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Two-Sided Markets A Challenge to Competition Policy

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Two-Sided Markets A Challenge to Competition Policy

Paper for The First Annual Competition Commission, Competition Tribunal and

    Mandela Institute Conference on Competition Law, Economics and Policy in

    South Africa, University of the Witwatersrand, Johannesburg, 21 May 2007

    Two-Sided Markets: A Challenge to Competition Policy?

     1MICHAEL HOLLAND

    PriceMetrics (Pty) Ltd

    Abstract

    Firms in two-sided markets provide a set of products or services, often known as a “platform”, to facilitate transactions between two distinct groups of customers. Examples of two-sided markets include

    newspapers, TV channels, computer operating systems, video game consoles, and card payment systems.

    A feature of these markets is an indirect network externality where the participation in the platform by

    one group raises the value of participation for the other group. Accordingly, two major activities of firms

    in two-sided markets are to maximise participation by both sets of customers “getting both sides on

    board” - and to balance the interests of each group. Optimal pricing for each group is complex. The price charged on one side affects market participation on the other side and the price structure becomes as

    important as the level of prices in the market. Typically, pricing is asymmetric, one side paying a price

    substantially below the other, and sometimes paying a price below marginal cost and even below zero.

    The externalities present in the markets, the interdependence of demand and the nature of pricing pose

    difficulties for competition policy. While the principles of competition policy still apply, analytical tools

    used for one-sided markets are sometimes not appropriate and need to be modified, notably in the areas of

    market definition, the assessment of market power, and the evaluation of coordinated activities, excessive

    pricing, predatory pricing and other abuses of market power.

1. Introduction

    Some young men enter the only nightclub in a town, each paying an R80 entrance fee.

    A few minutes later several young women enter the nightclub, each paying a R50

    2entrance fee. The nightclub is practising sex discrimination but is it also practising price discrimination in contravention of the Competition Act? A customer with a credit

    card purchases some products from a retailer and pays with her credit card. The credit

    card company, a dominant firm, does not charge the cardholder a transaction fee

    although there is some marginal cost in processing the transaction. Instead, the company

    charges the retailer a fee for the transaction. Is the credit card company undertaking

    predatory pricing by not charging a fee to the cardholder? Is the retailer justified in

    complaining that it is being charged an excessive price by the credit card company

    because it is effectively subsidising the cardholder and the fee it is charged does not

    bear a reasonable relation to the economic value of the service provided to it?

     1 Director, PriceMetrics (Pty) Ltd. Contact details: mholland@pricemetrics.co.za. 2 Nightclubs often price entrance fees in this way. Actual examples in Johannesburg during April 2007

    were Voodoo Lounge with a cover charge of R100 for women and R200 for men on Fridays and

    Saturdays; Catwalk, Fourways, entrance fees R50 for women and R100 for men; The Manhattan Club,

    entrance fees of R60 for women and R70 for men; Café Vacca Matta entrance fees of R40 for women and

    R60 for men, and Panache Café with an entrance fee of R30 for women and R50 for men. Of course,

    given the range of nightlife in the city, these clubs are not dominant firms.

    1

The conduct of the nightclub and the credit card company in these examples suggests

    anticompetitive behaviour as determined by the Act. However, the markets in which

    nightclubs and card payment companies compete are two-sided markets. Unlike a one-

    sided market where a firm supplies products to a single set of customers, firms in two-

    sided markets sell to two distinct sets of customers who want to undertake transactions

    with each other. Firms in two-sided markets provide value by bringing the two groups

    of customers together where otherwise the transactions between them will not take place

    or will occur at a sub-optimal level. The economics of two-sided markets indicates that

    the conduct of firms that may be considered anticompetitive in one-sided markets may

    in two-sided markets improve consumer welfare and economic efficiency.3 A nightclub

    that does not practise price discrimination and charges equal entrance fees for men and

    women may find that it does not attract the right proportion and sufficient number of

    patrons. For example, the same price for both sexes may attract too many men and not

    enough women. The lack of women reduces the attractiveness of the club to men, which

    in turn reduces the attractiveness of the club to women, which further reduces the

    attractiveness of the club to men. These demand interdependencies and feedback effects

    will result in both lower patronage and profits for the club and may lead to its closure,

    resulting in a market failure.

