Week 3: Strategies for Two-Sided Markets (Eisenmann et al., 2006) Article PDF

Stuvia - Koop en Verkoop de Beste Samenvattingen Week 3: Strategies for two-sided markets (Eisenmann et al., 2006) Companies in industries such as banking, software, and media make money by linking markets from different sides of their customer networks – audiences and advertisers, for example. The...

Stuvia - Koop en Verkoop de Beste Samenvattingen Week 3: Strategies for two-sided markets (Eisenmann et al., 2006) Companies in industries such as banking, software, and media make money by linking markets from different sides of their customer networks – audiences and advertisers, for example. The distinct character of these businesses demands a new approach to strategy. The products/services that have redefined the global business landscape often connect two distinct groups of users in a network. Platforms = Products and services that bring together groups of users in two-sided networks - Platforms provide infrastructure and rules that facilitate the two groups’ transactions and can take many shapes. In some cases, platforms rely on physical products: as with consumers credit cards and merchants’ authorization terminals. In other cases, they are places providing service: like shopping malls or Web sites such as Monster and eBay. Two-sided networks differ from other offerings in a fundamental way. In the traditional value chain, value moves from left to right: To the left of the company is cost; to the right is revenue. In two-sided networks, cost and revenue are both to the left and the right, because the platform has a distinct group of users on each side  The platform incurs costs to serve both groups and can collect revenue from each, although one side is often subsidized Network effect = platform’s value to any user largely depends on the number of users on the network’s other side  Value grows as the platform matches demand from both sides.  Because of network effects, successful platforms enjoy increasing returns to scale. Users will pay more for access to a bigger network, so margins improve as user bases grow. Yet for all the potential they’ve spotted, platform providers have struggled to establish and sustain their two-sided networks. Their failures are rooted in a common mistake: - Managers have relied on assumptions and paradigms that apply to products without network effects. As a result, they have made decisions that are inappropriate for the economics of their industries. 10 Gedownload door: matsmolenberg | [email protected] Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. ¤ 912 per jaar extra verdienen? Stuvia - Koop en Verkoop de Beste Samenvattingen The challenges of two-sided networks Pricing the platform, Winner takes all and the threat of envelopment Challenge 1: Pricing the platform In competitive industries, prices are determined by the marginal cost of producing an extra unit, and margins tend to be thin. - - - - Two-sided platforms providers have to choose a price for each side, factoring in the impact on the other side’s growth and willingness to pay A characteristic of two-sided networks is that there is a subsidy side= a group of users who, when many attracted, are highly valued by the money side= the other user group. The goal is to generate “cross-side” network effects: If the platform provider can attract enough subsidy side users, money-side users will pay handsomely to reach them. Cross-side network effects also work in the reverse direction. The presence of money-side users makes the platform more attractive to subsidy-side users, so they will sign up in greater numbers Pricing is further complicated by “same-side” network effects, which are created when drawing users to one side helps attract even more users to that side. o For example, as more people buy PlayStation consoles, new users will find it easier to trade games with friends or find partners for online play. Examples of two-sided networks: 11 Gedownload door: matsmolenberg | [email protected] Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. ¤ 912 per jaar extra verdienen? Stuvia - Koop en Verkoop de Beste Samenvattingen To make the right decision on pricing two-sided networks, the following factors are established:  Ability to capture cross-side network effects: Your giveaway will be wasted if your network’s subsidy side can transact with a rival platform provider’s money side.  User sensitivity to price: it makes sense to subsidise the network’s more price sensitive side and to charge the side that increases its demand more strongly in response to the other side’s growth. o For example: Adobe PDF viewers are more price-sensitive (less likely to view them when charged even a small price) than Adobe PDF writers, who greatly value the huge audience they get via PDFs and thus pay a fee for their software.  User sensitivity to quality: charge the side that must supply quality, instead of the side that demands it. o Such a strategy is evident in video games. To deliver compelling quality, game developers incur enormous fixed costs. To amortize these costs, they must be assured that the platform has many users. Hence the need for a consumer subsidy.  Output costs: if every new user on the subsidy side costs the platform provider basically nothing, pricing decisions are easier. o This will be the case when the giveaway takes the form of a digital good such as a software program or a low-cost service such as otherwise unused computer time. When a giveaway product has significant unit costs, such as with tangible goods platform providers should be more cautious. If a strong willingness to pay does not materialize on the money side a giveaway strategy with high variable costs can quickly incur large losses.  