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TECH TALK: Two-Sided Markets: Examples

November 9th, 2006 · 3 Comments

A 2001 paper entitled Platform Competition in Two-Sided Markets by Jean-Charles Rochet and Jean Tirole gives a number of examples of two-sided markets. One such example is the videogame market. They write: A platform cannot sell the console without games to play on and cannot attract game developers without the prospect of an installed base of consumers. In its thirty years of existence, the video game industry has had four leading platforms, Atari, Nintendo and Sega, and finally Sony. The business model that has emerged uses consoles as the loss leader and draws platform profit from applications development. To be certain, history has repeatedly shown that technically impressive platforms (e.g., Mattel in 1981, Panasonic in 1993, and Sega in 1985 and after 1995) fail when few quality games are written for them. But attracting game developers is only a necessary condition. In fact, the business model currently employed by Nintendo, Sega and Sony is to charge software developers a fixed fee together with a per-unit royalty on the games they produce. Microsoft releases in the fall of 2001 the Xbox in competition with Sony’s dominant PlayStation 2. Interestingly, Microsoft manufactures the Xbox console and uses it as a loss leader. While courting the developers21 by using the familiar X86 chip and Windows platform and by not charging for the Xbox Prototype kit, Microsoft has stated that it intends to draw revenue from royalties.

Another example they provide is from the payments industry. Historically,
the business model for credit and debit cards has been to attract cardholders and
induce them to use their cards. Visa and MasterCard are not-for-profit associations owned by over 6,000 bank (and non-bank) members. The associations centrally set interchange fees to be paid by acquirers (the merchants’ banks) to issuers (the cardholders’ banks). These interchange fees are proportional to transaction volume. A higher interchange fee is, via the competition among issuers, partly or fully passed through to consumers in the form of lower card fees and higher card benefits, which encourages card ownership and usage; and, via the competition among acquirers, partly or fully passed through to merchants, who pay a higher merchant discount (the percentage of the sale price that the merchant must pay the acquirer), which discourages merchant acceptance. The associations’ choice of interchange fees have typically favored cardholders over merchants who kept accepting the card despite the high level of the merchant discountsAmerican Express, a for-profit closed system, works on the same business model, with an even higher degree of cross-subsidization. Traditionally, it has charged a much higher merchant discount. It could afford to do so because the Amex clientele -in particular the corporate card clientele- was perceived as very attractive by merchants.The gap between Amex’s and the associations’ merchant discounts has narrowed in the 1990s as more and more Amex customers got also a Visa card or MasterCard. Such ‘multihoming’ by a fraction of cardholders made it less costly for merchants to turn down.

Wikipedia provides a few more examples: Although recently developed in terms of economic theory, two-sided networks help to explain many classic format battles, for example, Beta vs. VHS, Mac vs. Windows, CBS vs. RCA in color TV, American Express vs. Visa, and more recently Blu-Ray vs. HD-DVD. In the case of color TV, CBS and RCA offered rival formats but initially neither gained market traction. Viewers had little reason to buy expensive color TVs in the absence of color programming. Likewise, broadcasters had little reason to develop color programming when households lacked color TVs. RCA won the battle in two ways. It flooded the market with low cost black-and-white TVs incompatible with the CBS format but compatible with its own. Broadcasters then needed to use the RCA format to reach established viewers. RCA also subsidized Walt Disneys Wonderful World of Color, which gave consumers reason to buy the new technology.

Tomorrow: Business Application


TECH TALK Two-Sided Markets+T

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