Competition Policy in Two-Sided Markets - Some brief remarks Dr Amelia Fletcher Chief Economist Office of Fair Trading LEAR Conference 7th June 2007 NB The views expressed here are my own, and not necessarily those of the OFT

What do certain key factors of 2- sided markets mean for:  Market definition?  Predation?  Collusion?  Exclusive contracts?  Media regulation and mergers?

2-sided markets: First key factor  In a typical 2-sided market:  D A is function not only of p A but also of q B  D B is function not only of p B but also of q A  What does this mean for market definition?

Market definition  SSNIP test:  Could a hypothetical monopolist profitably sustain a small but significant and non-transitory increase in price?  If no, the relevant antitrust market must be wider  If yes, the market is not any wider (but could be narrower)  Key question for 2-sided markets:  Which feedback loops should be taken into account?

Market definition: Feedback loops pA↑pA↑ qA↓qA↓ πA↑πA↑πA↓πA↓ πA↑πA↑ Normal Market: Does total π A ↑? If yes, market no wider ?

Market definition: Feedback loops pA↑pA↑ qA↓qA↓DB↓DB↓qB↓qB↓ πA↑πA↑πA↓πA↓ πB↓πB↓ For given p B πA↑πA↑ Normal Market: Does total π A ↑? If yes, market no wider Feedback to market B

Market definition: Feedback loops pA↑pA↑ qA↓qA↓DB↓DB↓qB↓qB↓ πA↑πA↑πA↓πA↓ πB↓πB↓ For given p B πA↑πA↑ Normal Market: Does total π A ↑? If yes, market no wider Feedback to market B Should we take this into account?

Market definition: Feedback loops pA↑pA↑ qA↓qA↓DB↓DB↓qB↓qB↓DA↓DA↓qA↓qA↓ πA↑πA↑πA↓πA↓ πB↓πB↓ πA↓πA↓ For given p B For given p A πA↑πA↑ Normal Market: Does total π A ↑? If yes, market no wider Feedback to market A Feedback to market B

Market definition: Feedback loops pA↑pA↑ qA↓qA↓DB↓DB↓qB↓qB↓DA↓DA↓qA↓qA↓ πA↑πA↑πA↓πA↓ πB↓πB↓ πA↓πA↓ For given p B For given p A πA↑πA↑ Normal Market: Does total π A ↑? If yes, market no wider Feedback to market A Feedback to market B Should we take this into account?

Market definition: Feedback loops pA↑pA↑ qA↓qA↓DB↓DB↓qB↓qB↓DA↓DA↓qA↓qA↓ πA↑πA↑πA↓πA↓ πB↓πB↓ πA↓πA↓ For given p B For given p A πA↑πA↑ Normal Market: Does total π A ↑? If yes, market no wider pB↓pB↓qB↑qB↑ πB↓πB↓ Profits dissipated in market B Feedback to market A Feedback to market B Should we take this into account?

Market definition: Feedback loops pA↑pA↑ qA↓qA↓DB↓DB↓qB↓qB↓DA↓DA↓qA↓qA↓ πA↑πA↑πA↓πA↓ πB↓πB↓ πA↓πA↓ For given p B For given p A πA↑πA↑ Normal Market: Does total π A ↑? If yes, market no wider pB↓pB↓qB↑qB↑ πB↓πB↓ DA↑DA↑qA↑qA↑ πA↑πA↑ Profits dissipated in market B Feedback to market A Feedback to market A Feedback to market B

Market definition: Feedback loops pA↑pA↑ qA↓qA↓DB↓DB↓qB↓qB↓DA↓DA↓qA↓qA↓ πA↑πA↑πA↓πA↓ πB↓πB↓ πA↓πA↓ For given p B For given p A πA↑πA↑ Normal Market: Does total π A ↑? If yes, market no wider pB↓pB↓qB↑qB↑ πB↓πB↓ DA↑DA↑qA↑qA↑ πA↑πA↑ Profits dissipated in market B Feedback to market A Feedback to market A Feedback to market B

