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Mobile Application Pricing

Joshua Gans May 2011

Emergence of Mobile Platforms

Process
Revenue Sharing Exclusivity Most favored customer clauses

Purchase a device

Set Platform Developer Terms

Purchase Platform Access

Set App Prices

Purchase App

What motivates the ‘balance’ of platform and app pricing? Why might platforms impose restrictive conditions?

Why purchase access?

Direct access

Platform access

Model Set-Up
•  Consumer utility
•  •  •  •  Direct access: v – x – t – p Platform access: v – x – P – p h: share with high transaction cost x and t independently distributed t !{ t , t } x ! U[0,1]

" (1! h) v ! t ! p + h v ! t ! p $ d( p) = # v! t ! p $ %

(

) (

)

if

v!t & p v!t < p

Direct Access
•  No app costs •  Single app provider •  Two possible outcomes:
Cover market

p* = 1 (v ! (1! h)t ! ht ) 2

h ! (v" t()(2 tt "2t "v ) t" ) h < (v! t()(2 tt !2t !v ) t! )

Low only

p = (v ! t)
* 1 2

Platform Only
•  Timing
1.  Set ad valorem revenue share to platform, a 2.  Set platform access price, P 3.  App provider chooses price, ρ

•  Suppose platform marginal cost is c •  Result: For c sufficiently low, unique equilibrium involves P = 0, ρ = v/2 and a close to l. Platform only provided if v ≥ 2c.

Intuition
!

ˆ !
! =v"x
! =v"x"P

x

Independent Pricing
•  Suppose that both direct access and platform access are available •  With independent pricing, the app provider can set p and ρ separately •  Result: Platform only intuition carries over and unique equilibrium prices are the same.
–  There is no direct access –  a is constrained so that app provider earns direct access profits –  Platform only provided if av ≥ 2c

Evidence of unraveling?

Variations
•  Exclusivity: platform exclusivity would generate the same outcome •  Capped retail price: Amazon caps retail price at $9.99 if want 70% sharing, otherwise 35% share. •  Linear wholesale prices set by app provider and platform retail prices (old Kindle model)
–  In equilibrium, P = 0 and retail price is (3/4)v

•  Integrated platform features
–  Suppose that independent of app usage, consumers value platform access at Δ –  Unique equilibrium involves P = Δ and ρ = v/2 –  Still cost independent

Benchmark: Full Integration
•  Firm only wants to sell to high types on the platform (optimal if t < c) •  Firm sells to all on the platform (optimal if t > c) ! + P = 1 (v + c) 2 •  Thus, without integration, platform prices are ‘too low’ and result in potential over-use if t < c. •  If there are fixed costs associated with platform development, may be cases where it is not developed when it is socially efficient.

Equilibrium with P > 0?
•  Suppose platform improved reader experience (lowered transaction costs even for direct access)
–  In equilibrium ρ > p (all direct access if a > 0) –  Unraveling will still occur for P < t –  For P > t, there exists an equilibrium with a positive P. The app provider has some consumers who do not have platform access and this constrains its direct access price –  But if h is too high, the app provider switches to supply only on the platform and unraveling occurs.

•  Platform subscriptions: pricing of complements game.

Most Favored Customer Clauses
•  Apple and Amazon require ρ ≤ p •  When P = 0, an MFC does not bind •  What happens when P > t?
–  App provider’s price constrained by direct access consumers –  For low h, equilibrium involves a = 1 and P > 0 –  For high h, for low a, app provider can replicate direct access profits by setting its price equal to the pure direct access price. In equilibrium, it will price higher.

•  For low h, MFC will be welfare improving. For high h, low transaction cost types will be worse off and may prefer platform access option not to exist.

Conclusions
•  Non-trivial unraveling problem in providing platform access with independent app pricing
–  Constrains platform price to be 0 (independent of cost) –  May result in over-use of platform and too little appropriability

•  Contract restrictions on app providers may increase profits and possibly welfare