a Constraint

Critical question is the extent to which the other platforms provide substitutes for the customers on side A or side B of a platform.

• Key issue besides price is whether other platforms provide an attractive number and variety of complementary customers.

If Merged Mall 1+3 raises price to retailers do Malls 2 and 4 offer good alternative for retailers?

• Foot traffic at malls (size of other side).• Substitutability of shoppers in Malls 2/4. What if 1/3 are downscale and 2/4

are upscale?

13

Multihoming May Make Alternative Platforms Closer Substitutes in the Short-Run

Shoppers• Which malls do consumers

regularly patronize?• To what extent are these

merging malls differentiated and therefore not close substitutes?

• How easily can consumers switch between them which depends mainly on distance from work/home in the case of malls?

Retailers• Do retail stores operate at

several nearby malls (probably not, except for some large chains)?

• Could they switch sales emphasis between stores?

If customers on a side use multiple platforms (multihome) then they may be able to switch easily between them thereby constraining price increases.

14The Role of Single-Sided Competitors

• Advertising-supported media vs. pure subscription media• General purpose payment cards vs. store cards• Shopping malls vs. Main Streets vs. Stand-alone stores

In some situations platforms may provide services on one side in competition with single-sided firms.

Single-sided supplier to side A constrains the ability to raise price to platform side A.

Single-sided supplier to side B constrains ability to raise price to platform side A since if platform is less appealing, side B customers will switch to single-sided supplier.

15Single-Sided Competitors for Shopping Malls

If Merged Mall 1+3 tried to increase prices to retailers or decreased amenities for shoppers:

Retailers might consider setting up shop on a High St. or some other location.

Shoppers might consider going to a High St. or drive to separate locations for shopping.

16 Using a Single-Sided Market Definition in a Two-Sided World

17

Avoid Excluding One Side of the Platform From Analysis

Consider a unilateral practice that concerns one side of a two-sided platform business.Traditional market definition would start with the product/service for that side and define a market that only concerned that side.It would therefore exclude the other side of the platform from the analysis.As a result the analysis would be forced to ignore the interlinked customer sides and other relationships.

Next section deals with pragmatic approaches about dealing with this problem. This section shows that even on a single side the traditional analysis leads to improperly defined markets.

18Single-Sided Market Definition Tools Don’t Apply

The analytical machinery for the traditional SSNIP test is based on the simple price-cost markup rule that percent markup is equal to the inverse of the elasticity of demand for the product.The formulas for actual and critical loss are based on the simple markup rule.

The formula for diversion ratios is based on the simple markup rule.

Since the simple markup rule does not apply for two-sided platforms other formulae that are based on that rule do not apply for two-sided platforms.

19Single-Sided Critical Loss Wrong

• For an X% price increase, the critical loss is

• Where M is the Lerner index (% difference between price and marginal cost)

• We can compare the critical loss to the actual loss based on data on elasticity of demand to assess whether a price increase would be profitable

• In the previous example the actual loss will be greater than the critical loss if a 10% increase in price leads to a more than 16.7% decline in sales which means in turn that the elasticity demand is greater than 1.66 (in absolute value).

Formal calculation

MXXCL

PMCPM

WRON

G

WRON

G Single-sided formulas are wrong because they are

based on the simple price-cost markup result which

is wrong because it ignores linked demand between the two sides.

WRONG

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Applying Single-Sided Tests to Two-Sided Platforms Leads to Multiple Errors

“Hypothetical monopolist” may not be able to raise price by 10% or more (as required by SSNIP) once the constraining effect of the “other side” is considered.The margin used in critical loss and diversion analysis overstates the price elasticity of demand because it includes the positive-feedback constraint (so it is elasticity plus feedback). (“Lerner-bias”)Econometric demand estimates on price elasticity of demand will be understated if the analyst doesn’t model the feedback between the two sides. (“Econometric-bias”)From the standpoint of single-sided market definition the “Lerner-bias” results in defining too broad markets while the “Econometric-bias” results in defining too narrow markets—in the case of symmetric two-sided merging firms. Harder to predict in general.