    Similarly, a credit card company has to provide value to both its cardholders who use

    the card and merchants that accept its card as payment. Cardholders will not use a card

    that is unacceptable to a large number of retailers and retailers will not accept a card that

    has few cardholders. The resulting price structure that provides a sustainable and

    profitable network depends in part on the relative value attached to it by both

    cardholders and merchants and the prices they are prepared to pay to be part of the

    network. The optimal price structure to the benefit of both parties and the card payment

    firm is usually where merchants pay transaction fees and cardholders pay only access

    fees, often in the form of an annual membership fee.

    4

    Two-sided markets present some problems for competition policy. The Competition

    Act, like legislation in many other countries, was written for one-sided markets and

    does not address some of the complications and complexity that arise with two-sided or

    5multi-sided markets. Many two-sided markets operate on economic principles that are

    different to one-sided markets and competitive analysis considered appropriate for one-

    sided markets can lead to erroneous conclusions. The difficulties can occur particularly

    where there are per se prohibitions on conduct such as section 4(1)(b) which refers to

    parties in a horizontal relationship directly or indirectly fixing a price or trading

     3 Measured in terms of maximising the sum of consumer and producer surplus. 4 Cardholders generally do not pay transaction fees. Also, in the U.S. more than half of banks issuing

    credit cards do not charge annual fees. Other benefits to cardholders such as free credit for the first month

    or so and loyalty and incentive schemes may outweigh the annual cardholder fee, resulting in a negative

    “price” for membership of the card network for cardholders who do not use the credit facility on the card

    (i.e. paying-off the full outstanding amount each month). In South Africa banks generally charge annual

    membership fees for credit cards. Note that although it appears that merchants “subsidise” cardholders,

    this is not necessarily the case because of the interdependence of demand. 5 Many markets have more than two-sides, for instance computer operating systems where firms provide

    a platform for hardware manufacturers, applications developers and end-users. The principles that apply

    to two-sided markets generally apply to multi-sided markets.

    2

conditions, and in the sections of the Act dealing with the abuse of dominance such as

    excessive and predatory pricing. In addition, tools of competitive analysis used in one-

    sided markets may not be appropriate without modification when applied to two-sided

    markets. This is not to argue that two-sided markets do not raise competition concerns.

    Although diverse in nature, many two-sided platforms operate in concentrated industries

    where there is considerable capacity for anticompetitive behaviour to the detriment of

    consumers through the exercise of unilateral market power and coordination of market

    conduct. Often, the characteristics of some two-sided markets in terms of a combination

    of large economies of scale and strong network effects can result in high levels of

    dominance that raise serious competition concerns. Notably, there have been several

    high profile antitrust cases in the U.S. and Europe in recent years involving two-sided

    markets. For example, Microsoft has been the focus of much attention from competition

    authorities in the U.S. and E.U.6 In the case of card payment systems, competition

    authorities and regulators in some countries have questioned the structure and nature of

    fees set multilaterally by banks participating in multi-party card payment systems such

    7as Visa and MasterCard.

This paper is a non-technical introduction to the economic principles of two-sided

    markets and discusses some of the competition policy issues and challenges in South

    Africa arising from the nature and characteristics of two-sided markets. It draws on

    other studies of the antitrust consequences of two-sided markets including Evans

    (2003a), Evans and Schmalensee (2005) and Wright8 (2004). The paper is in four

    sections. Section one briefly reviews major economic concepts of two-sided markets.

    Section two discusses some of the characteristics of competition in two-sided markets.

    Section three outlines some of the problems for competition policy that arise in

    analysing firms‟ conduct in two-sided markets. Finally, section four provides some

    caveats and conclusions.

