The Economics of Vertical Restraints by Multisided Platforms David S. Evans GlobalEcon, University of Chicago, and University College London 6 December 2012 Vertical Restraints Adopted by Dominant Firms CEDES, Brasilia, Brazil
Why Focus on Multisided Platforms?
New and rapidly growing economic literature with important an4trust applica4ons
Many important industries including exchanges, media, cards, and key online businesses
Many compe44on policy cases such as shopping malls, media players, payment cards and search engines
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Overview
Economics of Mul4sided Pla>orms
Cri4cal Mass and Ver4cal Restraints
Pla>orm Governance and Ver4cal Restraints
An4trust Analysis of Ver4cal Restraints
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ECONOMICS OF MULTI-SIDED PLATFORMS
Section 1
OpenTable Is Intermediary between Diners and Restaurants
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Restaurants Pay and Consumers Use Free
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$119 million NA revenue in 2011 | $1.02 billion markets cap
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OpenTable Solves Transaction Cost Problem
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$119 million NA revenue in 2011 | $1.02 billion markets cap
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Positive Feedback Effects Fuel Growth
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Ø 27 million reserva4ons in 2011Q4 a month up from 19 million in 2010Q4
Ø 25k restaurants in 2011Q4 up from 20k in 2010Q4
Ø More than 40% annual growth in revenue
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Many Similar “Multi-sided Platform” Businesses Positive Feedback Effects Fuel Business Growth
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COMPANY CUSTOMER SIDE A CUSTOMER SIDE B CUSTOMER SIDE C
Apple iOS Users Applica4on Developers
MNOs
Google Search Searchers Adver4sers Websites
Deutsche Bourse Liquidity providers Liquidity takers
eHarmony Men Women
Época Readers Adver4sers
Aricanduva Retail Stores Shoppers
American Express Cardholders Merchants
Facebook Friends Adver4sers Applica4on Developers
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Multi-sided Platforms Create Value by Reducing Transaction Costs
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Pla>orms enable two or more types of
customers,
who could engage in mutually valuable exchange
to find each other though
search and matching
to transact,
and to thereby
create and exchange value.
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Common Platform Features
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PosiIve Indirect Network Effects
Type A customers value pla>orm more if there are more Type B customers and o\en vice versa.
Stores like malls with more foot traffic; shoppers like malls with more diverse stores.
Money/Subsidy Side
Pla>orms o\en give one side a “break” and make their profits for the other side.
Consumers don’t pay to make reserva4ons and even get reward points on reserva4on pla>orms.
Single/MulI-‐homing
If customers on side A only use pla>orm 1 (“single home”) then the customers on side B can only reach these customers through the pla>orm 1 (so pla>orm is a “compe44ve boeleneck”). So\ware developers can only “reach” iPhone users by developing by the iOS
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Impact on Economic Models
12
General Result Most economic models/tools used in an4trust ignore interdependent demands from mul4ple pla>orm sides and are therefore “misspecified”
We now know from literature that results of standard models do not necessarily hold for mul4-‐sided pla>orms
Market DefiniIon
Standard SSNIP and UPP tests wrong for mul4-‐sided pla>orms.
Standard tests are mathema4cally wrong and give biased results
Economic models of exclusionary pracIces
Economic models (e.g. Whinston on tying) based on many assump4ons to begin with and not very robust.
Results do not/may not once interdependent demand between two sides is introduced.
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CRITICAL MASS AND VERTICAL RESTRAINTS
Section 2
YouTube Ignited in Late 2005
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0.000
10,000.000
20,000.000
30,000.000
40,000.000
50,000.000
60,000.000
70,000.000
may 05
jun 05
jul 05
aug 05
sep 05
oct 05
nov 05
dec 05
jan 06
feb 06
mar 06
apr 06
may 06
jun 06
jul 06
aug 06
sep 06
oct 06
nov 06
dec 06
jan 07
feb 07
mar 07
apr 07
may 07
jun 07
jul 07
aug 07
sep 07
oct 07
nov 07
dec 07
jan 08
feb 08
TABLE 1 -- YOUTUBE UNIQUE VISITORS ('000)
YOUTUBE
Both sides essenIal for launch
YouTube needed content creators and content viewers
Need strategies to get both sides on board
YouTube tried mul4ple strategies to increase uploading and viewing of videos
IgniIon requires geQng enough on board
Slow growth from February to December 2005 when YouTube shows an inflec4on point
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Platforms Need Critical Mass to Ignite
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CriIcal mass
Cri4cal mass refers to the minimal set of customers on each side that is large enough to aeract more customers and result in sustainable posi4ve feedback
CriIcal mass depends on scale and balance
Probability of customers from two sets gejng together and exchanging value increases with the number of customers on each side
PlaRorms implode if they can’t reach criIcal mass
If there aren’t enough customers on the other side the probability of advantageous exchange falls and customers don’t join and the early adopters who have eventually leave
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Successful Platform Launch Depends on Critical Mass
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0 200 400 600 800 1000 1200
0 200 400 600 800 1000
Each point reflects a combina2on of scale (how many customers) and balance (propor2on of customer types)
CriIcal mass corresponds to a combinaIon of scale and balance that is minimally sufficient to ignite the plaRorm
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Critical Mass, Platform Ignition and Growth
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Catalytic Ignition and Critical Mass
Side B
D*- Long-run equilibrium
C`
C``
C*
Ignition
Points of critical mass
Movements at starting to achieve critical mass
O
In this example the cri4cal mass points are between C’ and C”. C* is the point that would lead to op4mal pla>orm launch. Points to the NW of the vector 0-‐C’ and to the SW of vector 0-‐C” would result result in pla>orm implosion.
