Sided Markets
A R T I C L E www.hbr.org
Strategies for Two- Sided Markets
by Thomas Eisenmann, Geoffrey Parker, and Marshall W. Van Alstyne
Included with this full-text Harvard Business Review article:
1 Article Summary The Idea in Brief—the core idea The Idea in Practice—putting the idea to work
2 Strategies for Two-Sided Markets
11 Further Reading A list of related materials, with annotations to guide further exploration of the article’s ideas and applications
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Strategies for Two-Sided Markets
The Idea in Brief The Idea in Practice If you listed the blockbuster offerings that To ensure your platform’s success: would negate any DVD player’s unique pic- have redefined the global business land- ture and sound capabilities. scape, you’d find that many tie together two GET PRICING RIGHT • Decide whether to share the single plat- distinct groups of users. HMOs, for instance, Consider these pricing strategies: form or fight for proprietary control. Shar- link patients to health-care providers. Search ing has benefits: Total market size expands engines join Web surfers and advertisers. • Subsidize quality- and price-sensitive us- ers. For example, if PDF document readers and rivalry lessens, reducing market outlays. When successful, these platforms catalyze a were charged even a tiny amount, Adobe That’s why DVD industry contenders opted virtuous cycle: More demand from one user Acrobat Reader’s immense user base would to pool their technologies. They jointly cre- group spurs more from the other. For exam- be much smaller, reducing document pro- ated the DVD format in 1995, avoiding a re- ple, the more video games developers (one ducers’ interest and their willingness to pay play of the costly video players’ VHS-Beta user group) create for the Microsoft X-Box a premium for access to readers. Readers, standards clash. platform, the more players (the other user much more price sensitive than document Want to fight for proprietary control? You’ll group) snap up the latest X-Box. Meanwhile, producers, wouldn’t pay for access to a big- need deep pockets, a reputation for past the more players who use X-Box, the more ger base of writers. prowess, and preexisting relationships with developers willing to pay Microsoft a licens- prospective users. When launching Acrobat, ing fee to produce new games. And as user • Secure “marquee” users’ exclusive partici- for instance, Adobe marketed to its existing bases grow, margins fatten. pation in your platform. Providing incen- tives for marquee users (for instance, an- user base for PostScript printing products. But as Eisenmann, Parker, and Van Alstyne chor stores in a mall) to participate contend, managing platforms is tricky: exclusively in your platform (the mall) can AVOID ENVELOPMENT Strategies that make traditional offerings attract more users from the other user Many platforms have overlapping user successful won’t work in these two-sided group (retailers who lease space in malls groups, tempting some related platform pro- markets. To capture the advantages that with prestigious anchor stores). Result? Your viders to swallow others’ users. Mobile platforms promise, you must address three platform’s growth accelerates. phones, for instance, now incorporate music strategic challenges. and video players, PCs, and credit cards. To VED. The key challenge? Get pricing right: “Subsi- COPE WITH WINNER-TAKE-ALL avoid being swallowed, consider changing dize” one user group while charging the COMPETITION your business model. other a premium for access to the subsi- The prospect of fat margins in two-sided mar- Example: dized group. Adobe’s Acrobat PDF market kets can fuel an intense desire among rivals to Under attack from Microsoft, RealNetworks ALL RIGHTS RESER comprises document readers and writers. become the only platform provider. To deal (which pioneered streaming media soft-
TION. Readers pay nothing for Acrobat software. with the competition: A ware) ceded the streaming media business.
OR Document producers, who prize this 500- • Decide whether the two-sided market It leveraged existing relationships with con- ORP million-strong audience, pay $299. you’re eyeing will eventually be served by sumers and music companies to launch If you seize a platform opportunity but a single platform. The answer’s “Yes” if Rhapsody—a $10-per-month subscription don’t get it right the first time, someone using more than one comparable platform music service that offers unlimited stream- ing to any PC from a library of a half-million OL PUBLISHING C else will. By mastering platforms’ unique would be costly to users and if special fea- strategic challenges, you’ll gain a head start tures don’t increase value to users. songs. It now profits from consumers ver- over your competition. sus subsidizing them. Example: The DVD industry meets these criteria: BUSINESS SCHO D R
A Owning multiple DVD players would be ex- V pensive for consumers; providing multiple formats, costly for movie studios. And DVD players don’t lend themselves to distinctive features, since they connect to TV sets that OPYRIGHT © 2006 HAR C
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Companies in industries such as banking, software, and media make money by linking markets from different sides of their customer networks—audiences and advertisers, for example. The distinct character of these businesses demands a new approach to strategy.