Same-side network effects: sometimes it makes sense to exclude some users from the network because of the possibility of negative network effects on the same side. o Sellers are happy to see fewer rivals; the same goes for buyers when goods are scarce.  Users brand value: attracting "large users" (these may be exceptionally large buyers or prominent suppliers) can be particularly important in attracting participants to the other side of the network. Challenge 2: The Winner Takes All Dynamics The prospect of increasing returns to scale in network industries can lead to winner-take-all battles, so an aspiring platform provider must consider whether to share its platform with rivals or fight to the death. A networked market is likely to be served by a single platform when the following three conditions apply: 1. Multi-homing costs are high for at least one user side Homing costs = all costs incurred by network users - including adoption, operation and opportunity costs of time - to establish and maintain connection to the platform. When users make a “home” on multiple platforms, they increase their outlays accordingly. For example, PC users rely on one operating system - like Windows - because using multiple operating systems is expensive in terms of the additional software training. 12 Gedownload door: matsmolenberg | [email protected] Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. ¤ 912 per jaar extra verdienen? Stuvia - Koop en Verkoop de Beste Samenvattingen 2. Network effects are positive and strong–at least for the users on the side of the network with high multihoming costs - When cross-side network effects are positive and strong, those network users will tend to converge on one platform. A small platform will be of little interest to users, unless it is the only way to reach certain users on the other side. 3. Neither side’s users have a strong preference for special features. - If certain users have unique needs, smaller, differentiated platforms can target those - needs and tap into niches in the shadow of a larger competitor For example, American Express earns high margins despite having issued only 5% as many credit cards as Visa. American Express cards have no preset spending. Visa cannot match this feature, because the loans it extends to cardholders put an upper limit on their spending. In cases where special features are not important, however, users will tend to converge on a single platform. The three abovementioned conditions all meet the DVD industry as: - First, multi-homing costs are high for consumers because it would be expensive to buy multiple players Second, cross-side network effects are strong for both sides of the network. Most consumers value access to a wide variety of titles, and studios realize scale economies when they can sell to more consumers. Third, opportunities for technical differentiation are modest, because DVD players connect to TV sets, which are standardized in ways that intrinsically limit DVD picture and sound quality. Challenge 3: The threat of envelopment Even when address pricing is successfully and winner-takes-all challenges and establish a successful new platform, a company can still face significant risks. Why? - The platform may be "surrounded" by a neighbouring platform provider who enters the market Networked markets are rich with envelopment opportunities that can blur market boundaries (Blurring is called convergence). - For example, mobile phones now incorporate the functionality of music and video players. In many cases, an independent company facing encirclement has little choice but to sell to the attacker or leave the field. - However, RealNetworks manage to survive. The pioneer of streaming media software, is at least so far, a good example. Real’s original business model was ideally suited to the needs of its two-sided network: Consumers downloaded its streaming media player for free, and content companies paid for its server software 13 Gedownload door: matsmolenberg | [email protected] Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. ¤ 912 per jaar extra verdienen? Stuvia - Koop en Verkoop de Beste Samenvattingen - Then they faced competition from Microsoft, who bundled its streaming software (Windows Media Player) with printing, mailing, and Web servers. The defence of RealNetworks against Microsoft and, more recently, Yahoo and Apple shows what a focused firm can do to survive envelopment. Namely: 1. Change business models: Real’s response to Microsoft’s envelopment attack was to switch its money side: - Real leveraged existing relationships with consumers and music companies to launch Rhapsody in 2003, charging $10 per month for unlimited streaming to any PC from a library of a half million songs. Real now profited from consumers, rather than subsidizing them 2. Find a bigger brother When bullied on the playground, a liEle guy needs a big friend. - Real has found allies through partnerships with cable TV system operators and cellular phone companies. Cellular carriers can aFord to subsidise digital music playback on their phones, since doing so would be likely to reduce mobile churn rates. That would present a big threat to Apple’s money side. 3. Sue Firms facing envelopment are wise to consider legal remedies, because antrust law for two-sided networks is sll in dispute - Antrust law was conceived to constrain the behavior of tradional manufacturing Irms and does not fully reect the economic imperaves of plaAorm-mediated networks. For this reason, dominant plaAorm providers that oFer bundles or pursue penetraon pricing run the risk of being charged with illegal tying or predaon. 14 Gedownload door: matsmolenberg | [email protected] Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. ¤ 912 per jaar extra verdienen?