Two-Sided Markets, Two-Sided Networks… The Yin-Yang of Business Models: Works for Google, eBay, Amazon, Apple, Microsoft…

Two-Sided Markets– It seems like the quickest way to make a billion dollars, these days, is to create a successful two-sided market (or also called– two-sided network, two-sided platform…). A two-sided market is an economic platform having two distinct user groups that provide each other with network benefits...

For example; Google is a two-sided market, it serves information seekers (on the one side) and advertisers on the other… Another is eBay; eBay provides space where people who want to sell something and people who want to buy something can interact (through an auction). The way that eBay makes money is by charging sellers whenever they list something…

There are many other examples, including; Facebook, Match.com, Amazon, Microsoft, Apple, Airbnb… The distinguishing characteristic of a two-sided market is that the price structure is not neutral; the structure of pricing will affect the extent of participation and usage in the marketAccording to Ruhai Wu; these platforms have gained remarkable success because of a unique feature– positive cross-side network effect; more buyers on a platform attract more sellers, and more sellers consequently attract more buyers…

two thKBFYIXPJPioneering work on the study of ‘platform markets’ or ‘two-sided markets’ or ‘two-sided networks’ was done by Jean Tirole, who won the 2014 Nobel prize in economics for his work… According to Tirole; two-sided markets are markets where a firm brings together two or more sides, both of which benefit by existence of the platform and both of which may (or may not) be monetized… Key difficulty in these markets is that the price charged to one side of the market influences the demand on other side of the market.

The concept is not especially complex; basic idea is that there’s a platform operated by a business that serves two or more groups of customers: When demand grows from one group, it exerts a disproportionate effect on demand from the other, and in the most interesting cases, a virtuous circle of demand forms on both sides… the key is to incentivize the group that benefits least from the relationship…

According to David S. Evans; when the theory of two-sided markets was first introduced it was common to hear at least two complaints, such as; it’s nothing new it’s just the indirect ‘network effects’ or ‘wine in new bottles’… it all been considered before… Or, it’s a theory of everything and therefore nothing, since everything seems to be two-sided… One of the problems with two-sided market analysis is that it’s hard to find formal limiting principles, but it’s not uncommon in economics. Sometimes a two-sided market perspective is highly informative, while other times it’s not: It matters when it matters…

Two-sided markets require a very different way of thinking and they have very different economics, and while only developed just a couple of decades ago, two-sided markets have become one of the most influential economic concepts…

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In the article Two-Sided Markets: An Overview by Jean-Charles Rochet, Jean Tirole write: Two-sided (or more generally multi-sided) markets are roughly defined as markets in which one or several platforms enable interactions between end-users, and try to get the two (or multiple) sides ‘on board’ by appropriately charging a fee to each side. That is, platforms court each side while attempting to make, or at least not lose, money overall…  

A market is two-sided when the platform can affect the volume of transactions by charging more to one side of the market and reducing the price paid by the other side by an equal amount; in other words, the price structure matters, and platforms must be designed so as to bring both sides on board. That is, the relationship between end-users must be fraught with residual externality; factors conducive to two-sidedness include; transaction costs among end-users and platform-imposed constraints on pricing between end-users…

In the article Platform Markets by Alex Tabarrok writes: A difficulty in two-sided markets is the price charged to one side of the market influences the demand on the other side of the market, for example; the price that a newspaper charges to readers influences the number of readers but that in turn influences the price that advertisers, the other side of the market, are willing to pay to advertise…

It often happens that one side of the market is harder to ‘get’ than the other, and so the profit-maximizing prices on the two sides of the market are very different, and one side of the market may even be ‘subsidized’… The price that newspapers charge readers, for example, is often much less than the cost of the newspaper…

In a shopping mall, for example, it’s often largest firm (anchor) gets the lowest rent (sometimes even zero): But, does this represent an unfair advantage that a large firm has over smaller rivals or is it a rational consequence of the fact that the ‘anchor’ store may bring the most customers to the other, smaller stores in the mall, so that the total package is welfare maximizing? Is Microsoft engaging in predatory pricing if it prices the Xbox at or below cost? Or, when a ‘singles’ bar may have– ‘ladies are free night’: Is that sexist or good economics? Platform markets mean that pricing at marginal cost can no longer be considered optimal in every market, and pricing above marginal cost can no longer be considered as an indication of monopoly power. The analysis also impacts such issues as network neutrality…