Market definition: Feedback loops pA↑pA↑ qA↓qA↓DB↓DB↓qB↓qB↓DA↓DA↓qA↓qA↓ πA↑πA↑πA↓πA↓ πB↓πB↓ πA↓πA↓ For given p B For given p A πA↑πA↑ Normal Market: Does total π A ↑? If yes, market no wider pB↓pB↓qB↑qB↑ πB↓πB↓ DA↑DA↑qA↑qA↑ πA↑πA↑ Profits dissipated in market B Feedback to market A Feedback to market A Feedback to market B

2-sided markets: Second key factor  p A will tend to be lower when either:  each additional buyer in market A generates significant extra revenue in market B; or  it is hard to persuade market A buyers to sign up.  More formally (Rochet & Tirole, 2006): price – ‘cost’ = 1. price elasticity of demand  If ‘cost’ increases (due to lower revs in other market), then so will price (The ‘waterbed effect’)

Predation and excessive pricing  In a two-side market, we may typically observe:  Prices below marginal cost on one side of a market; and  Prices well above marginal cost on the other  Such pricing is an efficient response to network externalities.  Competition authorities need to be aware of this when assessing predation or excessive pricing  We also need to be aware of the ‘waterbed effect’, when imposing remedies

However…  This does not mean predation (and excessive pricing) doesn’t occur  For example, what if pricing structure affects market structure?  Specifically, what if pricing low on one side of a market prevents entry into both sides?  Can such a pricing structure increase ‘tippability’ of already ‘tippable’ markets?  But how to assess?

A careful approach is needed  Low pricing on one side of a two sided market can be exclusionary  But application of simple Akzo type test for predation (ie is P < AAC?) problematic  A possible approach?  to apply an Akzo type test, but  to employ an ‘opportunity cost’ benchmark

Collusion on one side of the market  True that increased profits from collusion on one side of a market get competed away on the other  Does this justify a laissez faire approach?  No!  Not all additional profits are competed away  Prices typically even higher than without collusion, suggesting inefficient price asymmetry  But it does make it difficult to determine appropriate exemption criteria where relevant

2-sided markets: Third key factor  2-sided markets are often ‘tippable’  Often observe competition ‘for’ the market  This competition can get rough – but should competition authorities intervene?  After all – a monopoly anyway  Does it matter who wins?  Yes! And best for both consumers and dynamic competition if the best product wins

2-sided markets: Fourth key factor  The ‘tippability’ of 2-sided markets is reduced if there is multi-homing on one (or both) side of the market  A move to single-homing by a relatively small part of the previously multi-homing side of the market can sometimes have major effects.

The effect of single-homing Buyer 1Platform ASeller 1 Buyer 2Platform BSeller 2

The effect of single-homing Buyer 1Platform ASeller 1 Buyer 2Platform BSeller 2

Exclusivity contracts  Assessment of exclusivity contracts (or refusal to supply) is complicated in ‘tippy’ markets:  Small scale coverage could ‘tip’ the balance  Interesting that customers do better by being ‘single homing’ under profit-maximising pricing  So no need for profit sacrifice to ‘bribe’ customers to sign exclusive contracts or to refuse to supply  Could ‘multi-homing be a remedy?

2-sided markets: Fifth key factor  The advertising funded nature of media can result in imperfect product/political diversity  For media regulators:  This clearly provides a microeconomic justification for some form of regulatory intervention  But how to decide ‘what is welfare optimal’ in real life?  For competition authorities:  Does it suggest a need to think about wider ‘public interest’ issues when assessing media mergers?

Competition Policy in Two-Sided Markets - Some brief remarks Dr Amelia Fletcher Chief Economist Office of Fair Trading LEAR Conference 7th June 2007 NB The views expressed here are my own, and not necessarily those of the OFT