2-Sided Network Strategies

8/3/2019 2-Sided Network Strategies

http://slidepdf.com/reader/full/2-sided-network-strategies 1/69

Competition & Strategy in

2-Sided PlatformsMarshall Van Alstyne

Geoffrey Parker



© 2010 Eisenmann, Parker & Van Alstyne

Technology Smackdown












How does this really work?

7




8

Can we explain convergence?



Info Economics Research Agenda

Products &Network Effects

CommunicationsMarkets

Information &Productivity

Economics ofIP


http://slidepdf.com/reader/full/2-sided-network-strategies 8/69 © 2010 Eisenmann, Parker & Van Alstyne

10

Agenda

1. Definitions & ―new economy‖ concepts.

2. 2-Sided Network Pricing

3. Winner-Take-All Markets

4. Envelopment

Goal: Rigorous analysis of tradeoffs as a guide to strategy.



Platforms & Applications

• Platform: Components used in common across a product family whosefunctionality can be extended by 3rd parties (Boudreau 2007) characterizedby network effects (Eisenmann, Parker & Van Alstyne 2009).

• Examples:1. Desktop OS: Unix, Mac, Windows

2. PDAs: Palm, Psion, Newton

3. Game Consoles: Wii, Xbox, Playstation

4. Network Switches: Cisco, IBM, HP

5. Multimedia: Adobe/Flash, MS/Silverlight, Google-Apple/HTML5

6. Payment Systems: Paypal, Google Checkout, Visa, Apple, Mobile Felica

7. Mobile Devices: iPhone, Android, Symbian, Blackberry8. Enterprise Systems: Salesforce, Oracle, i2, IBM, SAP

9. Social Networks: Facebook, MySpace, LinkedIn, Monster, Twitter

10. Batteries: Sony, Panasonic, Sanyo, A123

11. Web Search: Google, Bing+Yahoo!, Baidu

12. Ebooks: Amazon, iPad, Nook, Sony



Managerial Implications

• But understand: Winners in a platform market generally have the “best” platform strategy, not necessarily the

“best” product

• Best platform?1. Open (but not too open) interfaces

2. Modular architectures (easy to build on/extend)

3. Compelling complements (generally result of vibrant ecosystem)

• Best product? Best standalone value proposition, but whilestarting here is good, usually not enough to win a platformmarket

13Source: Cusumano 2010



14

Remember this contest?



15

How about this one?

Between 1951-59 RCA spent $130 million in color TV battle with CBSwith nothing to show for it.



16

Cable vs. Telco



17

Google vs. Microsoft

vs. Apple



18

Skype vs. Verizon



19

Network vs Computer

Network as the Computer Computer as the Network



20

Question: What are ―network

externalities?‖ Hint: they matter for pricing,

winner-take-all markets, andstrategy…



21

A ―network externality‖ is a

demand economy of scale.Examples: phone, fax, IM, email

networks.



22

Supply vs. Demand ScaleEconomies

Price

Quantity

Demand

Supply

• Rising average costs• More competitive supply• Oil, Soda, Bread

Standard Goods

Demand

Supply

• Falling average costs• Monopolistic supply• Utilities, Semiconductors

Cost Econ of Scale

Demand

Supply

• Often falling avg cost• Monopolistic supply• OS, IM, MMOG

Demand Econ of Scale



23 FAX

(Re)interpreting NetworkExternalities

• ―Network Externalities‖

are demand economiesof scale.

• They imply at least somelevel of interaction aswhen I email you, or youFAX or IM me.

Phone E-Mail

IM



24

Reinterpreting NetworkExternalities

• Where is theinteraction when yourneighbor rents ―Lord

of the Rings‖?

• In fact, his rental maymean you have towait!



25

How did Sarnoff win the battle?

...backward compatibility to secure an installed base, and…




26

How did Sarnoff win the battle?




27

A ―2-sided‖ network externality

crosses markets from consumersto developers or developers to

consumers



28

Market One(Acrobat Reader)

Market Two(Acrobat Distiller)

Initially, there are profits to be made in both markets.

Consider profits in two markets




29

Market One(Acrobat Reader)

Market Two(Acrobat Distiller)

But subsidizing market one can increasedemand and profits in market two morethan the loss in market one.





30

Market One(Operating Systems)

Market Two(Developers)

Initially, there are profits to be made in both markets.





31

Market One(Operating System)

Market Two(Applications Developers)

But subsidizing market two can increase demand andprofits in market one more than the loss in market two.





32

Who should get the subsidy?




