Lecture 6 Final EC337

Lecture 6 Two-sided and Multi-sided Markets: 

EC337 Industrial Economics 2: Market Economics, Competition and Regulation Department of Economics University of Warwick Module Leader: Dr. Chris Doyle 24 October 2011 Lecture 6 Two-sided and Multi-sided Markets

Two-sided or Multi-sided Markets: 

Two-sided or Multi-sided Markets According to Evans (2003 ) + a two-sided market is one where firms (e.g. platform operators) serve two distinct types of customers (end-users) where these depend on each other in some important way (interaction), and whose joint participation makes platforms more valuable to each (indirect network externalities) There are indirect network externalities between the two different customer groups Rochet & Tirole (2008) ++ “Two-sided (or more generally multi-sided) markets are markets in which platforms offer interaction services to two ( o r several) categories of end-users” ++ Rochet, Jean-Charles and Jean Tirole (2008) “Competition Policy in Two-sided markets, with a special emphasis on Payment Cards” Ch. 15 page 543, PB on course reading list. + Evans , David S. (2003) “The Antitrust Economics of Multi-Sided Platform Markets,” Yale Journal on Regulation , 20(2), 325-82

Two or Multi-Sided Markets: Examples: 

Two or Multi-Sided Markets: Examples Platform Categories/End-users Newspapers Advertisers, Readers Video game consoles Game developers, Gamers Computer OS Software developers, users Payment card systems Merchants, consumers Media players Music publishers, listeners Dating agencies Different types Sports event Broadcasters, advertisers, sponsors, spectators, betting companies, newspapers, gamblers

Two-sided market for TV channels : 

iBuy TV (sellers - channels) subscribers (buyers) £5.50 monthly subscription fee Free at point of use Annual fee (marketing fee), Monthly average subscriber charge Royalty based on net revenue Two-sided market for TV channels

Two-sided markets – Multi-homing, subscriber single-homes : 

Each subscriber typically contracts with one platform Auctions Two-sided markets – Multi-homing, subscriber single-homes

Nested two-sided market : 

subscribers (buyers) Monthly subscription fee Auctions Merchants (sellers) Annual fee (marketing fee), Monthly average subscriber charge Royalty based on net revenue Nested two-sided market

Nested multi-homed two-sided market – horizontal competition and vertical structures : 

subscribers (buyers) Auctions Merchants (sellers) Broadband, mobile phones Nested multi-homed two-sided market – horizontal competition and vertical structures

Issues for Platforms and End-users: 

Issues for Platforms and End-users How should each side of the market be priced? Membership and usage fees on both sides Should a platform be open (free access) or closed (vetted access)? Examples such as iTunes vs. Android app stores Dynamic efficiency issues in relation to investment in platforms Net neutrality debate and broadband infrastructures (further discussion below) Conceptually issues relate to Network externalities, non-internalised externalities among end-users Example: Buyers of razor blades internalise in their purchase decisions the net surplus they will derive from buying razor blades. In two-sided markets end-users do not internalise the welfare impact of their use of the platform on other end-users Price discrimination, multi-product pricing Predicts profit maximisation will preserve optimal price structure but market power over platform gives excessive price-cost margin. The key for platforms is how to allocate surplus to different end-users to get the two (or multiple) sides on board while recovering costs

Economics of two-sided markets: 

Economics of two-sided markets Rochet and Tirole (2008) set out a framework of analysis Level and structure of prices Is the structure of tariffs across the market ‘optimal’? Is there scope for intervention? Mobile termination charges Price demand elasticities on the different sides of the market will influence structure of prices Platform S B Ex ante: Membership externalities Platform S B Ex post: Usage externalities

Possible competition concerns: 

Possible competition concerns One side of a market ‘tilts’ in favour of one platform Platform might leverage market power (abuse dominance e.g. exploitative behaviour, apply restrictive terms) Vertical integration Refuse to deal favouring own affiliates (possible anti-competitive discriminatory conduct) Collusion May arise if there are few sellers and many platforms, or more likely few platforms and many sellers In October 2002 Sotheby’s was fined £12 million by the European Commission for rigging the art market in collusion with rival Christie’s. Christie’s escaped a fine because it blew the whistle. The fine represented 6% of the company’s annual turnover. Horizontal bundling across platforms