    2. Economic Concepts of Two-Sided Markets

    Firms in two-sided markets provide a set of services and products, known as a

    platform,9 to facilitate transactions between two distinct groups of customers. There are numerous and diverse two-sided markets in an economy involving both physical

    products and services. Besides nightclubs and credit card payments, examples are

    market-making and broking services such as financial exchanges (JSE Securities

    Exchange and the Bond Exchange of South Africa), estate agents, business brokers and

    exchanges, employment agencies, ticket agencies (Computicket), dating clubs, village

     6 The European Commission ruled in 2004 that Microsoft had abused a dominant position in computer

    operating systems by including media player technologies in Windows. 7 For example, there have been investigations in the E.U., Australia and U.K. as well as currently in South

    Africa. 8 Wright (2004) uses nightclubs and card payment systems to demonstrate “fallacies” that can arise in

    competition policy analysis from “using conventional wisdom from one-sided markets in two-sided

    market settings.” 9 A platform consists usually of “architecture” and “rules.” Architecture refers to the design and provision

    of the platforms‟ products, services and infrastructure that physically or virtually facilitate the

    transactions between both sets of customers. The rules are the rights, obligations, prices and terms and

    conditions of trade that govern the transactions between both groups of customers and between customers

    and the platform.

    3

markets and fairs, and auctions (Ebay, Sotheby‟s and Christies); media industries

    including newspapers, magazines, directory services (yellow pages), web search engines

    (Google and Yahoo), and commercial radio and TV; personal computer operating

    systems (Windows); video game consoles (PlayStation and Xbox); shopping malls; and

    transaction systems such as debit card payments.

Two-sided markets have existed since antiquity and some have been of considerable

    economic importance. One of the earliest known was the introduction of coins as money,

    attributed to the Lydians in Asia Minor during the seventh century B.C.10 Another

    example is the European medieval fair, the most famous being the Champagne fairs, a

    region east of Paris, in the towns of Troyes, Provin, Lagny and Bar-sur-Aube, These

    fairs, which operated almost continuously throughout each year, served as a meeting

    place for merchants from the Low Countries, Northern Germany, Italy and the Iberian

    Peninsula and played an important role in the development of international credit

    markets during the middle ages.11 Despite their historical importance and ubiquity,

    however, the economic analysis of two-sided platforms is relatively recent and post-

    dates much competition law. An important early contribution was by Baxter (1983)

    although his empirical analysis was confined to card payments. The first general

    economic framework was developed in a series of seminal papers by Rochet and Tirole

    (2003), (2005), and (2006). Other important contributions to the literature are

    Armstrong (2005)12, Caillaud and Jullien (2003), and Evans (2003a), (2005). Evans

    (2003b) and Rysman (2004a), (2004b) have conducted detailed empirical research while

    Evans and Schmalensee (2005) and Roson (2005) have provided surveys of the

    literature.

Many of the conclusions from the economic models so far developed are narrow and

    precise in scope and their results depend on specific assumptions regarding the

    characteristics of competition, and individual market and industry circumstances.

    Nevertheless, some robust results have emerged. Economists have identified two major

    characteristics of two-sided markets that distinguish them from one-sided markets.

    Firstly, firms that supply two-sided or multi-sided platforms serve two or more sets of

    customers that want to transact with each other. Newspapers have two sets of buyers:

    readers who buy news and other content and advertisers who buy page space to reach

    existing or potential customers. Similarly, Google links advertisers to Web surfers.

    Customers for video game console suppliers are games developers and gamers. Games

    developers need consoles for customers to use their games and end-users need a console

    to play games. In capital markets, the JSE Securities Exchange enables buyers and

    sellers of financial instruments to trade with each other by providing market-makers that

    offer liquidity and security by trading through the exchange. In the labour market,

    employment agencies bring together people seeking work and firms seeking employees

    reducing search costs for both parties. All of these platforms provide value by enabling

     10 The coins were reputed to have been made from electrum, a natural alloy of gold and silver. Herodotus

    in The Histories states that the Lydians “are the first people we know of to mint and use gold coins and

    silver coins, and they were the first retail tradesmen.” Sardis, the capital of Lydia, offered another of the

    earliest known two-sided markets a marketplace. Source: Peter L. Bernstein (2000) The Power of Gold,

    John Wiley and Sons. 11 Outlined in Braudel (1992) and Heaton (1948). The Counts of Champagne provided not only land and

    facilities for the fairs but also commercial courts and protection for travelling merchants. 12 An early version of this paper was circulated in 2002.

