Conference Summary

Multi-Sided Markets
June 18, 2003

Introduction
On Wednesday, June 18, the AEI-Brookings Joint Center for Regulatory Studies convened a panel to discuss the economic and policy implications of “multi-sided” markets.

Robert Hahn, Executive Director of the Joint Center, introduced the discussion, noting that the consideration of multi-sided markets calls for a departure from the traditional “lemonade stand” model of economic analysis.  The rewards, he suggested, are considerable: growing interdependence among distinct classes of producers, vendors and customers in important markets such as software, but will require a shift in analysis to address very different sorts of regulatory challenges.

Mr. Hahn introduced the panelists, who are experts in the economic and legal aspects of multi-sided markets: David Evans, Senior Vice President of National Economic Research Associates; Richard Schmalensee, Dean of the Sloan School of Management at the Massachusetts Institute of Technology, and Douglas Lichtman, professor of law at the University of Chicago.

David Evans, NERA
Mr. Evans opened with some striking examples of multi-sided markets.  An Osaka-based “love club” in Japan charges men about $100 to join. But since the value of the club to men depends on the presence of an abundant number of potential partners, women are charged nothing at all. To have a viable business, credit card companies need to get both cardholders to use the cards and merchants to accept the cards – and thus must price cardholder and merchant services to balance the two sides of the market. Bloomberg leases electronic terminals that provide data services for a monthly fee. But much of the value of terminals turns on the quality and quantity of content from third parties, who must be attracted to the Bloomberg “platform” in sufficient numbers.

Evans explained that three conditions must be present for multi-sided market platforms to emerge.  There must be two or more distinct customer groups (i.e., cardholders and merchants); there must be indirect network externalities that generate benefits for these distinct groups, and; there must be opportunities for an intermediary (i.e., American Express, Bloomberg) to make each group better off by connecting them.

The incentive structures that drive pricing in multi-sided markets are quite different because the survival of a platform firm turns on its ability to get all sides on board.  This often results in pricing patterns that do not fit traditional market rules.

Evans described three types of multi-sided platform markets:

1. Matchmakers, such as stock exchanges or real estate agents, who bring buyers and sellers together on a single platform
2. Audience-makers, such as newspapers or yellow pages, which serve as intermediaries between interdependent readers and advertisers
3. Demand-coordinators, such as computer operating systems, credit cards, or Bloomberg, which do not fall into the first two categories but nevertheless balance the interests of two or more customer groups

Evans focused on operating systems firms, which coordinate three classes: applications software developers, computer end-users, and hardware manufacturers.  In principle, they could charge both developers and users. But to balance the market, they often charge the software developers little or nothing, and pass costs on to the operating system users.

Richard Schmalensee, Sloan School of Management
Dean Schmalensee focused on why regulators need a new approach to analyze multi-sided markets. Accordingly, he advised regulators, who are inclined to focus on one side of a market, to be more conscious of the complexities introduced by multiple sides.

Traditional approaches to antitrust analysis, for example, do not work well in the multi-sided context.  Evaluating market power, barriers to entry and predation are more complicated when there are two or more sides to consider.  Among the reasons: the definition of unit costs is elusive and there is no simple way to derive competitive prices from information about costs.

Schmalensee noted that it is even more difficult to evaluate behavior when firms in a multi-sided market have different business models.  Newspaper A may charge for newsstand sales, while Newspaper B may be distributed for free – earning all it revenues from advertising.  Is the latter engaging in predatory pricing?  It is difficult to say, and regulators need to act with caution in deciding, he said.

For platforms like yellow pages, Schmalensee argued, the services offered to readers and to businesses are complements, not substitutes.  In such cases, he says that regulators should examine the interdependence, acknowledging that distinct customer groups exhibit distinct demands.

Schmalensee closed by allowing that there will be multi-sided market cases for which competition regulators need not use a substantially different analysis. But he said the burden should be on those who choose to disregard the differences and fail to develop new methods for evaluating their efficiency consequences.

Douglas Lichtman, University of Chicago Law School
Professor Lichtman explained that he largely agreed with most of what Evans and Schmalensee said about the nature of multi-sided markets.  In his view, however, they presented only half of the story.

The other half, he suggested, lies in the complexity of coordination in some of multi-sided markets: not only must firms in these markets attract multiple classes of customers, they must organize and manage the platforms.

For example, in order to get both retailers and shoppers on board, developers of shopping malls must choose location and analyze parking arrangements as well as figuring how much rent to charge stores.  Moreover, they must coordinate the mix of stores in each mall to make sure that the whole exceed the sum of the parts – that traffic brought in by one store will stay to shop at others.

Lichtman noted that regulators often only become interested in a multi-sided market when a platform firm becomes involved in the complexities of contract negotiations. In many cases, though, regulators never intervene because the platform firms are not able to successfully negotiate contracts with vendors due to intellectual property issues.

In the video game market, for example, platform owners like Sony and Microsoft have no direct control over developers of games for their systems.  They do not have the authority to exclude game vendors, nor do they have the power to make any vendor sign a contract with them.  They are seeking intellectual property rights that would allow them to exclude, but so far the courts have not agreed, Lichtman said.

The policy debate over platform market regulation is just beginning, he suggested. And the coming debates will be about how much economic analysis the court system will tolerate in evaluating multi-sided market behavior.  Before we advocate introducing more economic analysis to the courtroom, Lichtman contended, it would be wise to estimate how it well it is likely to be used.

This conference summary was prepared by Kishan Putta.