2-Sided Network Strategies

Competition & Strategy in 2-Sided Platforms
Marshall Van Alstyne Geoffrey Parker
Technology Smackdown
2010 Eisenmann, Parker & Van Alstyne
How does this really work?
7
Can we explain convergence?
8
Info Economics Research Agenda

Products & Network Effects Communications Markets Information & Productivity Economics of IP
Agenda
1. 2. 3. 4. Definitions & new economy concepts. 2-Sided Network Pricing Winner-Take-All Markets Envelopment
Goal: Rigorous analysis of tradeoffs as a guide to strategy.
10
Platforms & Applications

Platform: Components used in common across a product family whose
functionality can be extended by 3rd parties (Boudreau 2007) characterized by network effects (Eisenmann, Parker & Van Alstyne 2009).
Examples:
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. Desktop OS: Unix, Mac, Windows PDAs: Palm, Psion, Newton Game Consoles: Wii, Xbox, Playstation Network Switches: Cisco, IBM, HP Multimedia: Adobe/Flash, MS/Silverlight, Google-Apple/HTML5 Payment Systems: Paypal, Google Checkout, Visa, Apple, Mobile Felica Mobile Devices: iPhone, Android, Symbian, Blackberry Enterprise Systems: Salesforce, Oracle, i2, IBM, SAP Social Networks: Facebook, MySpace, LinkedIn, Monster, Twitter Batteries: Sony, Panasonic, Sanyo, A123 Web Search: Google, Bing+Yahoo!, Baidu Ebooks: Amazon, iPad, Nook, Sony
Managerial Implications
But understand: Winners in a platform market generally have the best platform strategy, not necessarily the best product Best platform?
1. Open (but not too open) interfaces 2. Modular architectures (easy to build on/extend) 3. Compelling complements (generally result of vibrant ecosystem)
Best product? Best standalone value proposition, but while starting here is good, usually not enough to win a platform market
Source: Cusumano 2010
13
Remember this contest?
14
How about this one?
Between 1951-59 RCA spent $130 million in color TV battle with CBS with nothing to show for it.
15
Cable vs. Telco
16
Google vs. Microsoft
vs. Apple
17
Skype vs. Verizon
18
Network vs Computer
Network as the Computer Computer as the Network
19
Question: What are network externalities?

Hint: they matter for pricing, winner-take-all markets, and strategy
20
A network externality is a demand economy of scale.

Examples: phone, fax, IM, email networks.
21
Supply vs. Demand Scale Economies

Standard Goods Price Demand Supply Cost Econ of Scale Demand Supply Demand Econ of Scale Demand Supply
Quantity Rising average costs More competitive supply Oil, Soda, Bread Falling average costs Monopolistic supply Utilities, Semiconductors
22
Often falling avg cost Monopolistic supply OS, IM, MMOG
(Re)interpreting Network Externalities

Network Externalities are demand economies of scale. They imply at least some level of interaction as when I email you, or you FAX or IM me.
Phone
E-Mail
23
FAX
IM
Reinterpreting Network Externalities

Where is the interaction when your neighbor rents Lord of the Rings? In fact, his rental may mean you have to wait!
24
How did Sarnoff win the battle?
...backward compatibility to secure an installed base, and

25
How did Sarnoff win the battle?
26
A 2-sided network externality crosses markets from consumers to developers or developers to consumers
27
Consider profits in two markets

Market One (Acrobat Reader) Market Two (Acrobat Distiller)
Initially, there are profits to be made in both markets.

28

Market One (Acrobat Reader) Market Two (Acrobat Distiller)
But subsidizing market one can increase demand and profits in market two more than the loss in market one.
29

Market One (Operating Systems) Market Two (Developers)
Initially, there are profits to be made in both markets.