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In the article Strategies for Two-Sided Markets by Thomas Eisenman, Geoffrey Parker, and Marshall W. Van Alstyne write: Two-sided networks differ from traditional value chains in a fundamental way: In the traditional system, 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 to the right, because the ‘platform’ has a distinct group of users on each side. The platform product or service incurs costs in serving both groups and can collect revenue from each, although one side may be subsidized… Because of what economists call ‘network effects’, these platform products enjoy increasing returns to scale, which explains their extraordinary impact. Yet most firms still struggle to establish and sustain their platforms.

Their failures are rooted in a common mistake: In creating strategies for two-sided networks, managers typically rely on assumptions and paradigms that apply to products without considering ‘network effects’. As a result, they make decisions that are inappropriate for the economics of their industries… The key decision here is pricing; providers of platforms for two-sided networks are able to draw revenue from both sides. In most cases, though, it makes sense to subsidize certain users. The crucial strategy question is; Which side should you subsidize, and for how long?

Two side marketplace businesses are possibly one of the holy grails of online business models… According to Philip Brown; in a two-sided marketplace, buyers and sellers conduct transactions through a centralized platform. Both sides of the marketplace are self organized and so, the platform owner is able to take a transactional ‘rake’… These types of businesses are extremely defensible because of the ‘network effects’ of marketplaces and high switching costs of moving to another marketplace. For each new buyer or seller that enters the market, the market as a whole becomes stronger… However, two-sided markets are incredibly difficult to pull off due to ‘chicken or egg dilemma’; without buyers, you won’t attract sellers, and without sellers you won’t attract buyers…

Probably the most important overall strategy for building a two-sided marketplace is to start with a market niche. If you try to target a market opportunity that is too big, or take on a competitor head-on then that is a recipe for failure. If you try to appeal to everyone, you will end up appealing to no one… According to Geoffrey Moore; the ultimate goals of creating a two-sided marketplace is that it’s a business model that scales indefinitely. The real beauty of two-sided marketplaces is the power of the ‘network’ and how each side self organizes around the platform…

Two-sided marketplace businesses are very attractive because they are defensible and able to scale with a clear repeatable business model Platforms play an important role throughout the economy by minimizing transactions costs between entities that can benefit from getting together. In these businesses, pricing and other strategies are strongly affected by the ‘indirect network effects’ between the two sides of the platform…

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According to Thomas Eisenmann, Geoffrey Parker, Marshall W. Van Alstyne; the fact that circumstances make it possible for a platform to exist does not mean that it will. Moreover, even if a platform is built, potential customers may find other ways to obtain the services… Attracting complementary participants to a multi-sided market and keeping them there requires the right pricing structure, as well as the right price levels… Traditional market research, which predicts prospective customers’ reaction to varying price points, won’t help much, since the demand by multiple groups of platform customers is interdependent. You thus must figure out how much each side values the other, then calculate the prices that will make sure that both sides show up in the right numbers– and, of course, make sure the revenues will still be adequate to generate a profit…

Although pricing is important, it’s only one element in the design and implementation of a platform strategy… Experimenting on a small-scale and then expanding can help platform businesses avoid catastrophic losses… Markets hardly ever cooperate by following simple rules derived from economic theory. In traditional markets, however, economic truisms can at least serve as benchmarks and starting points for more nuanced analysis…

But by contrast, multi-sided platforms, especially those in new markets, too, often require clean-sheet planning from strategists. With multiple interdependent customer groups to serve, companies find that direct costs provide little guidance for pricing strategies… Consider, too, that customer group interdependence makes it far more difficult to anticipate the impact of changes in business environment…

Many of the great business empires of modern era have prospered precisely because they have excelled at making multi-sided platforms work to their advantage… According to Boris Wertz; building out both sides of the marketplace simultaneously can seem exponentially harder than a one-sided transaction model. But, once you reach scale, things truly start clicking and an established marketplace is hard to unseat due to the strong ‘network effects’ at play…  But the key is to give the business a long enough runway to build out both sides…