Recent developments in two-sided markets ESAM 07 Julian Wright National University of Singapore

1. Recent developments in two-sided marketsESAM 07 Julian WrightNational University of Singapore July 4th, 2007

2. INDUSTRY SPECIFIC APPLICATIONS Published papers Caillaud & Jullien (2003) Rochet & Tirole (2003) Armstrong (2006) Armstrong & Wright (2007), Caillaud & Jullien (2001), Evans (2003a, 2003b), Hagiu (2006, 2007), Jullien (2005), Noke, Peitz & Stahl (2007), Parker & Van Alstyne (2005), Rochet & Tirole (2006), Schiff (2003), Wright (2003) Fixed-to-mobile Media Payment systems Internet Debit/Credit Cards: Baxter (1983), Gans and King (2003a, 2003b, 2003c), Guthrie & Wright (2007), Rochet (2003), Rochet & Tirole (2002), Schmalensee (2002), Wright (2003, 2004) Armstrong (2002), Armstrong & Wright (2007), Gans and King (2000), Valletti & Houpis (2005), Wright (2002); Newspapers:Gabszewicz, Laussel & Sonnac (2001, 2002, 2005, 2006); Magazines: Kaiser & Wright (2006) Yellow Pages: Rysman (2004) TV: Anderson & Coate (2005) Net-neutrality: ?????

3. Transaction Systems:debit and credit card payment systems, fixed-to-mobile phone calls Advertising-supported Media:directory services (e.g. Yellow Pages), magazines, newspapers, public TV operators, web portals, search engines Examples Exchanges:e-bay, B2B markets, flea markets, shopping malls, trading posts, chatlines, dating agencies, nightclubs, employment agencies, real estate agencies, stock exchanges, brokerage firms, online intermediation, conferences, expos and trade fairs Software platforms:computer operating systems, video game consoles, word processors, PDAs, 3G mobile

4. Definition(s) of two-sided markets Configuration: platform must interact with both sides PLATFORM(S) aA aB Non-neutrality (the allocation of fees between the sides must matter) B A Externalitiesbetween the two sides

5. Two-sided platforms: Hagiu (2007) “A pure two-sided platform leaves control to sellers, whereas a merchant takes over full control” Sellers Sellers sale affiliation sale Pure merchant Pure platform affiliation sale Buyers Buyers

6. Lines of research • Price structure: “Topsy-turvy principle” - subsidize the side which provides greater surplus to the other side • Multiple equilibria, expectations, coordination • Divide and conquer strategies • Multihoming and competitive bottlenecks • Competition policy: market definition, exclusivity • Industry studies: real-estate, software platforms, stock exchanges, health providers, journals … • Empirical studies and econometric issues

7. PLATFORM 1 PLATFORM 2 Competitive bottleneck x 0 1 consumers s2 s1 Y n1 n2 y

8. Competitive bottleneck • Buyers select their preferred platform • v-p1-tx+bBn1 on platform 1 • v-p2-t(1-x)+bBn2 on platform 2 • s1=1/2 + (p2-p1 +bB(n1-n2)) / 2t • Sellers multihome to reach all consumers • y+bSs1-r1 on platform 1, y~U(-,Y] with density 1 • y+bSs2-r2 on platform 2, y~U(-,Y] with density 1 • Implies n1=Y+bSs1-r1 and n2=Y+bSs2-r2 • Solution is s1=1/2 + (bB(r2-r1)+p2-p1)/(2(t- bBbS))

9. Competitive bottleneck • Platform i maximizes (pi-c)si+(ri-f)ni • p*=c + t - bBbS - bS(r*-f) • r*= (Y+bS/2+f)/2 – bB/4 • rB+P=r* • rw=f-bB/2 < r* • Eqm: maximizes platform profit plus buyer surplus • Too few sellers on board (half as many as welfare max) • Cheaper on singlehoming side, possibly free • Expensive on multihoming side • Market failure not due to lack of competition

10. Net neutrality • The Internet seen as an open platform • End-to-end design • All data treated equally • No discrimination beyond different end-user plans • Certainly not over types of applications or user specific • Content providers, not platforms, control their users • Can think of as two-sided platform • Technology is available for network owners to prioritize or de-prioritize certain packets, possibly based on prices, or drop them altogether • E.g. Verizon plans to keep 80% of network capacity for its own services

11. Net neutrality • Different definitions and opposing views www.savetheinternet.com vs.www.handsoff.org • Net neutrality fails if platform providers take control over who receives particular content or on what terms • Examples of hypotheticals • Telstra de-prioritizes or even blocks access by its customers to other rival ISP websites • Telstra makes MSN search work faster than Google • Telstra signs up e-bay’s website exclusively in Australia • Telstra makes VOIP websites run slower for its customers

12. Net neutrality • Arguably many concerns are covered by existing competition law • Content providers are sophisticated and will monitor speed etc

13. Net neutrality • Allow networks to charge content providers • Competitive bottleneck concern applies • Users only sign up to one ISP • ISP controls access to these users • Content providers multihome to reach users • ISPs will not compete for content providers • Distorted price structure; too little content

14. Net neutrality Concerns may be alleviated since: • Content providers may commit to exclusive contracts thereby reversing the outcome • Strategic content providers (MSN, Google, Yahoo, Amazon, e-bay …) could threaten to leave ISP • Even niche content providers may have some bargaining power if there are group of users attached to them • Where is the customer loyalty – to the platform (switching costs) or specific content (product differentiation)? • Users may multihome (office, home, mobile, …) • Neutrality: content provider may also pass fees back to users

15. Net neutrality Problems with net neutrality • Inefficiency if cannot discriminate for different quality of service or willingness to pay • Lack of investment in capacity • Result could be fragmentation of the Internet • In part, debate is about distribution of profit between content providers and platforms