Competition in two-sided markets.

Many markets involve two groups of agents who interact via "platforms," where one group's benefit from joining a platform depends on the size of the other group that joins the platform. I present three models of such markets: a monopoly platform; a model of competing platforms where agents join a single platform; and a model of "competitive bottlenecks" where one group joins all platforms. The determinants of equilibrium prices are (i) the magnitude of the cross-group externalities, (ii) whether fees are levied on a lump-sum or per-transaction basis, and (iii) whether agents join one platform or several platforms.

1. Introduction

* There are many examples of markets in which two or more groups of agents interact via intermediaries or "platforms." Surplus is created--or destroyed in the case of negative externalities--when the groups interact. Of course, there are countless examples where firms compete to deal with two or more groups. Any firm is likely to do better if its products appeal to both men and women, for instance. However, in a set of interesting cases, cross-group externalities are present, and the benefit enjoyed by a member of one group depends upon how well the platform does in attracting custom from the other group. For instance, a heterosexual dating agency or nightclub can do well only if it succeeds in attracting business from both men and women. This article is about such markets. A brief list of other such markets includes: credit cards (for a given set of charges, a consumer is more likely to use a credit card that is accepted widely by retailers, while a retailer is more likely to accept a card that is carried by more consumers); television channels (where viewers typically prefer to watch a channel with fewer commercials, while an advertiser is prepared to pay more to place a commercial on a channel with more viewers); and shopping malls (where a consumer is more likely to visit a mall with a greater range of retailers, while a retailer is willing to pay more to locate in a mall with a greater number of consumers passing through). See Rochet and Tirole (2003) for further examples of two-sided markets.

As I shall argue in more detail, there are three main factors that determine the structure of prices offered to the two groups.

* Relative size of cross-group externalities. If a member of group 1 exerts a large positive externality on each member of group 2, then group 1 will be targeted aggressively by platforms. In broad terms, and especially in competitive markets, it is group 1's benefit to the other group that determines group 1's price, not how much group 1 benefits from the presence of group 2 (see Proposition 2 below). In a nightclub, if men gain more from interacting with women than vice versa, then we expect there to be a tendency for nightclubs to offer lower entry fees to women than to men.

Unless they act to tip the industry to monopoly, positive cross-group externalities act to intensify competition and reduce platform profit--see expression (13) below. To be able to compete effectively on one side of the market, a platform needs to perform well on the other side (and vice versa). This creates a downward pressure on the prices offered to both sides compared to the case where no externalities exist. This implies that platforms have an incentive to find ways to mitigate network effects. One method of doing this is discussed next.

* Fixed fees or per-transaction charges. Platforms might charge for their services on a lump-sum basis, so that an agent's payment does not explicitly depend on how well the platform performs on the other side of the market. Alternatively, if feasible, the payment might be an explicit function of the platform's performance on the other side. One example of this latter practice occurs when a television channel or a newspaper makes its advertising charge an increasing function of the audience or readership it obtains. Similarly, a credit card network levies (most of) its charges on a per-transaction basis, and the bulk of a real estate agent's fees are levied only in the event of a sale. The crucial difference between the two charging bases is that cross-group externalities are weaker with per-transaction charges, since a fraction of the benefit of interacting with an extra agent on the other side is eroded by the extra payment incurred. If an agent pays a platform only in the event of a successful interaction, the agent does not need to worry about how well the platform does in its dealings with the other side. That is, to attract one side of the market, it is not so important that the platform first gets the other side "on board" Because externalities are lessened with per-transaction charging, it is plausible that platform profit is higher when this form of charging is used. (1) (See Propositions 3 and 5 for illustrations of this effect.) Finally, the distinction between the two forms of tariff only matters when there are competing platforms. When there is a monopoly platform (see Section 3), it makes no difference if tariffs are levied on a lump-sum or per-transaction basis.

* Single-homing or multi-homing. When an agent chooses to use only one platform, it has become common to say the agent is "single-homing" When an agent uses several platforms, she is said to "multi-home." It makes a significant difference to outcomes whether groups single-home or multi-home. In broad terms, there are three cases to consider: (i) both groups single-home, (ii) one group single-homes while the other multi-homes, and (iii) both groups multi-home. If interacting with the other side is the primary reason for an agent to join a platform, then we might not expect case (iii) to be very common--if each member of group 2 joins all platforms, there is no need for any member of group 1 to join more than one platform--and so I do not analyze this configuration. (If all native French speakers also speak English, there is less incentive for a native English speaker to learn French.) Configuration (i) is discussed in Section 4. Although the analysis of that case provides useful insights about two-sided markets, it is hard to think of many actual markets that fit this configuration precisely.

By contrast, there are several important markets that resemble configuration (ii), and in Section 5 these are termed "competitive bottlenecks." Here, if it wishes to interact with an agent on the single-homing side, the multi-homing side has no choice but to deal with that agent's chosen platform. Thus, platforms have monopoly power over providing access to their single-homing customers for the multi-homing side. This monopoly power naturally leads to high prices being charged to the multi-homing side, and there will be too few agents on this side being served from a social point of view (Proposition 4). (2) By contrast, platforms do have to compete for the single-homing agents, and high profits generated from the multi-homing side are to a large extent passed on to the single-homing side in the form of low prices (or even zero prices).

2. Related literature

* I discuss some of the related literature later as it becomes most relevant in the analysis (especially in Section 5). However, it is useful to discuss two pioneering articles up front.

Caillaud and Jullien (2003) discuss the case of competing matchmakers, such as dating agencies, real estate agents, and internet "business-to-business" websites. (See also van Raalte and Webers (1998).) There is potentially a rich set of contracting possibilities. For instance, a platform might have a subscription charge in combination with a charge in the event of a successful match. In addition, Caillaud and Jullien allow platforms to set negative subscription charges and to make their profit from taxing transactions on the platform. Caillaud and Jullien first examine the case where all agents must single-home. (I provide a parallel analysis in Section 4.) In this case, there is essentially perfect competition, and agents have no intrinsic preference for one platform over another except insofar as one platform has more agents from the other side or charges lower prices. Therefore, the efficient outcome is for all agents to use the same platform. Caillaud and Jullien's Proposition 1 shows that the only equilibria in this case involve one platform attracting all agents (as is efficient) and that platform making no profit. The equilibrium structure of prices involves negative subscription fees and maximal transaction charges, since this is the most profitable way to prevent entry. Caillaud and Jullien go on to analyze the more complicated case where agents can multi-home. They analyze several possibilities, but the cases most relevant for my article are what they term "mixed equilibria" (see their Propositions 8 and 11). These correspond to my competitive bottleneck situations, and they involve one side multi-homing and the other side single-homing. They find that the single-homing side is treated favorably (indeed, its price is necessarily no higher than its cost), while the multi-homing side has all its surplus extracted. I discuss the relationship between the two approaches in more detail in Section 5.