R dil id tifi bl l tf k t




34

Product Category Mkt 1 Product Intermediary Mkt 2 Product

Portable Documents Document reader* Adobe Document Writer

Credit Cards Consumer credit* Issuing bank Merchant Processing

Operating Systems ComplementaryApplications

Microsoft, Apple, Sun Systems Developer

Toolkits*

HMOs Patient Treatment * Kaiser, Harvard Pilgrim Doctors’ Expertise

Ladies’ Nights Men’s Admission Bars, Restaurants Women’s Admission*

TV Format Color UHF, VHF,

HDTV*Sony, Phillips, RCA Broadcast Equipment

Advertisements Content* Magazines, TV, Radio Advertisers

Computer games Game Engine/ Player Games PublishersLevel Editors*

Auctions Buying* E-bay, Christie’s,

Sotheby’s Selling

Real Estate Home buyers* Multiple Listing Service Home Sellers

* Indicates which market is discounted, free or subsidized.

Source: Parker & Van Alstyne 2000, 2005

Readily identifiable platform markets

A t id d t k h




38

A two-sided network hasfour network effects

• A same-side effectfor each side, i.e.,preference regarding

number of otherusers on own side

• A cross-side effectin each direction, i.e.,preference regardingnumber of users onother side

Side1

Platform

Provider

Side2

E h t k ff t b




39

Each network effect can bepositive or negative

+ same-side : Player-to-playercontact in Xbox MMOG, end-user PDF sharing.

- same-side : competing suppliers

in Covisint auction, competingdates on Match.com

+ cross-side : merchants &consumers for Visa, developers& end-users for Windows

- cross-side : Digital RightsManagement costs toconsumers. Advertising clutterto viewers.

Side1

Platform

Provider

Side2



Q: Why is price more important in network markets?

A: The entire demand curve can change with price.

Q: Why is price more strategic in 2-sided networks?

A1: Imagine competing on the subsidy side – youneed a source of subsidy at least as great.

A2: You change the size of your (and their) user base!



P r i c e

Quantity

P r i c e

Quantity

Market One Market Two

q1 q2

p1

p2

To Model Complements

q1

Q1

Q1

V 1 p1 q2

Q2

Q2

V 2 p2

Use simple linear demand functions (but works for almost any functional form).




q2

Q2

e12q1

Q2

V 2 p2q1

Q1

e21q2

Q1

V 1 p1

P r i c e

Quantity

P r i c e

Quantity

Market One Market Two

q1 q2

p1

p2

To Model Complements

Just add network externality terms eij




Choosing which markets to

chargeRegion I -- Subsidize

C, charge D

Region II -- Charge C & charge D

Region III -- Charge C,subsidize D

Region IV – Subsidizeboth (bad idea)

Pdeveloper

Pconsumer

Pd0, Pc0Pd0, Pc0

Pd0, Pc0

I II

IIIIV

Adobe

ID

Magazine




P r i c e

Quantity

P r i c e

Quantity

Consumer Market Developer Market

Consider which market creates more surplus.

q1 q2

p1 p2

So which market is

subsidized?




P r i c e

P r i c e

Subsidize the one that creates more surplus in thecross market.

Quantity Quantityq1 q2

p1

p2


So which market is

subsidized? Consumer Market Developer Market




P r i c e

P r i c e

Subsidize the one that creates more surplus in thecross market.

Quantity Quantityq1 q2

p1

p2


So which market is

subsidized? Consumer Market Developer Market




Rules

• Subsidize consumer side when – Highly price sensitive

• Acrobat Reader, streaming audio, streaming video

– Presence is the stronger attractant• Ad markets, credit cards, auctions, search engines

• Subsidize developer side when – Critical for adding value

• Applications development, operating systems, computer

games – Stronger attractant or gatekeeper

• Trend setters, textbooks





64

Winner-Take-All Markets





Source: Fast Company.com 5/9/08
























74

Homing vs. Switching Costs

2 SETUPS + 2 ONGOING

1 SETUP + 1ONGOING

Mono-homing

Switching

Multi-homing

2 SETUPS + 1 TERMINATION + 1 ONGOING

Wh d Wi T k All



When do Winner-Take-AllNetworks Emerge?

1. Large Supply/DemandEffects (FB vs gas engine)

2. Large Multi-Homing Costs(OS vs credit cards).

3. Anywhere access?(MMOG vs HMO).

4. Niche specialization is lessfeasible.

Windows

Cyworld Koreahas ¼ pop Cyworld USclosed.

http://upload.wikimedia.org/wikipedia/commons/7/7b/Minihompy.jpg




83

Attack & How to Control Adjacent

Platform Layers

Taking over adjacent markets via

Platform Envelopment




84

Question: At the time of introduction,was MS Office best-of-breed in

anything?

