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

2. 2 GETTING MULTIPLE SIDES ON BOARD gam e rsvideogame platform game developers platform buyerssellers buyers "eyeballs" cardholders suppliers advertisers merchants debit & credit cards portals, newspapers, TV B2B platform Chicken and egg problem. Must get both sides on board/court each side while making money overall. B2C website

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

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

5. 5 Some 2SPs : Exchanges B2B. Employment agencies. Dating services. Exchanges/auctions (eBay, Amazon). Real-estate agencies. Futures and securities exchanges Internet backbone services. But also... Academic journals. Shopping malls. Telecoms. Communications

6. 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 BuyerGRIDProducer Bilateral contract Only the total price charged on the two sides matters, as they negotiate how to share it: similar to tax neutrality

7. 7 A « classical » industry may become a 2SMs Example 1 : computers / video games Example 2 : TV operators Hardware producers users Operating system developers Content (cinema, sport…) users operator Advertisers (vertical desintegration)

8. 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. Often results in very skewed pricing pattern Illustration :Videogame platforms. Sell console at or below cost, royalties on games

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

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

11. 11 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). 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.]

12. 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. 13 Other examples of skewed pricing patterns:

14. 14 Mind the cross-group externalities More complex story: within-side externality Marquee buyers Platform Sellers attracts Other buyers large fee (because marquee buyers) good deal Illustrations:  Amex corporate card.  Killer application/game.  Key store in shopping mall.

15. 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. 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. 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 i)participation generates a relatively higher externality on the other group, and ii) the own price demand elasticity is high

18. 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. 19 3 COMPETITION Variant 1 : single-homing bilateral price smaller on both sides expectations of users play an important role (multiplicity of possible equilibria) "divide and et conquer" Platform 1 Platform 2 buyerssellers

20. 20 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, t hen 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 Single-homing and competition

21. 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. 22 Divide and Conquer: example 1 buyer and 1 seller: ν B = ν S = ν Platform 1 charges p B and p S >0 Platform 2 charges: p B - ν to buyer and ν to seller Profit p B - c B -c S Eq. prices if small cost (total cost less than ν) p B = p S = c B +c S (if less than ν) Profit = c B +c S

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

24. 24 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 Multi-homing and competition Endogeneous MH: Easy to divide but difficult to conquer Limits tipping by facilitating coexistence

25. 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” (ν B, ν S ); 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. 26 (illustration: no surcharge for payments with card) The platform as a price regulator. The platform as a competition authority. 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) 2SP performs balancing act through other instruments than membership and usage fees: (illustrations: auto auctions arbitration processes, eBay’s feedback forum) The platform as a supplier of information and enforcement. Regulation of interactions between end-users

27. 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. 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. 29 Price abuse 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. 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. 31 Indirect network effect Possibility of coordination failure and multiple equilibria: Solving the problem may require negative prices and price skewness

32. 32 Coordination failure: positive price N N

33. 33 Solving coordination failure: one negative price N N

34. 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. 35 Some References Non-technical : David Evans (2003) "Some Empirical Aspects of Multi-Sided Platform Industries," Review of Network Economics, 2: 191-209. Rochet, J.C. et J. Tirole (2005). "Competition Policy in 2 SMs", mimeo IDEI, forthcoming "Advances in the Economics of Competition Policy". Jullien, B (2005): “Pricing and other Business Strategies for e-Procurement Platforms”, IDEI working paper, forthcoming “Handbook of Procurement” D. Evans, D. et R. Schmalensee (2005) “The Industrial Organisation of Markets with Two-Sided Paltforms”, NBER working paper.

36. 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. Caillaud B. et Jullien B. (2003) “Chicken and Egg: Competition between Intermediation Service Provider“, Rand J. Ec., 34. Jullien, B. (2005) "Two-Sided Markets and Electronic Intermediaries," CESifo Economic Studies, 51. Rochet, J.C. et J. Tirole (2003) “Paltform Competition in Two-Sided Markets”, Journal of the European Economic Association