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**Lecture Two-Sided Markets
**

Lapo Filistrucchi

Notes for the seminar Competition Policy: Advanced Theory and Cases - Tilburg 2009

1

**A Two-Sided Market - I
**

A market where firms act as platforms and sell two different products to two different groups of buyers taking into account that demand from one group of buyers depends on demand from the other group of buyers (so that these are not externalities for the firm) while buyers of the two groups do not take this indirect network effects into account (so that these are in fact externalities for buyers) (see Armstrong, 2006) So that a two-sided platform - is a particular two-product firm - is different from a firm selling complement products

**A Two-Sided Market - II
**

An additional condition is that customers on one side should not be able to pass through completely to customers on the other side an increase in the price they are asked by the platform. In a two-sided market one can distinguish a) the price level (roughly the sum of the two prices) b) the price structure (roughly the ratio of the two prices) The non-neutrality of the price structure (for firms profits and for welfare) is a sufficient condition for the existence of a two-sided market (see Rochet and Tirole(2006))

**Two-Sided markets: a clarification
**

Not all firms are two-sided platforms Because firms buy inputs and sell output This implies: -they do not offer a service to input producers -the input producers do not care about demand for their product by consumers once they are paid by the firm (note: it depends on the contract!) e.g. Is a supermarket a two-sided platform? Yes, but only to the extent it is able to make the wine producer pay (though a discount?) to have its wine on the right shelf (then it offers a service to them…) Only then the wine producer will care about how many clients the supermarket has …

Different Two-Sided Markets Two types of two-sided market: the “media type” and the “payment card type” or equivalently “two-sided transaction” markets and “two-sided non transaction” markets Also two types of two-sided markets of the “payment type”: the “3-party system” and the “4 (or 5) party system” .

g. auction houses 2) Two-Sided Non-Transaction Market: There is no transaction between end-users e.Two Types of Two-Sided Market-I 1) Two-Sided Transaction Market: There is a transaction between end-users and it is observable to the platform e. TV Note that A non-transaction market is an extreme case of twosided market At the other extreme there is a one-sided market .g. newspapers. payment cards.

Armstrong(2006) duopoly differentiated products.Rochet &Tirole(2006) differentiated goods. Parker&Van Alstyne(2005) monopolist .Two types of two-sided markets Distinction above corresponds roughly to : 1) usage (+membership) model .2003) homogeneous goods 2)membership model . Caillaud & Jullien(2001.

usually not observable (but see clicks on ads) . but interaction. Radio. TV.A Two-Sided Market: Media Newspapers. Internet… Media Firm F1A price for content Note: no per-interaction fees media content ad fees ad slot Note: maybe per-interaction fees reader/ viewer/ listener advertiser advertising message Note: no transaction here.

1 • two markets: advertisers & readers/viewers/listeners • Membership (or adoption) externalities (indirect network externalities): – the larger the audience. the demand from readers/viewers/listeners • not internalized by advertisers & readers/viewers/listeners • internalized by media company – Notes for the seminar Competition Policy: Advanced Theory and Cases . the higher the demand from advertisers at a given price or the higher the price which can be charged for a given ad slot – the more advertising (concentration).Media as two-sided markets: the idea . the ….Tilburg 2009 9 .

A Two-Sided Market: Payment Cards-1 Also: auction house. operating systems payment card scheme (3-party) card-holders fees fixed fee + per-transaction fee card service card service merchant fees fixed fee + pertransaction fees buyer good seller Note: transaction here. usually observable Notes for the seminar Competition Policy: Advanced Theory and Cases .Tilburg 2009 10 .

Tilburg 2009 11 .A Two-Sided Market: Payment Cards-2 payment card association (4 party system) interchange fee issuer card-holders fees fixed fee + per-transaction fee price acquirer merchant fees price price buyer good seller fixed fee + merchant discount Note: on-us vs off-us transactions Notes for the seminar Competition Policy: Advanced Theory and Cases .

the higher demand from sellers – the more sellers accept it.for the merchant to be paid with a card the cardholder must be willing to pay with it • not internalized by buyers and sellers • internalized by card firm/association Notes for the seminar Competition Policy: Advanced Theory and Cases .Payment cards as two-sided markets: the idea .Tilburg 2009 12 .2 • two markets: cardholders & merchants • membership externalities (indirect network externalities): – the more cardholders. the higher demand from buyers • usage externalities: .for the cardholder to pay with his/her card the merchant must be willing to be paid with it .