Magnitude and relevance of these errors depend on the degree of the cross-effects and thus how “two-sided” the relevant businesses really are.

21Consumer Welfare and Market Definition

All competition issues involving two-sided platforms ultimately concern two groups of distinct consumers.

Any business practice such as merger or exclusion that affects one side of a two-sided platform affects the other side.Economists would consider the effect of the practice on consumer surplus for both groups (men/women, readers/advertisers, software developers/software users, merchants/cardholders, etc.)

The market definition and market power analysis must enable this welfare calculation.

22 Market Definition with Additive Prices

23Market Definition with Two-Sided Platforms

Does the competition policy issue concern a two-sided platform and are the cross-effects significant enough to matter in practice?

If the issue pertains to one or more two-sided platforms identify potential alternative platforms as well as single sided-competitors in some cases.

Market is the group of substitutable platforms and single-sided competitors. Could take a judgmental approach to define this or apply the hypothetical monopolist test.

24Hypothetical Monopolist Test in Two-Sided Markets

What is the minimum set of two-sided platforms and single-sided competitors that if monopolized would be able to increase prices significantly?Easy case is when prices are additive because of joint production and fixed proportions. In some cases weighted average price for two sides might be effective proxy for overall prices. In other cases will need to focus on prices separately.This set of entities provides the relevant set of constraints for the exercise of market power through merger or unilateral practices of the firms at issue.

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Hypothetical Monopolist Test with Additive Prices

Before Price Increase After Price IncreaseSide A Side B Total Side A Side B Total

Price $8 $2 $10 Price $8.80 $2.20 $11.00Marginal Cost $4 $4 $8 Marginal Cost $4.00 $4.00 $8.00

Margin $4 ($2) $2 Margin $ 4.80 ($2.80) $3.00 Output 500 500 500 Output ? ? ?

Revenue $4,000 $1,000 $5,000 Revenue ? ? ?Cost $2,000 $2,000 $4,000 Cost ? ? ?

Operating Margin $1,000 Operating Margin ?Markup 50% -100% 20% Markup

Fixed Cost $1,000 Fixed Cost $1,000 Total Profit $0 Total Profit ?

Could hypothetical monopolist increase total price by 10%? Suppose the hypothetical price increase is 10% for each side.

One practical difficulty is that we should be looking at the profit-maximizing change in price structure which may not, and probably isn’t, a symmetric price increase to both sides.

26SSNIP Approach with Total Price and Additive Prices

Modified Lerner Index for simple Rochet-Tirole Model with each side jointly consuming a “transaction”

SSNIP Test with Additive Prices.

• Total Price = T = PA + PB• SSNIP = ∆T x 100• T• SSNIP > 10% given optional change in individual prices

27 Pragmatic Approaches to the Analysis of Two-Sided Market Definition and Power

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Key Lesson: Avoid Approaches that Result in the Exclusion of a Customer Side from the Analysis

Mechanical approaches such as traditional SSNIP may exclude important economic relationships coming from the other side of a two-side platform.

Could obscure linkages that provide additional avenues for consumer harm or additional sources of efficiencies.

Could ignore linkages that provide significant constraints on market power.

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Taking a More Open Approach to the Analysis of Market Definition and Power for Two-Sided Platforms

Assess the linkages between customer sides and whether the magnitude of the cross-effects merit consideration.

Establish the contours of the ”business ecosystem” in which the two-sided platform lives including competition with single-sided and multi-sided platforms.

Use platform concepts to assess effects including in market power for the platform overall and effects on the welfare of platform customers combined.

Focus on competitive effects rather than a precise market definition.

30End of Part 2, Next Class Horizontal Mergers

Part 1

Legal and Economic Background of Mergers

Unilateral Effects: Economic Theory