30

Market Two Market One (Operating System) (Applications Developers)
But subsidizing market two can increase demand and profits in market one more than the loss in market two.
31
Who should get the subsidy?
32
Readily identifiable platform markets

Product Category Mkt 1 Product Intermediary Mkt 2 Product
Portable Documents Credit Cards Operating Systems HMOs Ladies Nights TV Format Advertisements Computer games Auctions Real Estate
Document reader* Consumer credit* Complementary Applications Patient Treatment * Mens Admission Color UHF, VHF, HDTV* Content* Game Engine/ Player Buying* Home buyers*
Adobe Issuing bank Microsoft, Apple, Sun Kaiser, Harvard Pilgrim Bars, Restaurants Sony, Phillips, RCA Magazines, TV, Radio Games Publishers E-bay, Christies, Sothebys Multiple Listing Service
Document Writer Merchant Processing Systems Developer Toolkits* Doctors Expertise Womens Admission* Broadcast Equipment Advertisers Level Editors* Selling Home Sellers
34 * Indicates which market is discounted, free or subsidized.
Source: Parker & Van Alstyne 2000, 2005
A two-sided network has four network effects

A same-side effect for each side, i.e., preference regarding number of other users on own side A cross-side effect in each direction, i.e., preference regarding number of users on other side
Side 1
Side 2
Platform Provider
38
Each network effect can be positive or negative

+ same-side : Player-to-player
contact in Xbox MMOG, enduser PDF sharing.
Side 1
Side 2
- same-side : competing suppliers

in Covisint auction, competing dates on Match.com
+ cross-side : merchants & Platform Provider

consumers for Visa, developers & end-users for Windows
- cross-side : Digital Rights

Management costs to consumers. Advertising clutter to viewers.
39
Q: Why is price more important in network markets?
A: The entire demand curve can change with price.

Q: Why is price more strategic in 2-sided networks?
A1: Imagine competing on the subsidy side you need a source of subsidy at least as great. A2: You change the size of your (and their) user base!
To Model Complements
Market One
Price Price
p2 q1 q2
Market Two
p1
Quantity
Quantity
Q1 q1 Q1 p1 V1
Q2 q2 Q2 p2 V2
Use simple linear demand functions (but works for almost any functional form).
To Model Complements
Market One
Price Price
p2 q1 q2
Market Two
p1
Quantity
Quantity
Q1 q1 Q1 e21q2 p1 V1
Q2 q2 Q2 e12 q1 p2 V2
Just add network externality terms eij
Choosing which markets to charge

Pdeveloper Adobe Magazine
Pd0, Pc0
Pd0, Pc0
I IV
II
Pd0, Pc0
Pconsumer
III
ID
Region I -- Subsidize C, charge D Region II -- Charge C & charge D Region III -- Charge C, subsidize D Region IV Subsidize both (bad idea)
So which market is subsidized?

Consumer Market
Price
Developer Market
Price
p2
p1 q1
q2
Quantity
Quantity
Consider which market creates more surplus.

Consumer Market
Price
Developer Market
Price
p2
p1
q1
q2
Quantity
Quantity
Consider which market creates more surplus. Subsidize the one that creates more surplus in the cross market.

Consumer Market
Price
Developer Market
Price
p1
q1
p2 q2
Quantity
Quantity
Consider which market creates more surplus. Subsidize the one that creates more surplus in the cross market.
Rules
Subsidize consumer side when
Highly price sensitive
Acrobat Reader, streaming audio, streaming video
Presence is the stronger attractant

Ad markets, credit cards, auctions, search engines
Subsidize developer side when

Critical for adding value
Applications development, operating systems, computer games
Stronger attractant or gatekeeper

Trend setters, textbooks
Winner-Take-All Markets
64
Source: Fast Company.com 5/9/08 2010 Eisenmann, Parker & Van Alstyne
Homing vs. Switching Costs

1 SETUP + 1ONGOING
Mono-homing
2 SETUPS + 1 TERMINATION + 1 ONGOING
Switching
2 SETUPS + 2 ONGOING
Multi-homing
74
When do Winner-Take-All Networks Emerge?