Side A
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Three Phases of Platform Growth
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0.000
10,000.000
20,000.000
30,000.000
40,000.000
50,000.000
60,000.000
70,000.000
may 05
jun 05
jul 05
aug 05
sep 05
oct 05
nov 05
dec 05
jan 06
feb 06
mar 06
apr 06
may 06
jun 06
jul 06
aug 06
sep 06
oct 06
nov 06
dec 06
jan 07
feb 07
mar 07
apr 07
may 07
jun 07
jul 07
aug 07
sep 07
oct 07
nov 07
dec 07
jan 08
feb 08
TABLE 1 -- YOUTUBE UNIQUE VISITORS ('000)
YOUTUBE
IniIaIon
Pla>orm undertakes strategies to get to cri4cal mass
IgniIon and Rapid Growth
Pla>orm reaches cri4cal mass and gets self-‐sustaining posi4ve feedback effects
Maturity
Pla>orm reaches profitable equilibrium and grows through compe44on and market growth
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Some pla>orms can secure precommitments from both sides and thereby collapse ini4a4on and igni4on into immediate growth at startup.
Initiation and Getting to Critical Mass
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Early adopters
Customers who like to try new things
High-‐value customers
Customers that place high expected value on par4cipa4ng in the pla>orm
Highly aUracIve customers
Customers on one side who are highly valued to customers on the other sides
Exclusive deals
Exclusive deals force customers on the other side to use the pla>orm to gain access to these customers
ExpectaIons of success
Shape customer expecta4ons that the pla>orm will provide value in order to get customers to mul4-‐home or single home on pla>orm
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Making It Harder for Rivals to Reach Critical Mass
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Lock enough demand on either side
By keeping available demand below the minimal level on either side the new pla>orm cannot reach the cri4cal mass fron4er.
Lock up enough demand on both sides
By locking up enough demand on both sides the new pla>orm cannot reach the cri4cal mass fron4er
Lock up key assets needed for igniIon
By locking up customers that account for a dispropor4onate share of posi4ve feedbacks, are early adopters, or high value users, or by preemp4ng exclusive deals, the new pla>orm could be prevented from reaching the cri4cal mass fron4er
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These are possibili4es. Unclear how significant they are in prac4ce given that rivals have counterstrategies.
Vertical Restraints that Might Deter Entry
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Exclusive Deals
Locks up demand on one or both sides of the pla>orm
CondiIonal rebates
Discourages customers from using rival pla>orm and therefore engaging in mul4homing or single homing with entrant
Other restraints
Behavioral restraints (tying, pricing restric4ons, various behavioral restraints, etc.) could raise the cost of commijng demand to a rival pla>orm
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Some Procompetitive Explanations of Vertical Restraints
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Exclusivity benefits customers
Customers on side B benefit from knowing that when they use the pla>orm they will be get access to par4cular customers on side A. Reduces their search and transac4ons costs.
Exclusivity reduces plaRorm risks
By reducing risk that customers on one side will reduce demand and thereby jeopardize value of the value to all sides the pla>orm is able to make greater sunk cost investments including in innova4on.
Exclusivity prevents free riding
Pla>orm may have incurred significant risks in entering in developing customer groups to maximize pla>orm value. Exclusivity agreements prevent copycats from freeriding.
Behavioral restricIons benefit customers
Restric4ons on side A customers benefit side B customers by preven4ng opportunism
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Balancing and Some Complexities
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Degree of impediment to entry
Impediment depends on the “type” of customers excluded as well as and perhaps more so than sheer volume of demand foreclosure. Could prevent entry by foreclosing some demand on both sides.
