What to do if you are a platform with two-sided network effects February 9, 2007Posted by jeremyliew in Consumer internet, Digital Media, Ecommerce, Entrepreneur, Internet, start-up, startups, VC, Venture Capital, web 2.0.
I subscribe to Harvard Business Review but rarely read it – the long articles intimidate me! However, a friend of mine recently pointed me to a fantastic article in the October 2006 edition entitled “Strategies for Two-Sided Markets” by Thomas Eisenmann, Geoffrey Parker and Marshall W. Van Alstyne that is well worth reading.
The article addresses a common phenomona in technology, where a platform brings together two groups of users, each attracted to the other group. Examples might include Ebay (bringing together buyers and sellers), Monster (bringing together job seekers and employers), Youtube (bringing together video posters and video watchers), even Gaming Consoles (bringing together game developers and players). The article discusses all such platforms, but I found the most interesting cases to be when members of both groups want to be part of the platform where there are the most members of the other group, or “cross-side positive network effects” in the parlance of the article.
The article answers two critical questions to owners of such platforms:
Who do you charge?
In a two sided market, you can charge one side or the other, or both. Typically platforms end up charging one side (the Money side) and subsidizing the other.The article suggests that there are six guidelines in making this decision, some more obvious than others. I’ll highlight three of them here:
Subsidize the more price sensitive side. E.g. Adobe gives away its PDF reader for free but charges for Acrobat.
Subsidize the side that is more sensitive to quality (i.e. charge the side that has to PROVIDE quality – and let suppliers use their willingness to pay as a signal of quality). E.g. console game players (PS3, Xbox 360, Wii) demand high quality. Developers pay a high fixed cost to deliver quality so they need a lot of players to make their business models work. They are willing to pay a high royalty and adhere to strict licensing terms to reach those big audiences.
If strong “same-side negative network effects” exist on one side (e.g. if one side would prefer not to see too many others on the same side, such as competitive suppliers), charge that side and possibly limit the number of available slots. E.g. Autobytel gives zip code exclusivity to dealers in a given territory and charges dearly for that limitation
Proprietary or shared platform?
Often in these sorts of markets only one platform will survive because both groups want to be on the platform where there are the largest numbers of the other group. Competitive platforms need to make a “bet the company” decision – to fight to be the winning platform, or to cooperate and share a single platform. The article says that there is typically a single winner if the following conditions apply:
Multi-homing costs are high for at least one user side – i.e. it is expensive to support multiple platforms. This is true in the case of online auctions (if I only have one antique cuckoo clock, it can only list it in one place) and not true in the case of job sites (its easy to post my resume on both Hotjobs and Monster).
Neither side’s users have special needs. If the market can be segmented then different platforms can co-exist, each serving a niche.
High definition DVDs looks like a market that fits these criteria. Blu ray and HD DVD are battling it out to be the winning platform. Typically the winner of such a war of attrition will have (i) Cost or differentiation advantages (longer play times, better image quality) (ii) Pre-existing relationships with prospective users (movie studios) (iii) Reputation for past success and (iv) Deep pockets. Often, because of the confidence of the executive teams in their products and the winner-take-all nature of these industries, competitors will choose to fight. However, cooperating can also bring benefits including a greater overall market size (when standards take longer to emerge many users delay commiting to either platform) and lower overall marketing costs.
The article also addresses questions such as when to be a first mover (and more importantly, when not to be a first mover), and how to deal with envelopment from adjacent platforms (relevant to those facing Microsoft’s “Embrace, Extend, Destroy” strategy). If your company is a platform that faces these “cross-side positive network effects”, I highly recommend reading “the article ”