Platform Competition in Two-Sided Markets

1 Platform Competition INTWO- sided MARKETSJean-Charles RochetUniversite de Toulouse,Institut D Economie IndustrielleJeanTiroleInstitut D Economie Industrielle,Centre d Etudes et de Recherches enAnalyse Socio-EconomiqueAbstractMany if not most Markets with network externalities are Two-Sided . To succeed, platforms inindustries such as software, portals and media, payment systems and the Internet, must getboth sides of the market on board. Accordingly, platforms devote much attention to theirbusiness model, that is, to how they court each side while making money overall. This paperbuilds a model of Platform Competition with Two-Sided Markets . It unveils the determinantsof price allocation and end-user surplus for different governance structures (pro t-maximiz-ing platforms and not-for-pro t joint undertakings), and compares the outcomes with thoseunder an integrated monopolist and a Ramsey planner.

2 (JEL: L5, L82, L86, L96)1. IntroductionBuyers of video game consoles want games to play on; game developers pickplatforms that are or will be popular among gamers. Cardholders value credit ordebit cards only to the extent that these are accepted by the merchants theypatronize; af liated merchants bene t from a widespread diffusion of cardsamong consumers. More generally, many if not most Markets with networkexternalities are characterized by the presence of two distinct sides whoseultimate bene t stems from interacting through a common Platform . Platformowners or sponsors in these industries must address the celebrated chicken-and-egg problem and be careful to get both sides on board. Despite muchtheoretical progress made in the last two decades on the economics of networkexternalities and widespread strategy discussions of the chicken-and-egg prob-lem, Two-Sided Markets have received scant attention.

3 The purpose of this paperis to start lling this recognition that many Markets are multisided leads to new and inter-esting positive and normative questions. Under multisidedness, platforms mustchoose a price structure and not only a price level for their service. For example,video game platforms such as Sony, Sega and Nintendo make money on gameE-mail addresses: Rochet: Tirole: 2003 by the European Economic Associationdevelopers through per-unit royalties on games and xed fees for developmentkits and treat the gamers side as a loss leader. Interestingly, operating systemplatforms for the PC and handheld devices have adopted the opposite businessmodel and aim at making money on consumers. The choice of a business modelseems to be key to the success of a Platform and receives much corporateattention.

4 Table 1 provides a few illustrations1of the Two-Sided Markets andshows that platforms often treat one side as a pro t center and the other as a lossleader, or, at best, as nancially neutral. A number of these illustrations arediscussed in mini case studies in Section 7. And Table 2 lists a few importantsegments of the new economy that will be searching for a proper business modelin the next few years. Such conventional wisdom about business models foundin the trade press and summarized in Table 1 is of course subject to reason in terms of pro t centers, costs are often intuitively, but arbitrarilyallocated to either side of the market. Yet, the conventional wisdom points atsome more fundamental logic related to prices and surpluses on both sides of themarket. A major objective of our paper is to unveil this logic and the determi-nants of the choice of a business both positive and normative viewpoints, Two-Sided Markets differfrom the textbook treatment of multiproduct oligopoly or monopoly.

5 Theinteraction between the two sides gives rise to strong complementarities, but thecorresponding externalities are not internalized by end users, unlike in themultiproduct literature (the same consumer buys the razor and the razor blade).In this sense, our theory is a cross between network economics, which empha-sizes such externalities, and the literature on (monopoly or competitive) multi-product pricing, which stresses cross-elasticities. For example, socially optimal Ramsey prices are not driven solely by superelasticity formulae but alsore ect each side s contribution to the other side s new questions raised by Two-Sided Markets are more speci c to theexistence of Competition between platforms. In a number of Markets , a fractionof end users on one or the two sides connect to several platforms. Using the1. There are of course other illustrations, for example scienti c journals, that must match readersand authors.

