Network Effects & Two-sided Markets Unit 7 Cento Veljanovski Case Associates

1. Network Effects & Two-sidedMarketsUnit 7Cento VeljanovskiCase Associates King’s College PostGrad Diploma/MA Economics of Competition Law 9.30 Holiday Inn, Regent’s Park, London, 21 April 2007 Case Associates – Competition & Regulatory Economists www.casecon.com

2. Address three topics • general theory & definitions • network effects • multi-sided markets CASE ASSOCIATES

3. Three types of network effects direct – utility of subscriber higher the more subscribers indirect – value of network to subscriber based on number of complementary services. This includes herding, bandwagon effects and judging quality by network size induced – value of network increased by cheaper on-net call prices CASE ASSOCIATES

4. Other useful concepts Demand-side externality public good Supply-side economies of scale subadditive cost function = high fixed/small marginal costs economies of scope CASE ASSOCIATES

5. Impact of network effects creates reversal of normal supply and demand relationships, even said to lead to repeal of the laws of supply and demand CASE ASSOCIATES

6. Normal market outcomes upward or horizontal supply schedule downward demand schedule price that clears market stable outcome or ‘equilibrium’ CASE ASSOCIATES

7. Market with network effects demand schedule upward sloping supply schedule downward sloping due to economies of scale outcome unstable no determinate price CASE ASSOCIATES

8. Implications possibility of (natural) monopoly supply prices below marginal costs/indeterminate dynamic instability critical mass & tipping CASE ASSOCIATES

9. Tipping ‘chicken-and-egg’ problem snowballing/positive feedback effects path dependence irreversibility network unravelling – reverse feedback effects CASE ASSOCIATES

10. Conditions for tipping uncooperative – ‘winner-takes-all’ strategy network incompatibility customer lock-in/stranding high switching costs CASE ASSOCIATES

11. Case studies standards - VHS v. Betamax, and inefficiency? Microsoft (2004) - foreclosure through inoperability? mobile tariffs - induced network effects? CASE ASSOCIATES

12. Betamax again? Standards ‘battles’ played out and are cited as examples of market failure (‘wrong’ standard; wasteful competition) due to inertia, incompatibility, bandwagon effects etc., Or is this simply the market sorting out good from bad? Contrast views of technical literature with that of Liebowitz. CASE ASSOCIATES

13. Pause – different views of competition Neoclassical – perfect competition with static outcome Schumpeterian – gales of creative destruction; serial monopoly spurring innovation but constantly challenging firms Austrian – discovery process; efficient at collecting and disseminating information CASE ASSOCIATES

14. Multisided markets Definition: ‘markets in which one of several platforms enable interactions between end-users, and try to get the two (multiple sides) “on board” by appropriately charging each sides’ CASE ASSOCIATES

15. Main elements of multisided market demand of two or more groups which is interrelated intermediary coordinates their demands by providing platforms example – credit cards: customer and merchant (see later) CASE ASSOCIATES

16. Implications - I structure of prices as important as level all sides of market must be analysed prices demand-oriented rather than cost-oriented CASE ASSOCIATES

17. Implications - II price discrimination predatory pricing cross-subsidisation price-cost margins CASE ASSOCIATES

18. Credit card and interchange fees nature of credit card networks what is an interchange fee economic justification for interchange fee competitive concerns assessment CASE ASSOCIATES

19. About the tutor DR. CENTO VELJANOVSKI BEc (Hons), MEc, D Phil, ACIArb Dr Veljanovski is Managing Partner of Case Associates, Associate Research Fellow, Institute of Advanced Legal Studies, University of London, IEA Fellow in Law & Economics, and Member of the Economic Advisors’ Panel, Infocomm Development Authority of Singapore (IDA). He is a well-known economist with over thirty years' experience as an adviser to companies on competition, regulatory and communications economics. Dr Veljanovski has assisted a large number of fixed, mobile, internet and other communications operators in regulatory proceedings, merger investigations and on competition issues. He has been selected as one of the ‘most highly regarded’ competition economists globally and one of the top five in Europe by the 2006 Global Competition Review survey. He regularly acts as an Expert Witness in competition law, commercial and damage litigation, and on the communications and media sectors most recently in the English High Court, Irish High Court, Federal Court of Australia, Dutch District Court, Finnish Higher Administrative Court, the UK Competition Appeals Tribunal, and the International Court of Arbitration. CASE ASSOCIATES

20. competition & regulatory economists About CASE Case Associates provide economic analysis in competition law and regulatory investigations. Case use rigorous economic and quantitative techniques to address the critical issues and marshal evidence to define relevant markets, assess alleged monopoly abuses, anti-competitive practices, cartels, and evaluate the competitive impact of mergers. Case have provided expert reports and testimony to regulatory bodies in the UK, European Community, USA and Australia, on a wide range of issues in many different sectors. antitrust cartels state aids mergers regulation litigation market studies CASE ASSOCIATES