Strategy & Economics of Platforms Flashcards
Definition of Platforms
Platforms are intermediaries that facilitate and manage interactions between users. (Peitz & Belleflamme, 2017)
Digital Platforms - examples
- Airbnb
- Uber
- Ebay
- Amazon
- Netflix
- Microsoft
- BlaBlaCar
- Apple
- Kickstarter
- ClassPass
Definition Network Effects
Each user’s utility from using a good increases with every other user of the same good or with each user of compatible goods
Users of same good or compatible goods are called “the network”
Network effects are typical for platforms but also occur in other settings. (example languages)
Definition Externality
Costs or benefits of an agent’s action to other agent(s) that are not incorporated into the actions “price”
Because cost or benefits of externalities to other agents are not incorporated into price, there is usually “too much” or “too little” of that action.
This “too much” or “too little” from society’s perspective is referred to as market failure in economics: Without intervention, the market will fail to reach an “optimal state”.
Definition Network Externalities
Network effects arise from network externalities:
Definition:
The additional utility that users derive from other users of same good / platform or compatible goods / platforms.
Network externalities within the same group
Within-group network externalities
Network externalities across different groups
Across-group network externalities
Direct network effects
Users’ utility directly increases in the number of other users of the same side of the platform via positive within-group network externalities.
examples: telephony, facebook
Indirect network effects
Users’ utility increases in the number of other users on the other side of the product via positive across-group network externalities.
examples: video-game consoles, smartphone OS
(indirect network effects are most powerful if they work in both directions across groups)
Myopic expectations
ne = nt-1 (t: current period)
- consumers base their decision on past observed network size nt-1
- consumers will fail to anticipate future growth or decline of network
Fulfilled (“rational”) expectations
ne = nt
- Consumers’ expectations are always fulfilled such that excepted network size equals actual network size
- Consumers will always correctly anticipate growth or decline of network
What is the connection between myopic and fulfilled expectations?
Fulfilled expectations can be understood as an end-point / equilibrium of a dynamic process with myopic expectations.
Competing platforms: Brian Arthur Model
Idea:
- Two technologies
- Insignificant random events may matter
- Technology with more adopters improves faster either because of economies of scale or network effects
- Earlier adoption can lead to dominant position / monopoly
Questions:
- Multiple equilibria?
- Efficient outcome?
- Flexible diffusion process or lock-in?
- Small events averaged away or not, i.e. does history matter?
Model of Brian Arthur:
Base case:
- heterogeneous preferences
- increasing returns (r,s > 0)
- A random walk with absorbing barriers is observed -> lock-in
- Long-term market structure: Monopoly for A or B
Model of Brian Arthur:
Modification:
- heterogeneous preferences
- constant returns (r,s = 0)
- R-agents always choose technology A and S-agents always choose technology B
- The process is a random walk without drift (if proportions R- and S- types are the same)
- Market is shared between A and B in the long run (no lock-in)
Model of Brian Arthur:
Modification:
- heterogeneous preferences
- decreasing returns (r,s < 0)
- A random walk with reflecting barriers
- Market is shared between A and B
(hippe dingen zijn niet meer hip als iedereen ze aanneemt)
Model of Brian Arthur:
Modification:
- homogeneous preferences
- increasing returns (r,s > 0)
- Choice order (R or S) does not matter
- First agent chooses initially superior technology A. This increases the returns for adopting A and the other agents also choose A so that B is incapable of getting started.
Result:
- outcome is predictable: A corners the market and B is excluded
- outcome is path-efficient if returns accrue at the same rate, but if they increase at different rates, process may become path-inefficient
- the market may become locked-in to an inferior choice.
Three generic market structures can be observed in platform markets
- Monopoly after intitial competition:
If network effects are strong compared to idiosyncratic preferences (heterogeneity), the market will settle on a single platform - Niche survival:
If network effects are moderate compared to the degree of consumer heterogeneity, small platforms may be able to survive in the market even if there is one dominant platform - Dominant heterogeneity:
if network effects are small compared to consumer heterogeneity, no platform will gain a significant competitive advantage by building up a large network. The inherent consumer preferences will outweigh network effects, and expected market shares will closely resemble the distribution of inherent preferences
Examples for each generic market structure?
Which factors might limit network effects and tipping towards monopoly?
- Consumer heterogeneity
- Local network effects (example language)
- Decreasing strength of network effects
Strategies to induce market tipping
Battle between technologies or platforms are often characterized as “competition-for-the-market”
- “increasing installed-base”: increasing number of previous adopters
- Dynamic pricing / Free products
- Compatibility / Leveraging existing installed base
- Attracting influential adopters
- Vertical integration
- Being first mover
- Increasing strength of Network Effects: Shifting absorbing barrier
Dynamic pricing / free products
- Examples
- problems/risk
- investment in Network-size
- Pays off once platform becomes dominant and enjoys monopoly profits
examples:
- Video consoles are sold initially below cost
- Uber and Lyft offer discounts for first-time riders
Problems / Risk:
- Competitors can also price aggressively
- Dynamic pricing can therefore be very risky
(dot-com bubble)
Compatibility and Leveraging installed base
- Compatibility:
platforms can choose to be compatible with other platforms - Leveraging existing installed base:
Choosing compatibility with other products of same firm increases installed base
Example:
most versions of windows were backwards compatible with earlier versions.
Attracting Influential Adopters
In Brian arthur model, each potential user has equal importance. In reality, some adopters are more important than others.
Examples:
- early adopters
- people with large social networks (“influencers”)
- large companies
- government agencies
Vertical integration
On two-sided platforms, firms can provide complementary products on their own. Especially in early stages, good strategy to solve chicken-and-egg problem.
Examples:
- Netflix and Amazon produce their own movies and series
- Nintendo, Sony and Microsoft produce their own games
- Apple and Google provide own smartphone apps
Strategic Communication
Coordinated application of advertising and preannouncement to inform consumers and/or rival firms about (new) products
- even with fulfilled expectations, there can be low- and high-adoption equilibria
Goal of strategic communication:
- Favorably influence consumers’ expectation about network size and therefore increase (perceived) strength of network effects
- Help consumers to coordinate on high-adoption equilibria
- > Strategic communication (e.g. advertising) is also substitute for (standalone) quality.
Advertising:
- three types (and one additional type in markets with network effects)
- Persuasive Advertising:
Changes consumer preferences, i.e. consumers value the product more after advertising - Complementary Advertising:
Complement the plain good (e.g. by providing social prestige - “Veblen effect”) - Informative Advertising:
Informs about product’s existence and characteristics - Coordinative Advertising
Coordinate consumers on same product to maximize network effects
Investment effect
Lowering initial price attracts more consumers later. Platform “invests” into size.