6 Interestingly, theBell Journal of Economicsfor a number of years after it waslaunched was sent for free to anyone who requested it. There is currently much discussion of howthe business model for scienti c journals will evolve with electronic publishing. The list of socialgatherings examples of cross-subsidization could be extended to include dating or marital agencieswhich may charge only one side of the couple of explanations regarding Markets that will not be discussed in Section 7: Socialgatherings: celebrities often do not pay or are paid to come to social happenings as they attractother participants (who may then be charged a hefty fee); similarly, in some conferences, starspeakers are paid while others : In many countries buyers are not charged forvisiting real estate properties and thus marginal visits are heavily subsidized.

7 To be certain, the salepricere ects the real estate agency fee, but this does not imply that the arrangement is neutral (seeSection8).Shopping malls: shoppers are subsidized. They don t pay for parking; in France theycan also buy gasoline at a substantial coupon books: These are given away toconsumers. Intermediaries charge merchants for the : The picture given in Table1 is a bit simplistic. In particular, Netscape initially made about one third of its revenue on theclient side before giving the software away. But Netscape always viewed the software running ontop of the operating system on the web servers as a major source of pro and Tirole Platform Competition in Two-Sided MarketsInternet terminology, we will say that they multihome. For example, manymerchants accept both American Express and Visa; furthermore, some consum-ers have both Amex and Visa cards in their pockets.

8 Many consumers have theInternet Explorer and the Netscape browsers installed on their PC, and a numberof Web sites are con gured optimally for both browsers. Readers may subscribeto multiple newspapers, B2B exchange members may buy or sell their wares onTABLE1. ILLUSTRATIONS OFEXISTINGBUSINESSMODELSP roductLoss leader/break-evensegment/subsidized segmentPro t-making segment/subsidizing segmentSoftwareVideogamesconsumers (consoles)software developersStreaming mediaconsumersserversBrowsersusersWebser versOperating systems (Windows;Palm, Pocket PC)application developers (developmenttools, support, functionality, .. )clientsText processingreader/viewerwriterPortals and mediaPortals eyeballs advertisersNewspapersreadersadvertisers( Charge-free) TV networksviewersadvertisersPayment systemsCredit and differed debit cards(Visa, MasterCard, Amex,.. )cardholdersmerchantsOnline debit cardsmerchantscardholdersOthersSocial gatheringscelebrities in social happeningsother participantsShopping mallsconsumers (free parking, cheap gas) shopsDiscount coupon books (WantAdvertiser)consumersmerchants(Legac y) InternetWebsitesdial-up consumersRealestatebuyerssellersTABLE2.

9 PROSPECTIVEAPPLICATIONSP latformTwosidesInstruments of cost allocation orcross-subsidizationB2 Bbuyers/sellersdesign of auctions, information owsInternet backboneservicesconsumers/websitestermin ation (settlement) chargesPools and standardsrelevant sideslevel of royalties, inclusiveness of poolsSoftware as a service(.Net vs. Java)consumers/applicationdevelopersdeve lopment tools and other efforts to createan applications development environment,backward compatibility, pricing992 Journal of the European Economic Association June 2003 1(4):990 1029several exchanges, and real estate sellers and buyers may use the services ofmultiple real estate agencies. Competitive prices on one market then depend onthe extent of multihoming on the other side of the market. For example, whenVisa reduces the (transaction-proportional) charge paid by the merchants,2merchants become more tempted to turn down the more costly Amex card aslong as a large fraction of Amex customers also owns a Visa card.

10 Moregenerally, multihoming on one side intensi es price Competition on the otherside as platforms use low prices in an attempt to steer end users on the latterside toward an exclusive paper studies how the price allocation between the two sides of themarket is affected by a) Platform governance (for-pro t vs. not-for-pro t), b)end users cost of multihoming, c) Platform differentiation, d) platforms abilityto use volume-based pricing, e) the presence of same-side externalities, and f) Platform compatibility. It also investigates how privately optimal pricing struc-tures compare with socially optimal paper is organized as follows. Section 2 describes the simplest versionof the model, in which end users incur no xed cost and Platform pricing islinear on both sides of the market, and analyzes the (pro t maximizer andRamsey planner) monopoly benchmarks.