Business Platforms

Peter Troxler

…Platform…

The earlier uses of the word, such as for a plane geometrical figure, the ground plan of a building, and figuratively, for a plan, design, scheme, &c., are now obsolete.

a raised flat structure or stage, (…) from which speeches, addresses, lectures, &c., can be delivered. Similar structures are used in railway stations to have easy access to the carriages; and in fortification the word is used of the raised level surface on which guns are mounted.

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Photo © 2009 by Mike Baird, cc-by 2.0 Photo © 2011 by Creative Tools, cc-by 2.0

…Platform…

Business Platform •  an intermediary between two or more sides of a

market (Wikipedia) •  Two-sided market =

–  two distinct user groups –  provide each other with network benefits

•  Examples: –  credit cards: cardholders and merchants; –  HMOs: patients and doctors; –  operating systems: end-users and developers; –  travel reservation services: travelers and airlines, hotels,

etc.; –  yellow pages: advertisers and consumers; –  video game consoles: gamers and game developers; –  communication networks

More Examples

Electronic copy available at: http://ssrn.com/abstract=1177443

Parker and Van Alstyne: Two-Sided Network EffectsManagement Science 51(10), pp. 1494–1504, © 2005 INFORMS 1495

and identify which market receives the subsidy. Wealso demonstrate how the key insight is robust to sev-eral modeling generalizations. Section 4 offers furtherapplications and extensions and §5 concludes.

2. Historical Context andRelated Literature

Several branches of literature yield insight forthis research, including network externalities, multi-product pricing, and to a lesser extent bundling. In theclassic network externality story (Katz and Shapiro1985, Farrell and Saloner 1986, Arthur 1989), demandeconomies of scale cause growth in an existing stockof consumer value as new consumers join the net-work. Various authors have used network effects toexplain the popularity of QWERTY and VHS (Arthur1994), ad subsidies of content in “circulation indus-tries” (Chaudhri 1998), and the importance of stan-dards and switching costs in network economies(Katz and Shapiro 1985; Shapiro and Varian 1998,1999). In contrast, we consider a matched-market,chicken-and-egg problem, supporting an alternateinterpretation of conventional wisdom. We distin-guish between intramarket and intermarket networkexternalities. Producers want consumers and con-sumers want producers before either prefers a newformat.An incumbent firm producing content for one for-

mat probably does not welcome entry by a com-peting firm producing similar content if there is noprofitable exchange between them. This mitigates anetwork effect within one side of the market. Buyersin the end-consumer market, however, welcome entry

Table 1 Two-Sided Market Examples

Product category Market 1 Intermediary Market 2

Portable documents Document reader! Adobe Document writerCredit cards Consumer credit! Issuing bank Merchant processingOperating systems Complementary applications Microsoft, Apple, Sun Systems developer toolkits!

Plug-ins Applications software Microsoft, Adobe Systems developer toolkits!

Ladies’ nights Men’s admission Bars, restaurants Women’s admission!

TV format Color UHF, VHF, HDTV! Sony, Phillips, RCA Broadcast equipmentBroadcast & publishing Content! Magazine publishers, TV, Advertisements

radio broadcastersComputer games Game engine/player Ubisoft, ID, valve, electronic arts Level editors!

Auctions Buyers! E-Bay, Christie’s, Sotheby’s SellersAcademic journals Articles Management Science Author submissions!

Recruiting Applicants! Monster.com EmployersReservation systems Travelers! Expedia, Travelocity, Orbitz Hotels, airlines, rental carsShopping malls Shoppers! Mall of America StoresStreaming audio/video Content! Real audio, Microsoft, Apple ServersPaid search Searchers! Google.com MarketersStock exchange Equity purchasers! NYSE, NASDAQ Listed companiesHome real estate Home buyers! Real estate agents Home sellers

Notes. This table shows how one side of a two-sided network market receives a discounted, free, or even subsidized good (indicated with ! ). In generalthough not always, Market 1 can be interpreted as the user/consumer market and Market 2 can be interpreted as the producer/developer market. We providea test for which side receives the free good below.

because it increases the prospect of a viable formatshould the incumbent fail. It also increases varietywhile possibly lowering prices. This increases boththe value to individuals and the number of individ-uals willing to switch formats. Thus, in the presentexample, the externality runs from content creators toend consumers.Conversely, consider the end consumer’s original

choice of VHS versus Beta. Initially, at least, con-sumers probably care less about adding another con-sumer to a new format—it could even bid up pricesif supply is limited—than they care about the numberand diversity of firms who provide content for thatformat. Producers, however, care immensely aboutthe size of the consumer market. The existence of alarger consumer base makes production under anygiven format more attractive. Again, in the presentarticulation, the externality runs across markets fromconsumers to providers of content.Importantly, the externality benefit can run across

markets and back again. Both content creators andconsumers do value growth in their own markets,but this may be mediated by the indirect effect ofthe internetwork externality. At issue is whether own-market entry expands participation on the other sideof each transaction. Content creators may not objectto other content-providing firms if effective consumerdemand rises instead of falls.Consider, finally, a third participant, the focus of

our attention here, who produces tools to supportboth content creators and end consumers. Theseare “platform” intermediaries. Examples in Table 1include Sun, Apple, and Microsoft, who support soft-ware developers as well as private and business

Parker and Van Alstyne (2005): Two-Sided Network Effects Management Science 51(10), pp. 1494–1504 available online at http://ssrn.com/abstract=1177443

Business Platform

Platform

1 2

Value of the Network

(Metcalfe’s Law) Vj = n2 * p V: Value of Network n: number of participants (nodes, end points) p: some constant

(Beckstrom’s approach) Vj = ∑i,j(∑Bi - ∑Ci) V: Value of Network j ∑B: benefit value of all transactions ∑C: cost of all transactions

Network Effect

Illustration by Derrick Coetzee

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Verdier, M. (2006). Retail Payment Systems: What can we Learn from Two-Sided Markets? MPRA Paper No. 2606. Available at: http:// mpra.ub.uni-muenchen.de/ 2606/

Pricing

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Figure 2: A fraction, σ, of the original platform value, VA is made freely available, leaving direct

platform profit of (1 − σ) VA. Opening the platform permits developer enhancements, which add

value ∆V , and brings additional consumers to the platform. This process repeats using period 1 as

input.

a particular developer enhancement. When the proprietary period is very short, the consumer will

pay very little since she knows that the product will soon become free. In the analysis below, we

let δ = e−r t.

Given this tradeoff, the platform author factors consumers’ strategic behavior into determining

the optimal time to release code under a free license. Forcing earlier release of enhancements pulls

consumer surplus and participation earlier in time at the cost of reducing developer incentives.

3.4 Developer Problem

In order for market incentives to influence innovation, let profit motivated developers produce in

direct proportion to (i) the amount of free code they can incorporate and (ii) the length of time

they can benefit from their effort. In Section 4.5.1, we also allow non-market incentives to influence

development. In any period, developer output y increases in both t and in the open code base Ω.

Let Ωt represent open code at time t, let kr be a re-use coefficient that scales the ability to use

open code in new production, and let L(Ωt, t) be labor or effort as a function of costs and the time

to recover investments. Then new code created by a developer is kr Ωt L(Ωt, t). We capture the

incentive effect of time by replacing L(Ωt, t) with a concave increasing function of time (1− δ).

10

Parker, G., Van Alstyne, M (2005). Innovation Through Optimal Licensing in Free Markets and Free Software. Woprking Paper. Available at: http://ssrn.com/abstract=639165