A fine balance

Jean Tirole considers some of their key strategy issues and suggests that regulatory policies need to keep pace.

What do the Sony PlayStation, Windows, American Express, Google and your telecoms provider have in common? They are two-sided platforms whose business model requires bringing two or more sides of a market on board. For example:

• A videogame platform such as the PlayStation needs to attract both users and game developers.
• Advertising-supported media such as newspapers, TV stations or Internet portals must attract both eyeballs and advertisers.
• Payment systems like American Express or MasterCard must ensure that their card is accepted by merchants and used by shoppers.

Two-sided platforms face a chicken-and-egg problem – how to get both sides on board and get them to interact on the platform while making money overall. There are some key issues that platform managers have to consider.

What each side can support

Platforms need to consider what each side brings to the other and what price each can bear. This may lead platforms to “subsidize” one side of the market by “taxing” the other. For example:

• Operating systems such as Windows charge only the consumer; Microsoft loses money or perhaps breaks even on developers of Windows applications.
• Newspaper, television or portal services are often provided free of charge or below cost to readers while advertisers pay to reach their audience.
• PDF-reading software is given away while PDF files are expensive to create.

In the credit card industry, platforms have converged to a model that provides consumers with inexpensive cards while merchants pick up transaction costs. Even at a discount of one or two per cent of the transaction, merchants find it worthwhile to accept the card. The pricing structure is thus designed with an eye to get the cardholder on board.

In most markets, users interact through multiple platforms, which may or may not be interconnected. For instance, in telecommunications, platforms are interconnected: they terminate each other’s traffic in exchange for termination fees. Many platforms, though, are not interconnected. You cannot use your American Express card at a merchant who accepts only Visa and MasterCard. You cannot use an application written only for Windows on your Linux operating system. Connectivity is then achieved through “user multi- homing”. Merchants may choose to accept all cards, or a consumer may have both an American Express and a Visa card in her pocket. Game developers may write their games in two versions, one for the PlayStation and another for the X-box.

Multi-homing matters for the choice of business model

The story of the decrease in merchant discounts is illustrative. American Express, while still quite expensive for merchants, has reduced its merchant fee substantially. In the past, most shoppers had a single credit card that they used for all purchases. With the advent of no- fee cards in the US, Amex customers started to carry other credit cards, such as Visa cards, in their pockets. Merchants understood this and could more easily turn down the high-fee Amex card without losing patrons. Amex was thus forced by increased multi-homing to lower its merchant discount.

The chicken may come before the egg

A new operating system or videogame console must be “evangelized” to developers a few years before it reaches consumers. Since developers must sink large amounts of money upfront, they ask themselves whether there will be users on the other side a few years ahead. Some platforms address this by in-house production or the provision of venture capital to start- ups. Microsoft produced many games itself when introducing its X-Box.

Another approach is to charge fees to the user, the dominant business model for videogame platforms.

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