Transcript New Regulatory and Business Challenges

TWO SIDED MARKETS
Bruno Jullien
IDEI and GREMAQ, Toulouse
ESNIE - CARGESE
1
GETTING MULTIPLE SIDES ON BOARD
platform
buyers
B2C website
buyers
B2B platform
gamers
"eyeballs"
cardholders
videogame platform
portals, newspapers, TV
debit & credit cards
sellers
suppliers
game developers
advertisers
merchants
Chicken and egg problem. Must get both sides on board/court each side
while making money overall.
2
Organization of lecture
1
INTRODUCTION
2
MONOPOLY
3
COMPETITION
4
USAGE FEES
5
COMPETITION POLICY
3
Platform enables or facilitates interaction between "buyers" and "sellers"
Platform
usage charge
+ membership charge
Buyer
usage charge
+ membership charge
Seller
4
Some 2SPs:
Exchanges
 Exchanges/auctions (eBay, Amazon).
 B2B.
 Employment agencies.
 Dating services.
 Real-estate agencies.
 Futures and securities exchanges
Communications
 Telecoms.
 Internet backbone services.
But also...
 Academic journals.
 Shopping malls.
5
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
Buyer
GRID
Producer
Bilateral contract
Only the total price charged on the two sides matters, as they negotiate
how to share it: similar to tax neutrality
6
A « classical » industry may become a 2SMs
Example 1 : computers / video games
(vertical desintegration)
Hardware producers
users
Operating system
developers
Example 2 : TV operators
Content
(cinema, sport…)
users
operator
Advertisers
7
Often results in very skewed pricing pattern
 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.
 Illustration :
Videogame platforms.
• Sell console at or below cost, royalties on games
8
2.1 MONOPOLY WITH SUBSCRIPTION
Registration
pB
buyers
Platform
Registration
pS
sellers
Access cost cB , cS
For the moment no transaction fee/ cost
Network size  N B  DB ( pB  vB N S )

 N S  DS ( pS  vS N B )
demand
functions
externalities
9
MONOPOLY PRICES
Profit:
 pB  cB  DB ( pB  vB NS )   pS  cS  DS ( pS  vS N B )
NB
NS
Volume / margin trade-off
pB  (cB  vS N S ) 1

pB
B
Adjusted margin
p S  ( cS  v B N B ) 1

pS
S
Demand elasticity
for fixed participation of the other side
10
 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.]
 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).
11
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).
12
Other examples of skewed pricing patterns:
13
Mind the cross-group externalities
 More complex story: within-side externality
Platform
attracts
Marquee
buyers
Other
buyers
good deal
Illustrations:  Amex corporate card.
 Killer application/game.
 Key store in shopping mall.
Sellers
large fee (because
marquee buyers)
14
Welfare: Optimal prices
 Unrestricted :
pB  cB  vS N S
pS  cS  vB N B
 Price equal to the net opportunity cost
→
marginal cost net of the value created for
the members of the other side
15
Optimal prices
 Budget constraint
p B  ( c B  vS N S ) 

pB
B
p S  ( cS  v B N B ) 

pS
S
 Ramsey-Boiteux prices depend on elasticity and on
externalities (λ is determined by the budget constraint or
cost of public funds)
16
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
17
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?
18
3 COMPETITION
Variant 1 : single-homing bilateral
Platform 1
• price smaller on both
sides
• expectations of users
play an important role
(multiplicity of possible
equilibria)
• "divide and et conquer"
Platform 2
buyers
sellers
19
Single-homing and competition
 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, then 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
20
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”
21
Divide and Conquer: example
 1 buyer and 1 seller: νB = νS= ν
 Platform 1 charges pB and pS>0
 Platform 2 charges:
 pB - ν to buyer and ν to seller
 Profit pB- cB -cS
 Eq. prices if small cost (total cost less than ν)
 pB= pS= cB +cS (if less than ν)
 Profit = cB +cS
22
Variant 2 : competitive bottleneck
Platform 1
Platform 2
buyers
(single-homing)
sellers
(multi-homing)
 lower prices for buyers
 higher prices for sellers
23
Multi-homing and competition
 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
Endogeneous MH: Easy to divide but difficult to conquer
 Limits tipping by facilitating coexistence
24
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”
(νB, νS ); 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
25
Regulation of interactions between end-users
2SP performs balancing act through other instruments than membership
and usage fees:
The platform as a competition authority.
The platform as a price regulator.
(illustration: no surcharge for payments with card)
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)
The platform as a supplier of information and enforcement.
(illustrations: auto auctions arbitration processes, eBay’s feedback forum)
26
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
27
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
28
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?
29
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.
30
Indirect network effect
N B  DB ( pB  vB DS ( pS  vS N B ))

N B ( p B , pS )
Possibility of coordination failure and multiple equilibria:
Solving the problem may require negative prices and price
skewness
31
Coordination failure: positive price
N
N
32
Solving coordination failure: one negative price
N
N
33
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, …) ?
34
Some References
Non-technical :
 Jullien, B (2005): “Pricing and other Business Strategies for e-Procurement
Platforms”, IDEI working paper, forthcoming “Handbook of Procurement”
 David Evans (2003) "Some Empirical Aspects of Multi-Sided Platform
Industries," Review of Network Economics, 2: 191-209.
 D. Evans, D. et R. Schmalensee (2005) “The Industrial Organisation of
Markets with Two-Sided Paltforms”, NBER working paper.
 Rochet, J.C. et J. Tirole (2005). "Competition Policy in 2 SMs", mimeo IDEI,
forthcoming "Advances in the Economics of Competition Policy".
35
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.
 Jullien, B. (2005) "Two-Sided Markets and Electronic Intermediaries,"
CESifo Economic Studies, 51.
 Caillaud B. et Jullien B. (2003) “Chicken and Egg: Competition between
Intermediation Service Provider“, Rand J. Ec., 34.
 Rochet, J.C. et J. Tirole (2003) “Paltform Competition in Two-Sided
Markets”, Journal of the European Economic Association
36