Market definition and two-sided markets: 

Market definition and two-sided markets The EC acknowledged indirectly two sides play a role in market definition in the Telia/Telenor merger case 1999 (see http://ec.europa.eu/competition/mergers/cases/decisions/m1439_en.pdf ) Paras 108/9 : “ local telephone directories are produced once a year and delivered to households and businesses free of charge. Publishers earn revenues from selling advertising space to a range of advertisers, mainly large and medium sized businesses…the sale of advertising space in local telephone directories can be taken as a distinct relevant product market.” “ After examination of the notification, the Commission concluded that the notified operation fell within the scope of the Merger Regulation and raised serious doubts as to its compatibility with the Common Market, because it could create or strengthen a dominant position as a result of which effective competition would be significantly impeded in the common market or in a substantial part of it and in the territory covered by the EEA Agreement.”

Relevant markets: 

Relevant markets In a two-sided market interdependency means that the correct competitive price to use when applying the HMT is the total price charged by the platform to sellers and buyers In a two-sided market involving a TV platform and a TV channel, the total price combines the price charged by the TV platform to a channel and the price charged to its subscribers The structure of the price charged by a TV platform to a basic channel typically comprises an annual charge, a monthly charge based on subscriber numbers, and a royalty fee related to any turnover generated on the channel On the other side of the market the charge levied on viewers for viewing a basic channel is in practice zero – where pay-per-view charges do not exist Note that the two-sides of the competitive price may not equal the underlying marginal costs on each side of the market

Lyons: OFT Horseracing case: 

Lyons: OFT Horseracing case Bruce Lyons (2009) discusses a UK OFT competition case ( Ch 1 CA 1998 case ) that involved British horseracing Two sides of the market interact via a platform Bookmakers Racehorse owners The platform is the governing body which owns race data rights Bookmakers need race data to offer betting services to punters The payment for race data by bookmakers could be used by the governing body as prize monies and to support governance costs (credibility) Prize money attracts racehorse owners and hence there is a ‘membership’ externality More horses in training leads to a better product for punters and enthusiasts If this externality is strong, bookmakers should be charged a price above the ‘marginal cost’ of the data

OFT Horseracing case: 

OFT Horseracing case OFT case focussed on Order and Rules of British Horseracing Levy on bookmakers Fixtures and race planning The OFT objected to the monopolisation of race and runners data The OFT defined three relevant markets and proceeded to analyse them ‘independently’ Fails to account for interactions and indirect externalities Lyons links the markets illustrating their multi-sided nature The ‘gross win’ for bookmakers is assumed to be B( n ), where n is the number of horses in training Outside option for bookmakers (e.g. foreign races) is a gross win

OFT Horseracing case: 

OFT Horseracing case Assume bookmakers contribute P in prize money, then the net benefit to bookmakers is: Inverse demand for racehorses is v ( n ) where v  ( n )<0 Annualised cost of a horse is assumed to be c >0 Net benefit of owning n th horse is: Equilibrium number of horses given by: The relationship between number of horses n and P :

OFT Horseracing case: 

OFT Horseracing case Benefit to owners as a group: The social optimum number of horses is given by maximising: The combined marginal benefits to owners and bookmakers should equal marginal cost c Coase Theorem – does not hold for this case according to Lyons Bargaining extremes relative to n* Bookmakers under-invest Owners over-invest OFT withdrew objections following undertakings from British horseracing

The racing world’s view of the OFT case: 

The racing world’s view of the OFT case Front cover of the specialised trade paper Racing Post, 4 September 2000 Probably the most inflammatory (excuse the pun) headline ever witnessed by a competition agency!

Funding Internet Infrastructure: Net Neutrality: 

Funding Internet Infrastructure: Net Neutrality

Take-away questions: 

Take-away questions Provide a simple algebraic example illustrating the effect of indirect externalities on optimal prices set by a platform owner. Hint: Consult readings and references therein especially Rochet and Tirole (2008) How might a first-mover advantage strengthen the position of a platform? If a platform applies controls over membership (is not open), when should a competition agency be concerned? Why is the two (or multi) sided market concept relevant to the debate on net neutrality? Show why horse owners in the Lyons model above would over-invest in horse ownership, that is set n>n *