Caillaud & Jullien(2001.Tilburg 2009 13 . TILEC and HOWREY(2010) Notes for the seminar Competition Policy: Advanced Theory and Cases . Argentesi & Filistrucchi(2007). Evans & Noel (2008). Filistrucchi (2008). Filistrucchi & Michielsen(2010). Evans & Schmalensee & (2005).2003) and by now… many others •Competition Policy: Wright(2004).Two-sided markets: the literature •General: Rochet & Tirole(2006). Parker & Van Alstyne(2005). Klein. Armostrong(2006).

Fallacies from a single-sided approach to a two-sided market Profit-maximizing prices: • A high-price cost margin indicates market power • A price below marginal cost indicates predation Welfare maximizing prices: • An efficient price structure reflects relative costs (in mature networks) The role of competition: • Higher competition results in a more balanced price structure • Higher competition results in a more efficient price structure (only price level) Notes for the seminar Competition Policy: Advanced Theory and Cases .Tilburg 2009 14 .

N s ) N b = nb ( F b .. F ) N = ns (F b .F s Armstrong (2006) N b = N b ( F b .A model of membership • A monopolist 3-party scheme. and Notes for the seminar Competition Policy: Advanced Theory and Cases . N s ) F b . membership max F b N b + F s N s − C ( N b .Tilburg 2009 15 . F s ) If ⇒ s s s b s N = N (N . F s ) then ∂n b ∂F b = ..

Tilburg 2009 16 .F s F b − cb Fb F s − cs F s s s s s s F − c F n 1 1 n ε b = b − s F F F b n b nb n ε Fb ε Fb b b b b b F − c F n 1 1 n ε s = s − b F F F s n s ns n εFs εFs Mark-up depends on own elasticity and cross-elasticity (indirect network effect) Markup on one side maybe negative! (then other higher than standard monopoly) Notes for the seminar Competition Policy: Advanced Theory and Cases . F s )) F b . F s ) − C(nb (F b .max F b nb (F b . F s ) + F s ns (F b . ns (F b . F s ).

p s b s Rochet & Tirole (2006) p + p −c b pb s b = 1 ε T pb p + p −c s b p 1 s = 1 p s s b εT p p = εT p εT p s b p + p −c p +p s b = T εT + ε p p s b Intuition? b s Note : T ( p . p ) b s b s p . use max( p + p − c) T( p . but how ? b s Notes for the seminar Competition Policy: Advanced Theory and Cases .A model of usage • A monopolist 3-party scheme. D( p )). p ) = T ( D( p ).Tilburg 2009 17 .

p s b s s.t.Tilburg 2009 18 . p ) pb . p =p +p * b s Notes for the seminar Competition Policy: Advanced Theory and Cases .Some mathematical intuition: the profit maximizing price level is determined by the total elasticity of transactions price structure is then determined by maximising number of transactions given p* p* = pb + ps max T ( p .

F s . F s .. p s . adoption+use max F b . N s ) N b = N b ( F b . and Notes for the seminar Competition Policy: Advanced Theory and Cases . p b . N s ) N b = nb ( F b . p s ) If ⇒ s s s b s s N = N (N . F s . p ) N = ns (F b . F . p s ) then ∂n b ∂F b = . p s F b N b + F s N s − C ( N b ..A model of usage and adoption • A monopolist 3-party scheme.Tilburg 2009 19 . pb . pb . p b . N b . N s ) + ( p b + p s − c) T ( p b .

p s )) + + ( p b + p s − c) T ( p b . n b ( F b . n s ( F b . p b . p s . p b . p s ) + − C (n b ( F b . F s . F s . p b . p b . F s . F s .Tilburg 2009 20 . F s . p b . F s . F s . p b . pb . p s )) F b − cb Fb = 1 εF s nb b − F − c ε F b MREV s ns s b F b εF 1 + b nb b MREV − p + p −c ε s b T nb ε F UREV b nb b b p b εF nb b MREV − p + p −c ε s b T ns ε F UREV s b ns ps εF nb b MREV b p s + pb − c p b = ε − T pb F − c ε p b MREV s nb b b F b ε T pb UREV − F − c ε p b MREV s s ns s b F s ε T pb UREV − p + p −c ε s b T ns ε p UREV s b ns ps ε T pb UREV b and so on… Notes for the seminar Competition Policy: Advanced Theory and Cases . p s ). p s ). p s F b nb ( F b .max F b . p s ) + F s n s ( F b . n s ( F b .