1. Large Supply/Demand Effects (FB vs gas engine) 2. Large Multi-Homing Costs (OS vs credit cards).
Windows
3. Anywhere access? (MMOG vs HMO). 4. Niche specialization is less feasible.

Cyworld Korea has pop
Cyworld US closed.
Attack & How to Control Adjacent Platform Layers

Taking over adjacent markets via Platform Envelopment
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Question: At the time of introduction, was MS Office best-of-breed in anything?

Bundling Components to Envelope Markets
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Independent Pricing: Spreadsheet
100 Word Processing Charge 50 Sell to mkt Make 25
100 50 Spreadsheet
Based on (defense) Nalebuff 2004, (attack) Eisenmann, Parker & Van Alstyne 2011
Independent Pricing: Word Processing
100 Word Processing 50 Charge 50 Sell to mkt Make 25
100 Spreadsheet
Independent Pricing Word & Excel
100 Word Processing 50

Buy Excel
Buy Word
Buy Both
Charge 50 Sell to mkt Make 25

Incumbent Profits from both markets are 50
100 Spreadsheet
Competitor WordPerfect (or Lotus) undercuts price

100 Word Processing 50
Charge 49 Sell to 0.51 mkt Makes ~25 Incumbent profits drop from 50 to 255
100 Spreadsheet
Pricing Word & Spreadsheet as a Bundle
100 Word Processing
Charge $100 for 2 Sell to market Make 50 (same combined profits as before)
100 Spreadsheet
Competitor WordPerfect (or Lotus) undercuts price but makes as much

Charges $49 Sells to .25 mkt Makes 12.25
Entrant profits cut by half Incumbent Bundled profits fall only half as much
100 Word Processing
100 Spreadsheet
Side by Side Comparison

Independent Sales Product A
Product A
Bundled Sales
Product B
Incumbent profit: .5x.5=.25 Entrant profit: .49x.51.25
Product B Incumbent profit: 1*.5-.125=.375 Entrant profit: .5*.25=.125
Rhapsody
Who are the players? Where are the network effects? What would you do?
94
Real Audio & Envelopment

RA pioneers streaming audio (gives away player) Microsoft bundles WMP in Windows
$ Users Content
Real Audio
Microsoft

RA pioneers streaming audio Microsoft bundles WMP in Windows RA switches strategy ( introduces subscription content)
$ Users Content
Real Audio
Microsoft

Yahoo!
Portal Ads
Users
Content
RA pioneers streaming audio Yahoo! attacks, subsidizes users via portal advertising
Real Audio
Microsoft

Apple Yahoo!
iPod Sales
Users
Content
RA pioneers streaming audio Apple subsidizes iTunes via iPod sales
Real Audio
Microsoft