Counter strategies
Can differen4a4on enable entry despite exclusive deals by incumbent pla>orms? Can entrant enter into exclusive deals of its own?
Stage of compeIIon
Incumbent may have exclusive dealing arrangements as part of entry strategy to deal with cri4cal mass
Behavioral restricIons
Ver4cal restraints may benefit customers that are not subject to ver4cal restraints (e.g. the other side of the pla>orm).
Incumbent vs. entrant
Entrant could be powerful pla>orm in adjacent business while incumbent could be successful startup. Difficult to assess impact of an4trust restraints on long run social welfare (Microso\ vs. Netscape).
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PLATFORM GOVERNANCE AND VERTICAL RESTRAINTS
Section 3
Platforms Harness Externalities
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A Place to Get Together
Pla>orm provides a physical or virtual environment for different types of customers to get together.
Ways to Connect and Create Value
Pla>orm provides search and matching methods for helping customers find “value-‐crea4ng” transac4ons and for exchanging value.
Manage externaliIes
Pla>orms manage posi4ve and nega4ve externali4es to increase value that members can realize from the pla>orm.
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Platforms Helping One Side
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Kanyon Mall in Turkey “is appropriately named in light of the shape of the building, with the "canyon walls" comprised of four winding retail levels.” The canyon was made primarily with stone, 4le and concrete.
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Platform Design and Rules Promote Positive Externalities
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SorIng Devices to Get Right Customers
“Exclusionary vibe” (JDate discourages Gen4les)
“Exclusionary amenity” (Upscale anchor stores discourages low-‐end shoppers)
Search Diversion
Design rules encourage one type of agent to meet another type of agent who really values them but may not seek out by themselves
Shopping malls with anchor stores at either end
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Platforms and Bad Behavior
Vitaly Borker Gets 4 Years for Threats, Terror Used to Boost Google Rankings
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SAC Insider Case Rides Finra Referral to Cohen’s Backyard
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Governance of Bad Behavior that Mitigates Negative Externalities
29
Rules Prohibi4ons on ac4ons that could harm other agents (usually those on other side of match/transac4on)
eBay has detailed rules for buyer and seller behavior No misleading ads (sellers) and no mul4ple auc4ons for same good (buyers)
DetecIon and Monitoring
Systems to determine if rules are being broken
Facebook has hundreds of employees looking for bad pictures and bad language
Enforcement Pla>orms have and use “Bouncers Rights” to exclude violators
Google manually reduces ranks of websites that violate rules for 90 days and some4mes delists websites
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Welfare Effects of Rules
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PromoIng posiIve externaliIes has costs
Sor4ng devices harm customers that can’t get on pla>orm or don’t get their preferred matches
Search diversion benefits side that gets from looks but not necessarily side that has been diverted.
Governing bad behavior has costs
Customers lose benefits from viola4ons
Customers also lose from false posi4ves in enforcement
PlaRorm has incenIves to balance benefits and costs
Pla>orm can make more money by promo4ng posi4ve externali4es and reducing nega4ve ones
Pla>orm value is greater and pla>orm profit greater too
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Vertical Restraints and Platform Governance
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AnI-‐steering/exclusive dealing rules
Might deter entry, but…
Give customers on other side assurance that when they use the pla>orm they will get the pla>orm’s products
No surcharge rules
Might deter entry, but …
Prevents opportunis4c behavior and provides customers price certainty for pla>orm
PlaRorm exclusion penalIes and rules
Might prevent alterna4ve pla>orm from accessing users, but …
Punishes customers on one side from harming customers on the other side through fraud, decep4on, and other bad behavior.
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ANTITRUST ANALYSIS OF VERTICAL RESTRAINTS
Section 4
Factors to Consider in Evaluating Vertical Restraints for Platforms
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Impact of restraints on achieving criIcal mass
To what extent do restraints preclude strategies necessary for reaching cri4cal mass and are there effec4ve counterstrategies
PlaRorm and Industry Stage of Development
Restraints more likely to be residue of procompe44ve strategy and s4ll provide efficiencies in earlier stages.
Impact on all sides Benefits and costs should be evaluated by looking at impact on all customer sides
Role in managing externaliIes
Possible efficiencies from managing posi4ve and nega4ve pla>orm externali4es should be considered.
Robustness of standard economic models
No reason to believe that the result of economic models that do not consider interdependent demand hold for mul4sided pla>orms and results of literature so far show that the results do not in fact hold in important cases.
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Thank You!
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DAVID S. EVANS
Global Economics Group | Chairman
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