TWO SIDED MARKETS

1. TWO SIDED MARKETS Bruno Jullien IDEI and GREMAQ, Toulouse ESNIE - CARGESE

2. 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.

3. Organization of lecture 1 INTRODUCTION 2 MONOPOLY 3 COMPETITION 4 USAGE FEES 5 COMPETITION POLICY

4. Platform enables or facilitates interaction between "buyers" and "sellers" Platform usage charge usage charge + membership charge Buyer + membership charge Seller

5. 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.

6. 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

7. 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

8. 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

9. 2.1 MONOPOLY WITH SUBSCRIPTION Registration Registration sellers buyers Platform Access cost For the moment no transaction fee/ cost Network size externalities demand functions

10. MONOPOLY PRICES Profit: Volume / margin trade-off Adjusted margin Demand elasticity for fixed participation of the other side

11. 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).

12. 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).

13. Other examples of skewed pricing patterns:

14. 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.

15. 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

16. 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)

17. 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

18. 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?

19. 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

20. 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

21. 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”

22. 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

23. Variant 2 : competitive bottleneck Platform 1 Platform 2 buyers (single-homing) sellers (multi-homing) • lower prices for buyers • higher prices for sellers

24. 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

25. 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

26. 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)

27. 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

28. 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

29. 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?

30. 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.

31. Indirect network effect Possibility of coordination failure and multiple equilibria: Solving the problem may require negative prices and price skewness

32. Coordination failure: positive price N N

33. Solving coordination failure: one negative price N N

34. 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, …) ?

35. 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".

36. 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