Two-Sided Markets

• Pages: 437-469

437

CHAPTER XI

TWO-SIDED MARKETS

A. Introduction

Nightclubs and online dating companies provide services to men and

women who want to meet. Credit cards enable consumers who have

them and merchants that accept them to transact with one another. Video

game platforms, such as Sony PlayStation or Nintendo, provide software

tools that enable publishers to develop games and a device on which

consumers can play those games. In each case, the business provides a

platform that enables two distinct but related groups of customers to

obtain value. These “two-sided platforms” or “two-sided markets”

characterize a wide variety of industries.1

1. For a review of the literature on two-sided markets and antitrust cases

involving such markets, see TILBURG LAW AND ECONOMICS CENTER &

HOWREY LLP, MERGERS IN TWO-SIDED MARKETS (2010), available at

www.nma.nl/Images/NMa%20Two-Sided%20Markets%20-

%20Report%20-%2016%20July%202010_tcm16-140396.pdf.

[hereinafter MERGERS IN TWO-SIDED MARKETS]. See also E . Glen Weyl,

A P rice Theory of Multi-Sided Platforms, 100 AM. ECON. REV., 1642

(2010; David S. Evans & Richard Schmalensee, Industrial Or ganization

of Markets with Two-Sided Pla tforms, 3 COMPETITION POL’Y INT’L 150,

152 ( 2007) [hereinafter Evans & Schmalensee, Industrial Organization]

(“Many diverse industries are populated by businesses that operate ‘two-

sided platforms.’ These businesses serve distinct groups of customers

who need each other i n some way, and the core business of the two -sided

platform is to provide a common (real or virt ual) meeting place and to

facilitate interactions between members of the two distinct customer

groups. Two-sided platforms are common in old-economy industries

such as those based on advertising -supported media and new-economy

industries such as those based on software platfor ms and web portals .

They play an important role throughout the economy by minimizing

transactions costs between entities that can benefit from getting

together.”). Many platforms have more than two groups of distinct users.

See David S. Evans & Michael Noel, The Analysis of Mergers That

Involve Multisided Platform Businesses, 4 J. COMPETITION L. & ECON.

438 Market Definition in Antitrust

In antitrust cases involving two-sided platforms, market definition

and market power analyses must take into account several economic

issues that do not arise in other contexts. The two sides of a platform

business are closely linked, with interdependent prices and outputs and

intertwined strategies. For example, if an online dating service increased

its prices to women, it would attract fewer women to its site. As a result,

it would lose male members and, with fewer men, even more women

would desert the service. As another example, credit card issuers offer

reward programs to persuade more people to use credit cards. As credit

card use increases, card issuers can convince more merchants to pay to

accept the card. To understand the relevant competitive relationships,

one must consider both sides of the platform business.

A platform can earn profits on either side. In practice, two-sided

platforms often obtain most of their incremental profits on one side and

may provide services to the other side at prices below incremental costs.

For example, video game platforms earn most of their profits “on game

developers through per-unit royalties on games and fixed fees for

development kits and treat the gamers side as a loss leader.”2

Most standard approaches to market definition, such as the small but

significant and nontransitory increase in price (SSNIP) test, diversion

ratios, and other economic models and formulae, do not apply to two-

sided markets without modification, occasionally radical in nature.3

663, 664 (2008) [hereinafter Evans & Noel] (“ Many old industries are

based on [multisided platforms or] MSPs, ranging from village

matchmakers that date from ancient times to advertising supported

newspapers introduced in the seventeenth century to payment cards

introduced in the mid-twentie th century. However, an increasing number

of significant modern businesses are MSPs as a result of technological

changes that have drasticall y lowered the costs and increased the benefits

of connecting diverse customer groups on a single platform. These

include most Internet-based businesses such as eBay, Faceb ook, and

Google. These businesses ar e creating new products and services such as

social networking platforms and are disrupting existing industries such as

advertising-supported media.”). This chapter focuses on two-sided

platforms, but most concepts extend readily to multisided platforms.

2. Jean-Charles Rochet & Jean Tirole, P latform Competition in Two-Sided

Markets, 1 J. EUR. ECON. ASS’N 990, 990-91 (2003) [hereinafter Rochet

& Tirole, Pla tform Competition].

3. David S. Evans, Competition and Regulator y P olicy for Multi-Sided

Platforms with Applications to the Web Economy, 2 CONCURRENCES 57

¶ 28 (2008) (providing an overview of two-sided platforms); E vans &

Noel, sup ra note 1, at 675 (explaining that “the one-sided Critical Loss

Two-Sided Markets 439

Many of these “standard tools of antitrust and merger analysis . . . were

developed based on the economics of single-sided businesses” and “do

not necessarily apply in ways that are material to the analysis of

competition that involves multisided businesses.”4 For example, one

common approach—using the price-cost margin on one side to assess

critical loss—tends to understate the effects of a merger on prices

compared with the two-sided market formula.5 Another approach—

estimating demand elasticities directly based on a standard one-sided

model—tends to overstate the effects of a merger on prices.6

This chapter describes how two-sided platforms operate, explains the

basic economics of profit-maximization for two-sided businesses, and

notes some of the unique aspects of competitive strategies when one of

the rivals is two-sided. It summarizes key market definition issues,

shows the extent to which the use of standard techniques for two-sided

platforms can result in bias, and addresses some basic conceptual issues

for markets with two-sided platforms, such as how to measure output and

which firms to include in the analysis. Finally, it discusses cases and

agency decisions concerning two-sided markets.

B. The Economics of Two-Sided Platforms

A two-sided platform provides goods or services to two distinct

groups of customers who need each other in some way and who rely on

formulas for conducting the hypothetical monopolist test are wrong when

applied to two-sided markets”); Evans & Schmalensee, Industr ial

Organization, supra note 1, at 151 (“[P]rofit-maximizing prices may

entail below-cost pricing to one set of customers over the long run and, as

a matter of fact, many two-sided platforms charge one side prices that are

below marginal cost and are in some ca ses negative. These and other

aspects of two-sided platforms affect almost all aspects of antitrust

analysis—from market definition, to the analysis of cartels, single-firm

conduct, and efficiencies.”).

4. Evans & Noel, supr a note 1, at 664 (“Each side of the MSP’s business

influences and constrains its strategies on the other side. Antitrust

analysis that focuses on one side of the business in isolation from the

other side is incorrect as a matter of economics, and can lead to the wrong

answer when indirect network effects ar e significant and are relevant for

assessing the practice at issue.”).

5. Id. at 682.

6. Id. at 670.