Apple + AT&T Apple Yahoo!
Cellphone Svc
Users
Content
RA pioneers streaming audio Mobile phone service bundles music in service agreement.
Real Audio
Microsoft
like playing 3D chess.
Defensive Strategies
Innovate (e.g., Adobe moving from document presentation to document management) Cede and redeploy preferably through platform envelopment! (e.g., RealNetworks move from streaming media to subscription media) Find a bigger brother (e.g., RealNetworks + Comcast, Cingular in response to envelopment threat from Yahoo et al. in subscription media) Sue (e.g., RealNetworks collects $760 million from Microsoft, forces unbundling in EU)
10 1
Platform Envelopment Explains Convergence
10 2
Coming Platform Applications
Smart Grid Energy Platform Standards (WSJ 5-18-09!) Electronic Medical Records (Google, Experimentation ) Cloud Computing & Business Model Microsoft, WebMD
Conclusions
Business models that give strategic advantage in network markets:
Design products for 1) proprietary complementarity, 2) price sensitivity, 3) developer value add, and 4) low marginal costs.
Winning Standards Battles: Winner-take-all platforms arise from both supply and demand economies of scale.
Find ways to manipulate 1) multi-homing costs, 2) same & crossside network effects, and 3) localization 4) bundling.
Platform envelopment is a means of bundling a competitors users or technology money side into your platform.
Explains convergence!
104
Questions?
Information Complements, Substitutes & Strategic Product Design Parker & Van Alstyne 2000. http://ssrn.com/abstract=249585 Two Sided Network Effects Parker & Van Alstyne Management Science, Oct. 2005; 51(10), pp. 14941504. http://ssrn.com/abstract=1177443 Strategies for Two-Sided Networks Eisenmann, Parker & Van Alstyne Harvard Business Review Oct. 2006. Opening Platforms: How, When & Why Eisenmann, Parker & Van Alstyne Ch. 6 in Gawer, A. (ed) (2009) Platforms, Markets and Innovation, http://ssrn.com/abstract=1079712 Innovation, Openness & Platform Control Parker & Van Alstyne (2008)
http://ssrn.com/abstract=1079712
"Six Challenges in Platform Innovation and Open Licensing," Parker & Van Alstyne Communications & Strategies, no. 74, Q2 2009, p. 17-36. http://ssrn.com/abstract=1559013 Platform Envelopment Eisenmann, Parker & Van Alstyne; Strategic Management Journal (forthcoming 2011). http://ssrn.com/abstract=1496336 [email protected] [email protected] [email protected]

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Competition & Strategy in 2-Sided Platforms

Marshall Van Alstyne Geoffrey Parker

2010 Eisenmann, Parker & Van Alstyne

2010 Eisenmann, Parker & Van Alstyne

2010 Eisenmann, Parker & Van Alstyne

How does this really work?

Can we explain convergence?

Info Economics Research Agenda

Platforms & Applications

Remember this contest?

How about this one?

Cable vs. Telco

Google vs. Microsoft

Skype vs. Verizon

Question: What are network externalities?

A network externality is a demand economy of scale.

Supply vs. Demand Scale Economies

Often falling avg cost Monopolistic supply OS, IM, MMOG

(Re)interpreting Network Externalities

2010 Eisenmann, Parker & Van Alstyne

Reinterpreting Network Externalities

How did Sarnoff win the battle?

...backward compatibility to secure an installed base, and

How did Sarnoff win the battle?

Consider profits in two markets

Initially, there are profits to be made in both markets.

Consider profits in two markets

Consider profits in two markets

Initially, there are profits to be made in both markets.

Consider profits in two markets

Who should get the subsidy?

2010 Eisenmann, Parker & Van Alstyne

Readily identifiable platform markets

34 * Indicates which market is discounted, free or subsidized.

Source: Parker & Van Alstyne 2000, 2005

2010 Eisenmann, Parker & Van Alstyne

A two-sided network has four network effects

Each network effect can be positive or negative

- same-side : competing suppliers

+ cross-side : merchants & Platform Provider

- cross-side : Digital Rights

Q: Why is price more important in network markets?

A: The entire demand curve can change with price.

Source: Parker & Van Alstyne 2000, 2005

Just add network externality terms eij

Source: Parker & Van Alstyne 2000, 2005

Choosing which markets to charge

Source: Parker & Van Alstyne 2000, 2005

So which market is subsidized?

Consider which market creates more surplus.

Source: Parker & Van Alstyne 2000, 2005

So which market is subsidized?

So which market is subsidized?

Presence is the stronger attractant

Subsidize developer side when

Stronger attractant or gatekeeper

Source: Parker & Van Alstyne 2000, 2005

Homing vs. Switching Costs

When do Winner-Take-All Networks Emerge?

3. Anywhere access? (MMOG vs HMO). 4. Niche specialization is less feasible.

Product B Incumbent profit: 1.5-.125=.375 Entrant profit: .5.25=.125