Bundling Components to

Envelope Markets



Independent Pricing: Spreadsheet

50 0 100

100

Spreadsheet

Charge 50

Sell to ½ mktMake 25

WordProcessing

Based on (defense) Nalebuff 2004, (attack) Eisenmann, Parker & Van Alstyne 2011



Independent Pricing: Word Processing

100

100

0 Spreadsheet

50

Charge 50


WordProcessing




Independent Pricing Word & Excel

100

100

0 Spreadsheet

WordProcessing

50

Charge 50


Incumbent

Profits from both markets

are 50

BuyWord BuyBoth

Buy

Excel


Competitor WordPerfect (or Lot s)



Competitor WordPerfect (or Lotus)undercuts price

100

100

0 Spreadsheet

50 Incumbent

profits drop

from 50 to 25 5

Charge 49Sell to 0.51 mkt

Makes ~25 WordProcessing




Pricing Word & Spreadsheet as a Bundle

Charge $100 for 2Sell to ½ market

Make 50(same combinedprofits as before)

100

100

Spreadsheet 0

WordProcessing


Competitor WordPerfect (or Lotus)



Competitor WordPerfect (or Lotus)undercuts price but makes ½ as much

Charges $49Sells to .25 mkt

Makes 12.25

Incumbent

Bundled profits fall only half as much

Entrant profits cut by half

100

0 100 Spreadsheet

WordProcessing




Side by Side Comparison

Product B

P r o d u c t

A

Incumbent profit: .5x.5=.25

Entrant profit: .49x.51.25

Independent Sales

Product B

P r o d u c t

A

Incumbent profit: 1*.5-.125=.375

Entrant profit: .5*.25=.125

Bundled Sales





94

Rhapsody

Who are the players?Where are the network effects?What would you do?

http://www.rhapsody.com/?pageid=rotw.homepage&pageregion=topNavBar




Microsoft

Real Audio & Envelopment

• RA pioneersstreaming audio(gives away

player)• Microsoft

bundles WMP inWindows

Users Content

Real Audio

$




Microsoft


• RA pioneersstreaming audio

• Microsoftbundles WMP inWindows

• RA switchesstrategy (introducessubscriptioncontent)

Users Content

Real Audio

$




Microsoft



• Yahoo! attacks,

subsidizes usersvia portaladvertising

Users Content

Real Audio

Yahoo!

PortalAds




Apple

Microsoft



• Apple subsidizes

iTunes via iPodsalesUsers Content

Real Audio

Yahoo!

iPodSales




Apple + AT&TApple

Microsoft



• Mobile phone

service bundlesmusic in serviceagreement.

• …like playing 3D

chess.

Users Content

Real Audio

Yahoo!

CellphoneSvc




10

1

Defensive Strategies

• Innovate (e.g., Adobe moving from documentpresentation to document management)

• Cede and redeploy — preferably through platformenvelopment! (e.g., RealNetworks move from streaming

media to subscription media)• Find a “bigger brother” (e.g., RealNetworks +Comcast, Cingular in response to envelopment threatfrom Yahoo et al. in subscription media)

• Sue (e.g., RealNetworks collects $760 million from

Microsoft, forces unbundling in EU)

Platform Envelopment Explains




10

2

Platform Envelopment ExplainsConvergence




Cloud Computing & Business Model ExperimentationSmart Grid Energy Platform Standards (WSJ 5-18-09!)

Coming Platform Applications

Electronic Medical Records (Google, Microsoft, WebMD …)




104

Conclusions

• Business models that give strategic advantage innetwork markets: – Design products for 1) proprietary complementarity, 2) price

sensitivity, 3) developer value add, and 4) low marginal costs.

• Winning Standards Battles: Winner-take-all platformsarise from both supply and demand economies of scale. – Find ways to manipulate 1) multi-homing costs, 2) same & cross-

side network effects, and 3) localization 4) bundling.

• Platform envelopment is a means of bundling acompetitor’s users or technology ―money side‖ into your platform. – Explains convergence!

Questions?



Quest o s―Information Complements, Substitutes & Strategic Product Design‖ Parker & Van

Alstyne 2000. http://ssrn.com/abstract=249585

―Two Sided Network Effects‖ Parker & Van Alstyne Management Science , Oct. 2005;51(10), pp. 1494 –1504. http://ssrn.com/abstract=1177443

―Strategies for Two-Sided Networks‖ Eisenmann, Parker & Van Alstyne Harvard Business Review Oct. 2006.

―Opening Platforms: How, When & Why‖ Eisenmann, Parker & Van Alstyne Ch. 6 in

Gawer, A. (ed) (2009) Platforms, Markets and Innovation , http://ssrn.com/abstract=1079712

―Innovation, Openness & Platform Control‖ Parker & Van Alstyne (2008) http://ssrn.com/abstract=1079712

"Six Challenges in Platform Innovation and Open Licensing," Parker & Van Alstyne

Communications & Strategies , no. 74, Q2 2009, p. 17-36. http://ssrn.com/abstract=1559013

―Platform Envelopment‖ Eisenmann, Parker & Van Alstyne; Strategic Management Journal (forthcoming 2011). http://ssrn.com/abstract=1496336

[email protected] [email protected]

http://ssrn.com/abstract=249585






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