Issues in Competition Policy • Market Power • Total welfare • Market Definition • Assessment of Market Power • Merger evaluation • Incentives to collude • Predation • Tying Notes for the seminar Competition Policy: Advanced Theory and Cases .Tilburg 2009 21 .

2008) – media.payment cards. elasticities used should include network effects Emch & Thomson (2006) . raise price level adjusting the price structure.Market Definition in 2-Sided Markets: The Literature Argentesi & Ivaldi (2005) – media.Tilburg 2009 22 . raise price on one side keeping fixed the price on the other side. usage only Evans & Noel (2005. membership only Filistrucchi(2008) Tilec & Howrey(2010) Notes for the seminar Competition Policy: Advanced Theory and Cases . review of cases. no implementation. critical loss analysis.

The SSNIP Test in 2-Sided Markets: the Issues Key questions for 2-sided markets: How many markets need to be defined (together)? Which price should the hypothetical monopolist be thought of as raising? Which profit changes and feedbacks should be taken into account between the twosides of the market? .

a product can be on one side of the market but not on the other (example…) .In a non-transaction market.How many markets? Observing that .In a transaction market. a product is either on both sides of the market or on none (example…) Then .In a transaction market. two interrelated markets need to be defined .In a non-transaction market . only one market needs to be defined .

each time allowing the hypothetical monopolist to adjust optimally the price structure (=Emch&Thomson(2006)) Notes for the seminar Competition Policy: Advanced Theory and Cases . first one of the two prices should be raised and then the other price. first one of the two prices should be raised and then the other price. each time allowing the hypothetical monopolist to adjust optimally the price structure (≠Evans&Noel(2008)) In a market of the payment card type.Tilburg 2009 25 .Which price? Remembering the rationale behind the SSNIP test defining the market as the smallest set of products on which a monopoly would find it profitable to exercise market power -> the hypothetical monopolist should be allowed to adjust optimally the price structure Therefore In a market of the media type.

Which profit changes and feedbacks? Remembering the rationale behind the SSNIP test: defining the market as the smallest set of products on which a monopolist would find it profitable to exercise market power Observing that A monopolist will take into account Then: total profits (i. profits from both sides) should be considered all feedbacks should be considered (=Emch&Thomson(2006) and Evans&Noel(2008)) .e.

g.Feedbacks:Objections -1 Objections and Answers: Antitrust authorities worried that if two positive externalities and all feedbacks considered. market much wider than single-sided market But that is exactly the point: it is a two-sided market and in a twosided market an hypothetical monopolist is concerned about feedbacks Lawyers worried that the practical benchmark for “enough substitution” is changed (e. but the market still defined as the minimum set of products it is worth monopolising . with positive externatilies you need lower substitution in the initial market to have a loss in profits and therefore a wider market) True.

Feedbacks:Objections-2 Some worried that feedbacks may not be instantaneous True. during such a period feedbacks should have taken place . but irrelevant. as the test requires a “non-transitory” increase in price and a period of one or two years is usually considered.

The SSNIP Test: Feedbacks Positive externalities pA1↑ qA1↓ πA1↑ πA1↓ πA1↑ Normal Market: Does total πA↑? If yes. market not wider .

The SSNIP Test: Feedbacks Positive externalities For given p1B pA1↑ qA1↓ πA1↑ πA1↓ qB1↓ πA1↑ Normal Market: Does total πA↑? If yes. market not wider Feedback to market B πB↓ .

The SSNIP Test: Feedbacks Positive externalities For given p1B pA1↑ qA1↓ πA1↑ πA1↓ qB1↓ πA1↑ Normal Market: Does total πA↑? If yes. market not wider Feedback to market B Should we take this into account? πB1↓ .

