Two-Sided Markets: Implications for Competition A nalysis

1. Two-Sided Markets: Implications for Competition Analysis Anne Perrot 08 February 2013

2. Introduction • Topical subject • One of the most recent advances in industrial organization • Seminal papers by Caillaud and Jullien (2003), Rochetand Tirole (2004) • In connection with the digital economy and the emergence of “platforms” • Allows to better understand the business models of these platforms and the competitive problems associated with them • Many examples: • Media (newspapers, TV…) • Credit cards • Stock exchange and market places • Real estate agencies • Singles clubs • And of course search engines • Specific issues for competition analysis • Relation between prices/costs and pricing problems • Trends towards integration and building-up of big firms

3. Overview of the presentation • Examples of two-sidedmarkets • Pricing issues • Competitive issues on two-sidedmarkets • Single homing vs. Multi-homing • Costs and benefits of competition on two-sidedmarkets

4. A classicalexample : the singles clubs • Network externalities • The value of the service depends on the number of users • The club must have women to attract men… • …And men to attractwomen • Eachside of the platformexerts a positive externality over the other one. • But the presence of network effectsis not enough to define a two-sidedmarket • Example: telephone, softwares… • Network effectassociatedwith the number of users : the larger the installed base of users, the higher the utility derivedfrom the use of the telephone, the softwares… • This is a « direct » network effect. • The externalityderivedfrom the two-sided dimension is an « indirect network effect »: one side of the marketexerts an externality over the other one.

5. Consequences of the « two-sided » dimension • Coordination problem • Both sides have to be present on the platform to make it work • Therefore, in order to trigger the network effect off, it may be necessary to subsidize one side in order to attract the other one. • In a e-commerce platform, subsidize labels to attract buyers, • In the singles club example : subsidize women in order to attract men • This does not mean that women are less costly for the club, • but rather that they generate externalities overthe other side (men) • that benefit the activity of the platform. • This subsidization mechanism induces a disconnection between costs and prices, regardless of any competitive mechanism. • The side whose demand is more elastic and that generates externalities over the other side has to be subsidized.

6. Manyexamples of that type of indirect network effects • Creditcards: • Twosides = merchants and customers, Platform = payment system (2 banks) => « four-sidedmarket » • Real estateagencies: • Twosides = buyers and sellers, platform = website, physicalagency • Operating systems: • Twosides = users and developpers, platform = operating system • Stock exchange: • Twosides = portfolio managers and issuing agents • Media: • Twosides = readers and advertisers, platform = newspaper, searchengine, TV channel • And of course searchengines • Threesidesat least : internet users, content providers and advertisers.

7. Consequences for the pricing • Pricescharged to bothsidesmaydiffer • One sidemay face a zeroprice • Or evenmaybepayed in order to participate in the market • This enhances the value of the platform • During the introductoryperiod of the good, pricesmaybeverylow in order to attractusers and make the platform attractive in the future. • A platformwith an installed base mayhold a competitiveadvantage • First moveradvantage • Magnitude of the advantagedepends on the ability to belong to manyplatforms (multi-homing or single-homing) • This mayintensifycompetition in the initial period to attract the installedbase.

8. Searchengines : pricing issues • A search engine is a multi-sided platform • Internet users, content providers, advertisers • Price structure : • For Internet users, free access. • Content providers can put their content at the disposal of usersat zero price • Advertisers pay for the whole system. • Internet users are attracted by contents • But content providers receive traffic through the search engine • On Google, prices charged to advertisers result from an auction mechanism • In principle, this leads to competitive prices • But Google is able to determine the supply of advertising space: has an impact on prices. • Some content providers (newspapers’ websites) want to receive a payment, due to their positive externality on users

9. Consequencesfor the pricing • In a two-sidedmarket, the value generated by the platformdepends • On the total pricepayed by bothsides (P = p1+p2) • But also on the pricestructure (p1, p2), thatis, on the split of P betweenbothsides • Examples: fixedfee or use-based unit prices; free subscription … • Allows to separatetwo-sidedmarkets and other types of markets • Retail (simple vertical interaction) • Labor market (relationshipsbetweenemployers and employees in the firm) • … • In these « simple » markets • The price structure does not matter • Negociation and transactions occurbetween the twosidesdirectly

10. Competitive issues • Manycompetingplatforms: • This situation raisesdifferent issues according to the factthat « multi-homing » or « single-homing » prevails. • Mixed situations (multi-homing on one side, single-homing on the other) are also possible, for example if exclusivitycontracts on one side • Advantages of competition vs. monopoly: depend on manyfeatures. • In the case of single-homing on bothsides : • Eachplatformoffers a restrictedaccess to the otherside • Ex: in an airport, each traveller has onlyaccess to the shops of his terminal, and conversely • Competitionmaybe an unstable situation • Competition or switch to monopoly, depending on • initial conditions, • relative strength of differentiation versus network effects.

11. Competitive issues : multi-homing on bothsides • This makesbothplatforms (at least partially) substitutes • But multi-homing maybeunstable • If platforms are close substitutes • And if there are fixedsubscriptioncosts • In this case: • Switch to monopolyis possible • Someexclusivitycontractsmaybe pro-competitive (to favourdifferentiation and to preservemutiplicity of platforms) on one side • But not « toomuch » exclusivity • If thereis multi-homing on one side (1), and single-homing on the other (2), then the platformmayobtainhigh profits fromside 1 agents whowant to have access to side 2 agents • Thencompetitionerodes the profits and benefits the agents belonging to the multi-homing side 1.

12. Searchengines : structural issues • Advantage of first entrant • Helps to build an installed base, triggers the network effect. • Advantage of large size of the engine : multiplicity of contents attractsusers, whoattractadvertising revenues. • Multi-homing on the side of users and of contents providers, but manyexclusivity contrats on the advertisers’ side (whocannotpublish the same ad on twodifferentengines) • Exclusivity + dominance maypreventotherenginesfromdeveloppingtheiractivity • But on the other hand: • spontaneous (structural) trends towards dominance • And exclusivitymaypreservedifferentiationbetweenplatforms and preventthe marketfromswitching to monopoly. • Ambiguouseffects of exclusivity on the competitive structure.

13. Conclusion • Pricing: usualanalysiscanbeirrelevant • predation, • pricesdriven by costs… • Number of platforms • Withsingle homing, the multiplicity of platformslowers the quality of service (a user on the single homing side 1 cannotinteractwith all the potentialmembers of side 2) • But thisalsoacts as a discipline device on the behavior of platforms and detersfrompricing to high. • Switch to monopoly possible • Withmulti-homing, manyplatformsenhance the quality of service (all members of one sidecaninteractwith all members of the other) • But canbe an unstable situation and lead to monopoly • Exclusivity • Balance betweencompetition « for » the market and « on » the market • Someexclusivitycanbe pro-competitive, toomanyexclusivitycontracts are not.

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