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TECH TALK: Two-Sided Markets: Pricing

November 8th, 2006 · No Comments

The HBR article authors categorise the two sides as a subsidy side and a money side who interact with each other via a platform. Thus, for example, Google is a platform which connects users interested in search or content (subsidy side) with advertisers (money side). Online recruitment sites connect job seekers (subsidy side) with employers (money side).

One of the most important issues in two-sided markets is that of pricing. In an interview with HBS Working Knowledge, Andrei Hagiu explained the pricing challenge further: Two-sided platforms must solve a chicken-and-egg problem. For example, without sufficient applications developed for it, an operating system has no value for, and therefore cannot attract, users. Without a solid user base, no application developer will be interested in supporting that operating system. If the platform vendor decides to charge positive prices on both sides, it might end up attracting neither. The same goes for dating clubs, game consoles, and so on. So the idea is to subsidize one side in order to attract it more or less irrespectively of the other side and then turn to the second side and charge it positive prices.

Wikipedia adds: In two-sided networks, users on each side typically require very different functionality from their common platform. In credit card networks, for example, consumers require a unique account, a plastic card, access to phone-based customer service, a monthly bill, etc. Merchants require terminals for authorizing transactions, procedures for submitting charges and receiving payment, signage (decals that show the card is accepted), etc. Given these different requirements, platform providers may specialize in serving users on just one side of a two-sided network. A key feature of two-sided markets is the novel pricing strategies and business models they employ. In order to attract one group of users, the network sponsor may subsidize the other group of users. Historically, for example, Adobes portable document format (PDF) did not succeed until Adobe priced the PDF reader at zero, substantially increasing sales of PDF writers. Relative to Apple computers initial pricing, Microsoft also steeply discounted systems developer toolkits (SDKs) leading to more rapid development of applications for MS Windows.

The HBR article authors discuss pricing in more detail:

Because the number of subsidy-side users is crucial to developing strong network effects, the platform provider sets prices for that side below the level it would charge if it viewed the subsidy side as an independent market. Conversely, the money side pays more than it would if it were viewed as an independent market. The goal is to generate cross-side network effects: If the platform provider can attract enough subsidy-side users, money-side users will pay handsomely to reach them. Cross-side network effects also work in the reverse direction. The presence of money-side users makes the platform more attractive to subsidy-side users, so they will sign up in greater numbers. The challenge for the platform provider with pricing power on both sides is to determine the degree to which one group should be encouraged to swell through subsidization and how much of a premium the other side will pay for the privilege of gaining access to it.

Pricing is further complicated by same-side network effects, which are created when drawing users to one side helps attract even more users to that side. For example, as more people buy PlayStation consoles, new users will find it easier to trade games with friends or find partners for online play. Economists call this snowballing pattern a positive same-side network effect.

It is not always obvious which sideif eitherthe platform should subsidize and which it should charge.

The authors recommendation: subsidise quality- and price-sensitive users, and secure marquee users exclusive participation on the platform.

Tomorrow: Examples

TECH TALK Two-Sided Markets+T

Tags: Tech Talk

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