The SSNIP Test: Feedbacks Positive externalities For given p1B pA1↑ qA1↓ πA1↑ πA1↓ qB1↓ qA↓ πA1↑ Normal Market: Does total πA↑? If yes. market not wider Feedback to market B πB1↓ Feedback to market A πA1↓ .

market not wider Feedback to market B πB1↓ Feedback to market A πA1↓ .The SSNIP Test: Feedbacks Positive externalities For given p1B pA1↑ qA1↓ Should we take this into account? πA1↑ πA1↓ qB1↓ qA1↓ πA1↑ Normal Market: Does total πA↑? If yes.

market not wider Feedback to market B πB1↓ Feedback to market A πA1↓ .The SSNIP Test: Feedbacks Positive externalities For given p1B pA1↑ qA1↓ and so on πA1↑ πA1↓ qB1↓ qA1↓ … πA1↑ Normal Market: Does total πA↑? If yes.

p1B .p2B πA1↑ πA1↓ qB1↓ qA1↓ … πA1↑ Normal Market: Does total πA↑? If yes.The SSNIP Test: Feedbacks Positive externalities qA2↑ pA1↑ qA1↓ For given p2A . market not wider Feedback to market B πB↓ Feedback to market A πA↓ .

market not wider Feedback to market B πB↓ Feedback to market A πA↓ .The SSNIP Test: Feedbacks Positive externalities qA2↑ pA1↑ qA1↓ qB2 ↑ For given p2A . p1B .p2B πA1↑ πA1↓ qB1↓ qA1↓ … πA1↑ Normal Market: Does total πA↑? If yes.

market not wider Feedback to market B πB↓ Feedback to market A πA↓ . p1B .The SSNIP Test: Feedbacks Positive externalities qA2↑ pA1↑ qA1↓ qB2 ↑ Should we take these into account? For given p2A .p2B πA1↑ πA1↓ qB1↓ qA1↓ … πA1↑ Normal Market: Does total πA↑? If yes.

p2B qA2 ↑ πA1↑ πA1↓ qB1↓ qA1↓ πA1↑ Normal Market: Does total πA↑? If yes. p1B . market not wider Feedback to market B πB↓ Feedback to market A πA↓ .The SSNIP Test: Feedbacks Positive externalities qA2↑ pA1↑ qA1↓ qB2 ↑ For given p2A .

p2B qA2 ↑ Should we take these into account? πA1↑ πA1↓ qB1↓ qA1↓ πA1↑ Normal Market: Does total πA↑? If yes.The SSNIP Test: Feedbacks Positive externalities qA2↑ pA1↑ qA1↓ qB2 ↑ For given p2A . p1B . market not wider Feedback to market B πB↓ Feedback to market A πA↓ .

p2B and so on qA2 ↑ … πA1↑ πA1↓ qB1↓ qA1↓ … πA1↑ Normal Market: Does total πA↑? If yes. p1B .The SSNIP Test: Feedbacks Positive externalities qA2↑ pA1↑ qA1↓ qB2 ↑ For given p2A . market not wider Feedback to market B πB↓ Feedback to market A πA↓ .

Klein & Michielsen (2010) -Song(2011) 41 .The literature on mergers in two-sided markets Mergers in two-sided markets -Chandra and Collard-Wexler(2009) -Lionello(2010) Merger simulation in two-sided markets: -Fan(2010) -Van Cayseele and Vanormelingen (2010) -Filistrucchi.

it might increase consumers’ welfare even if it increases the price consumers pay. 42 . The necessary condition is that at least on one side customers’ enjoy after the merger a higher utility from the network effect. Most importantly.Mergers in two-sided markets A merger in a two-sided market. absent (productive) efficiency gains. Indeed a merger might decrease the price on one side and increase the one on the other side. would lead to a higher price level but not necessarily higher prices on both sides.

you need to collude on both sides (otherwise collusive gain on one side washed out by competition on the other side) -then you need to coordinate on the two sides Probably ok if no institutional constraint (and two network effects?) Argentesi & Filistrucchi (2007) Collusion on the cover price in Italian newspapers Boffa & Filistrucchi (2010) In order to sustain collusion you may want to collude above the twosided monopoly price (preliminary) 43 .Incentives to collude-1 Evans & Schmalensee (2008) More difficult than in one-sided market because .

this makes collusion more desirable. Latter effect dominates and collusion becomes harder to sustain with stronger indirect network externalities. -the gain from deviation increases. -the gain from collusion increases (collusive profits increase and punishment profits decline) . higher asymmetry in network efects reduces the incentive to collude. 44 . Also.Incentives to collude-2 Izabel Rhumer (2010) higher indirect network externalities have two opposing effects on the sustainability of a cartel.

the more likely it is that tying will be a profit maximing strategy and benefit consumers The more asymmetric the network externalities. the more likely it is that subsidizing the low externality side of the market will benefit consumers on both sides. Multi-homing may reduce the negative effects of tying 45 .Tying and bundling Maybe a profit maximizing strategy May increase not only total welfare but also consumers surplus The larger the network externalities across sides.

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