    4

both groups of customers to reach and interact with each other or by reducing the

    transaction costs of exchange.

A second distinguishing feature of two-sided markets is the interdependence of demand

    on each side of the platform. In other words there is joint demand with sales on one side

    of the platform dependent on sales on the other side. The number of advertisements in a

    newspaper will depend on the size and characteristics of its readership. The number of

    applications for a computer operating system will depend on the number of end-users of

    the system. The number of men going to a nightclub will depend on the expected

    number of women expected to be at the club.

The interdependence of demand usually involves positive indirect network externalities

    where the participation in the platform by one side raises the value of participation for

    the other side.13 The platform internalises these externalities to the benefit of both sides.

    Strong positive indirect network effects exist in some media markets. The success of a

    newspaper depends on enabling advertisers to reach as many targeted customers in the

    readership as possible. Advertisers will pay more to newspapers with more readers and

    will pay more as circulation increases. To attract advertisers the newspaper needs to

    create an audience by providing content that appeals to readers while taking into

    account the readership‟s attitude towards advertising.14 Similarly, applications

    developers will create more games as the demand for a particular console increases or

    more programs as an operating system increases in popularity with end-users.

    Given these characteristics, the tasks of firms in two-sided markets are to build a

    platform network to a minimum sustainable level (“bringing both sides on board”) and

    to optimise the size and growth of the platform over time by balancing the level of

    demand and interests of customers on each side. The first task involves the chicken and

    egg problem: how to persuade customers on both sides to join the platform. An entrant

    into the yellow pages directory market will only succeed if it can attract sufficient

    advertisers that make the directory useful to households while a shopping mall will not

    be viable if it does not attracts enough retailers or shoppers. A new credit card will fail

    if too few consumers carry the card or too few shops accept it. Video games developers

    will create games only for consoles that have a critical mass of players because they

    need to recover a sufficiently large number of customers to recover their development

    and programming costs.

    Once established, the platform provider has to encourage the use of the platform in the

    face of competition from other platforms and perhaps one-side rivals.

    15 The need to

    grow is often important to long-term success. Many two-sided platforms have scale

     13 Indirect network effects can be negative as well as positive. Aversion to TV advertisements by many viewers is one example. 14 The nature of the externality is more complex than in other markets. Research in the U.S. shows that the circulation of retail newspapers and magazines sometimes rises as the quantity of advertising

    increases. In contrast, in some European countries there is an aversion to advertising that limits the

    positive indirect network effect and may lead to a negative effect (Evans and Schmalensee (2005)). In

    South Africa many readers of suburban free newspapers obtain benefit as much from the inserts and

    supplements of advertisers as from the sometimes sparse content. 15 The print media and TV stations are two-sided platforms that face one-sided rivals such as billboard and other street advertisements.

    5

economies arising from substantial fixed costs and relatively low marginal costs of

    production that result in significantly lower unit costs and higher profit margins as

    production expands. For instance, in newspaper and magazine publishing there are

    typically relatively high fixed costs in creating an issue of a publication but relatively

    low marginal costs in printing and distribution.

To meet these challenges firms create and manage their platforms through promotion

    and advertising; by creating features, functionality and incentives that attract customers;

    and by designing a pricing structure that encourages participation and usage of the

    platforms to both sets of customers. Some platforms solve the chicken and egg problem

    by supplying products on one side of the market. In the 1990s Microsoft created its own

    applications software to encourage the adoption of Windows and Palm wrote its own

    operating system and numerous application programs before launching its PalmPilot

    PDA. Once the platforms were established both companies reduced their emphasis on

    „supplying the chicken‟ and relied on external applications developers. Other firms use

    pricing to encourage participation in their platform. Diners Club, which introduced the

    first charge card in the form of a piece of cardboard in 1950, was distributed free to

    affluent residents in New York. Also, users did not pay interest from the time of the

    meal to the time they paid their account. Diners Club earned its revenue by charging

    restaurants about 7% of the value of the meal and only four years after the launch of the

    card did the firm begin to charge an annual membership fee to cardholders.

