TECH TALK: Two-Sided Markets: HBR article

While reading the latest issue of Harvard Business Review (Octover 2006), I came across an article on Strategies for Two-Sided Markets by Thomas Eisenmann, Geoffrey Parker, and Marshall W. Van Alstyne. The title was intriguing. It was the first time I had actually come across the phrase two-sided markets even though as I realised later, I had experienced these markets closely over the past decade. The article was interesting enough for me to think and delve into the topic some more.

Here is the abstract for the article:

If you listed the blockbuster products and services that have redefined the global business landscape, you’d find that many of them tie together two distinct groups of users in a network. Case in point: The most important innovation in financial services since World War II is almost certainly the credit card, which links consumers and merchants. The list would also include newspapers, HMOs, and computer operating systems–all of which serve what economists call two-sided markets, or networks. Newspapers, for instance, bring together subscribers and advertisers; HMOs link patients to a web of health care providers and vice versa; operating systems connect computer users and application developers. Two-sided networks differ from traditional value chains in a fundamental way. In the traditional system, value moves from left to right: To the left of the company is cost; to the right is revenue. In two-sided networks, cost and revenue are both to the left and to the right, because the “platform” has a distinct group of users on each side. The platform product or service incurs costs in serving both groups and can collect revenue from each, although one side is often subsidized. Because of what economists call “network effects,” these platform products enjoy increasing returns to scale, which explains their extraordinary impact. Yet most firms still struggle to establish and sustain their platforms. Their failures are rooted in a common mistake: In creating strategies for two-sided networks, managers typically rely on assumptions and paradigms that apply to products without network effects. As a result, they make many decisions that are wholly inappropriate for the economics of their industries. In this article, the authors draw on recent theoretical work to guide executives negotiating the challenges of two-sided networks.

When we think about it, two-sided markets are all around us. Newspapers and magazines are often sold at prices below cost. The publishers make the money from advertisers. TV programming, for the most part, comes for free, with advertisers again paying the channel to reach the audience. Google has taken the notion of free to extraordinary heights (quite literally, with services like Google Earth!). As users get an increasing number of services for free, advertisers have been spending money to connect with the eyeballs.

So, what are two-sided markets? What are the business opportunities around these type of markets?

Tomorrow: Overview

Published by

Rajesh Jain

An Entrepreneur based in Mumbai, India.