TECH TALK: Two-Sided Markets: Business Application

In an interview with HBS Working Knowledge (March 2006), Andrei Hagiu discussed out the practical aspects of the ongoing research in the area of two-sided markets:

  • The pricing structurethat is, how much to charge to one side relative to othersmatters; and in order to determine the optimal pricing structure one needs to carefully analyze the relative interdependencies among the multiple sides as well as their willingness to pay and join the platform. More often than not, one has to subsidize the participation of one side, i.e., forego profits there, in order to derive them from other sides.

  • The scope of the platform is also a key decision variable: More than determining competitive advantage under an exogenously given industry structure, many platforms are in a position to change the structure of their industry by their decision of how much vertical and/or horizontal integration to have. Vertical disintegration and licensing can help expand the market, but vertical integration allows for tighter control and perhaps higher profit-extraction power. Horizontal expansion can bring in new sides and create more sources of profits by unleashing new virtuous circles of value; but at the same time they bring the platform in competition with new competing platforms from previously separate industries.

  • Managers should be clearly aware of the fundamental economic functions performed by their platformsthese functions are the main sources of competitive advantagein order to be able to make the best decisions on what new functionalities and services to build and enhance. They should always look first for those functionalities/services that enhance and enrich the core functions they already perform as they offer the highest synergies and payoffs, rather than adding functionalities related to fundamental functions they do not yet have, which could prove distracting and counterproductive.

  • Understanding two-sided markets is especially critical for entrepreneurs and managers in the Internet and mobile space. One of the dominant models that has emerged over the years is that of giving away services for free. While this has been around for some time, the Internet provides scale which would never otherwise have been possible previously. The combination of software engines and contextual advertising has made Google a powerhouse on the Internet. The next big opportunity is on the mobile. What will be the equivalent on the mobile Internet where screen-size limitations and user impatience could potentially limit advertising. I can imagine mobile content (ringtones, wallpapers and games) being offered for free at a not-too-distant future subsidised by advertising. This can shift power from mobile operators in India who keep a lions share of the end-user charges to platform providers who can build direct-to-consumer relationships and enable advertisers to connect with this audience.

    We are in for interesting times. With a fast-changing landscape in the world of technology, a company like YouTube can come from seemingly nowhere, build an audience of tens of millions and get sold for $1.65 billion all in less than a couple of years. Web 2.0 companies are using network effects to build new platforms to compete with incumbents. In India, too, we will see the emergence of innovative companies leveraging new ideas and new technologies. Two-sided markets are going to be the heart of many of these innovations.

    TECH TALK Two-Sided Markets+T

    Published by

    Rajesh Jain

    An Entrepreneur based in Mumbai, India.