    16

    For some firms the optimal pricing structure from the outset is not to charge one side of

    the market at all. Some newspapers and magazines are free to readers as are yellow

    17pages directories to households; estate agents do not charge fees to buyers of

    properties nor do employment agencies charge job-seekers. The pricing decision is a

    major determinant of success for a two-sided platform and is significantly more

    important in two-sided than one-sided markets. In fact, Rochet and Tirole have defined

    two-sided markets in terms of pricing behaviour:

“A market is two-sided if 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 design it to bring both sides on board.”

For many platforms with strong indirect network effects the pricing structure between

    the two sides of the platform is as important as the level of prices it charges customers.

    If a firm charges too much or too little on either side it will reduce the network to below

    its optimum size for profit maximisation. For example, consider a firm setting prices for

    its customers, side A and side B. If it charges too much on side A of the market, demand

    from side A will fall as consumers are lost or spend less. Since the demand from side B

    depends on the level of demand from side A, demand from side B will begin to fall

    which in turn will reduce the demand from side A. The feedback effects will continue

    until a new balance is found at a lower and less profitable level of transactions on the

    platform.

     16 Source: Evans (2003b). 17 In South Africa sales commissions on residential property paid by sellers to estate agents in 2006 were around 5% of the actual selling price. For higher priced properties average commissions are often lower, between 2-3%. Source: Financial Mail 28 April 2006.

    6

Economists have established that the optimal pricing structure for a two-sided platform

    depends on the following factors:

    ? The price elasticities of demand on each side of the platform. The side that

    values the platform more will pay more.

    ? The strength and characteristics of the indirect network effect between the two

    sides.

    ? The level of competition from other platforms and substitute products on both

    sides. These include the extent of multi-homing18 and product differentiation.

    ? The marginal costs of production on both sides of the platform.

    The price structure to get both sides on board and optimise usage of the platform is

    usually asymmetric with prices on one side substantially above those on the other side.

    In many cases prices charged on the “low” side are below marginal cost, zero or even

    negative while on the “high” side prices bear little relationship to the marginal costs

    incurred on that side. Examples of wide differences in prices charged to either side are

    video games consoles and computer operating systems. Traditionally, Sony, Nintendo

    and Microsoft have priced their video game consoles below cost and earn their profit

    from revenue obtained from games developers in the form of a fixed fee and royalties

    on the number of games sold. The price structure is based on the need to recover the

    large fixed costs in developing both the console and the games by reaching as many

    gamers as possible. The pricing model for computer operating systems is also skewed

    but in a different way. End-users are less price sensitive to owning computers than

    video game consoles and rely heavily on applications software working on the operating

    system supplied with the computer. To encourage adoption of their operating systems

    by end-users suppliers need a wide range of applications software and stimulate the

    creation of new programs by giving away software development kits and charging no

    royalties to applications developers. Instead, operating system providers make their

    profits by charging end-users prices well above costs.

    Highly skewed pricing is also typical in media industries. Besides free titles, the cover

    prices of many newspapers and magazines are either close to or below the marginal cost

    of production. Ulrich and Wright (2006) researched a number of German magazine

    markets and concluded from their analysis of the price structure of nine magazines that

    the magazines discounted their cover prices to attract readers and therefore to draw

    more advertisers, in doing so setting cover prices below the cost of printing and

    distribution.

    19 Further indirect evidence of the “subsidisation” of readers is the high

    proportion of revenue earned from advertising by print media publishers: in the U.S.

    over 80% of newspapers‟ total revenue comes from advertisers.

In card payments systems, pricing is typically asymmetrical, favouring cardholders

    rather than merchants. For example, American Express in 2005 obtained over 70% of

    total revenue in its card payment business from fees charged to merchants.20 The nature

     18 Multi-homing is a term first used by Rochet and Tirole to describe market circumstances when

    consumers on either side of the platform buy from other platforms in the same market. 19 The authors state that their results are consistent with other research findings in Germany that indicated

    Die Zeit and Der Spiegel in the 1990s charged cover prices below paper, printing and distribution costs.

