New Regulatory and Business Challenges

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TWO SIDED MARKETS
Bruno Jullien
IDEI and GREMAQ, Toulouse
ESNIE - CARGESE
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GETTING MULTIPLE SIDES ON BOARD

B2C website
buyers
B2B platform
suppliers
gamers
videogame platform
game developers
"eyeballs"
portals, newspapers, TV
advertisers
cardholders
debit credit cards
merchants
Chicken and egg problem. Must get both sides on
board/court each side while making money overall.
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Organization of lecture
1 INTRODUCTION 2 MONOPOLY 3
COMPETITION 4 USAGE FEES 5 COMPETIT
ION POLICY
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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.
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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
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A  classical  industry may become a 2SMs
Example 1 computers / video games
(vertical desintegration)
Hardware producers
Operating system
users
developers
Example 2 TV operators
Content (cinema, sport)
users
operator
Advertisers
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Often results in very skewed pricing pattern
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2.1 MONOPOLY WITH SUBSCRIPTION
Registration
Registration
sellers
buyers
Platform
Access cost
For the moment no transaction fee/ cost
Network size
externalities
demand functions
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MONOPOLY PRICES
Profit
Volume / margin trade-off
Adjusted margin
Demand elasticity for fixed participation of the
other side
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• 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).

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Other examples of skewed pricing patterns
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Mind the cross-group externalities
? More complex story within-side externality
Platform
attracts
large fee (because marquee buyers)
good deal
Illustrations ? Amex corporate card. ? Killer
application/game. ? Key store in shopping mall.
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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

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Optimal prices

• Budget constraint

• Ramsey-Boiteux prices depend on elasticity and
  on externalities (? is determined by the budget
  constraint or cost of public funds)

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

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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?

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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
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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

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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

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Divide and Conquer example

• 1 buyer and 1 seller ?B ?S ?
• Platform 1 charges pB and pSgt0
• Platform 2 charges
• pB - ? to buyer and ? to seller
• Profit pB- cB -cS
• Eq. prices if small cost (total cost less than ?)
• pB pS cB cS (if less than ?)
• Profit cB cS

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Variant 2 competitive bottleneck
Platform 1
Platform 2
buyers (single-homing)
sellers (multi-homing)

• lower prices for buyers
• higher prices for sellers

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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

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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 (?B, ?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

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Regulation of interactions between end-users
2SP performs balancing act through other
instruments than membership and usage fees
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, eBays feedback forum)
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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

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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

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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?

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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.

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Indirect network effect

• Possibility of coordination failure and multiple
  equilibria
• Solving the problem may require negative prices
  and price skewness

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Coordination failure positive price
N
N
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Solving coordination failure one negative price
N
N
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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, ) ?

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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".

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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