    Earlier research by the authors using different methodologies for two other magazines also showed that

    cover prices were set close to marginal cost. 20 American Express Annual Report 2005.

    7

of the pricing structure can also vary between sides. Generally, credit card payment

    systems charge merchants a usage (transaction) fee but not a fee for joining or obtaining

    access to the system. Conversely, cardholders pay a fee for access (an annual

    membership fee) but not a transaction fee or sometimes a negative one of they receive

    rewards for using the card. The difference is explained by the fact that cardholders care

    about card acceptance and merchants care about card usage. Therefore it is better, as

    Evans and Schmalensee (2005) point out, not to charge merchants for access and not to

    charge cardholders for usage.

Another major feature of the price structure in two-sided platforms is that prices do not

    reflect costs on either side. As demonstrated above, many platforms price below the

    marginal cost of providing the platform on one side and substantially above total cost on

    the other side. Pricing strategies are not designed to recover the operating costs of one

    side or the other but are set to maximise profits by getting both sides on board and

    optimising usage of the platform. Consequently, profit maximising principles in one-

    sided markets of setting marginal revenue to marginal cost on each side of the platform

    will not generally result in optimal prices for the firm. Moreover, marginal costs on

    each side of the platform are not independent of each other. For example, if demand

    increases on one side of the platform raising variable costs on that side it will also raise

    demand on the other side and increase its variable costs, the extent depending on the

    strength of the indirect network effect. Typically, the relationship between the prices

    and costs on both sides are interdependent and complex and the simple formulae of one-

    sided markets do not apply.

3. Competition in Two-Sided Markets

There are many and diverse two-sided markets in an economy. Some consist of

    numerous, relatively small firms in what would be called competitive markets such as

    nightclubs, dating agencies, estate agencies and employment agencies where anti-

    competitive behaviour is relatively uncommon unless there is some form of coordinated

    activity, for example through industry associations.

    21 Success in two-sided markets

    requires customer acceptance on both sides of the market simultaneously, a more

    difficult and complex task than for firms in single-sided markets. It is not surprising that

    many platforms fail predominantly because of the failure to get one side on board.

    Eisenmann et al (2006) report that in the U.S. many business to business exchanges

    (B2B) such as Covisint, a B2B exchange set up by U.S. vehicle manufacturers for

    supplying parts to them, fail because they cannot recruit enough participants on the

    selling side of the platform.22 At the same time, other two-sided markets such as those

    involving large economies of scale and networks can lead to highly concentrated markets and the exercise of substantial market power that can lead to serious competition concerns.

     21 For example, the Competition Commission found in October 2004 that the Institute of Estate Agents of South Africa (IEASA) contravened the Act by indirectly fixing the selling prices of the various services rendered by estate agents. 22 In Covisint‟s case, vehicle parts manufacturers refused to participate as sellers, concerned that the

    exchange would put further downward pressure on prices for their products.

    8

Typically, large two-sided platforms, especially in the „new economy,‟ display

    substantial economies of scale arising from large fixed costs in developing and

    maintaining a platform and relatively low marginal costs in serving both sets of

    customers. Examples are computer operating software, video game consoles, and

    satellite T.V. stations. Examples in other industries are financial exchanges, card

    payment systems such as MasterCard and Visa, and the print media. Where substantial

    economies of scale exist the typical market structure is likely to consist of a few large

    firms each with significant market power. Strong network effects reinforce the trend

    towards a concentrated market structure. Platforms with more customers on one side are

    more valuable to customers on the other side and become more valuable as the demand

    from each side grows. In a platform with large economies of scale, unit costs fall as

    demand grows and profit margins increase. In these market circumstances, firms that are

    first or early movers have a natural advantage, which combined with economies of scale,

    means that competition in some two-sided markets can be a race „for‟ the market,

    raising serious competition concerns.

While these market conditions can result in high levels of dominance or super-

    dominance such as in personal computer operating systems there are often other

    countervailing market forces at work that constrain the market power of individual firms

    and lead to multiple platforms competing in many large two-sided markets. Factors

    reducing market power by individual platforms include diseconomies of scale,

    congestion effects and product differentiation.

    23

    Although economies of scale may exist for a wide range of output they eventually can

    be exhausted and diseconomies of scale in the form of rising average costs will appear

    on one or both sides of the market, limiting the size of individual platforms. For

    example marginal costs can increase as a platform becomes more complex when it

    expands in size or grows in functionality and features. Software programmes are an

    example. Congestion costs can increase, reducing the appeal of a platform as it grows in

    size and complexity. These constraints can be physical and on both sides of the market

    such as in shopping malls and nightclubs. Other congestion costs can be on one side

    only. For example, as the number of adverts appears in a newspaper or magazine they

    may crowd each other out reducing the effectiveness of each advert. Negative indirect

    network effects can also emerge as a platform expands on one side. A magazine having

    too high a proportion of adverts to content may find that some readers become

    increasingly averse to them and no longer buy, leading to a fall in circulation.

    The most important constraint, however, on the domination of single platforms in a

    market is probably product differentiation. There is often considerable scope for vertical

    differentiation where platforms can compete in different levels of product quality or

    service. Shopping malls may be upmarket or downmarket as can nightclubs and dating

    clubs. Alternatively, platforms can compete through horizontal differentiation by

    appealing to different tastes and preferences among customers. In response, consumers

    may also support product differentiation through multi-homing participating in several

     23 The following discussion is based on Evans and Schmalensee (2005).

    9

platforms at the same time. One example is credit cards where most consumers have 24more than one card.

    In conclusion, competition in two-sided markets is as varied and diverse as in one-sided markets. There are many that show the characteristics of competitive markets. However, the features of two-sided markets suggest that large platforms with strong network effects are more than likely to present problems for competition authorities. There are a few like computer operating systems (Windows for personal computers) that are super-dominant25. Other markets that demonstrate substantial positive indirect network effects

    and economies of scale often display a few large differentiated platforms typical of highly concentrated oligopolistic market structures in one-sided markets (card payment systems and video console manufacturers).

4. Two-sided Markets and Competition Policy

    In principle, competition concerns are the same whether firms compete in two-sided markets, multi-sided or one-sided markets. Firms supplying two-sided platforms can exercise their market power unilaterally or through coordinated action with other firms by engaging in anti-competitive practices that harm consumer welfare and economic

    efficiency. Nevertheless, two-sided markets do present some problems for competition policy. There are two major issues. The first is a practical one: the complexity of analysis. In a one-sided market competitive analysis of a market involves a single set of buyers supplied by a single set of sellers. In a two-sided or multi-sided market the analysis becomes one of a set of suppliers providing a platform for two sets of

    customers transacting with each other. Competition authorities need to take into account not only the behaviour of each group of customers to the platform providers and the responses of the suppliers to each set of customers but also the behaviour of the two sets of customers to each other, particularly as demand conditions change on each side.

The other problem is a conceptual one. Two-sided markets operate on different

    economic principles to one-sided markets: the „rules of the game‟ are different.

    Competition authorities can err in a number of ways in their analysis of two-sided markets. They may fail to identify a two-sided market and treat it as a one-side market by looking at one side only. They may recognise the market as two-sided but treat each side in isolation. Wright (2004) points out a number of fallacies in adopting a one-sided approach to two-sided markets, including the following: an efficient price structure should reflect relative costs, a high price cost margin indicates market power, a price below marginal cost indicates predation and an increase in competition necessarily results in either a more efficient or balanced price structure. A further dimension of the problem is that the conventional tools of assessment used by competition authorities such as the SSNIP

    26 test and critical loss analysis for defining relevant markets and the

     24 There are limitations to multi-homing in credit cards. Although consumers may have several cards empirical research indicates that one card is used predominantly (Rysman 2004a). 25 Eisenmann et al (2006) argue that single platforms arise where multi-homing costs are high on one or both sides, network effects are strong and positive and there is little demand on either side for platform heterogeneity or special features. 26 Small but Significant Non-transitory Increase in Price. The price increase is normally 5-10% and the

    non-transitory period is usually a year or more.

    10

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