Strategies for Two- Sided Markets
by Thomas Eisenmann, Geoffrey Parker, and Marshall W. Van Alstyne
If you listed the blockbuster products and ser- ing services, like shopping malls or Web sites vices that have redefined the global business such as Monster and eBay. landscape, you’d find that many of them tie to- Two-sided networks can be found in many in-
VED. gether two distinct groups of users in a net- dustries, sharing the space with traditional prod- work. Case in point: What has been the most uct and service offerings. However, two-sided important innovation in financial services since networks differ from other offerings in a funda- World War II? Answer: almost certainly the mental way. In the traditional value chain, value
ALL RIGHTS RESER credit card, which links consumers and mer- moves from left to right: To the left of the com-
TION. chants. Newspapers, HMOs, and computer op- pany is cost; to the right is revenue. In two-sided A
OR erating systems also serve what economists call networks, cost and revenue are both to the left
ORP two-sided markets or two-sided networks. News- and the right, because the platform has a dis- papers, for instance, join subscribers and adver- tinct group of users on each side. The platform tisers; HMOs link patients to a web of health incurs costs in serving both groups and can col- care providers, and vice versa; operating sys- lect revenue from each, although one side is
OL PUBLISHING C tems connect computer users and application often subsidized, as we’ll see. developers. The two groups are attracted to each other— Products and services that bring together a phenomenon that economists call the net- groups of users in two-sided networks are plat- work effect. With two-sided network effects, BUSINESS SCHO D
R forms. They provide infrastructure and rules the platform’s value to any given user largely A V that facilitate the two groups’ transactions and depends on the number of users on the net- can take many guises. In some cases, platforms work’s other side. Value grows as the platform rely on physical products, as with consumers’ matches demand from both sides. For exam- credit cards and merchants’ authorization ter- ple, video game developers will create games minals. In other cases, they are places provid- only for platforms that have a critical mass of OPYRIGHT © 2006 HAR C
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Strategies for Two-Sided Markets
players, because developers need a large begin by looking at the factors that senior enough customer base to recover their upfront managers must consider in designing their programming costs. In turn, players favor plat- platforms’ business models. The key decision forms with a greater variety of games. here is pricing. As we’ve noted, providers of Because of network effects, successful plat- platforms for two-sided networks are able to forms enjoy increasing returns to scale. Users draw revenue from both sides. In most cases, will pay more for access to a bigger network, though, it makes sense to subsidize certain us- so margins improve as user bases grow. This ers. The crucial strategy question is, Which side sets network platforms apart from most tra- should you subsidize, and for how long? ditional manufacturing and service busi- The next step is to figure out how to man- nesses. In traditional businesses, growth be- age winner-take-all dynamics. Many two- yond some point usually leads to diminishing sided network industries are served almost returns: Acquiring new customers becomes entirely by a single platform. In some cases, harder as fewer people, not more, find the just one company controls that platform, as firm’s value proposition appealing. with eBay’s auctions or Microsoft’s Windows. Fueled by the promise of increasing returns, In other cases, multiple companies share the competition in two-sided network industries dominant platform, as with DVD and fax can be fierce. Platform leaders can leverage standards or, in real estate, a regional multi- their higher margins to invest more in R&D or ple listing service. (See the exhibit “Examples lower their prices, driving out weaker rivals. As of Two-Sided Networks.”) When a network a result, mature two-sided network industries industry is likely to be served by a single plat- are usually dominated by a handful of large form, aspiring providers must make a “bet the platforms, as is the case in the credit card in- company” decision. Should they fight to gain dustry. In extreme situations, such as PC oper- proprietary control over the platform or share ating systems, a single company emerges as the the spoils with rivals? winner, taking almost all of the market. Platform providers that have vanquished Platforms serving two-sided networks are their immediate rivals can’t rest on their lau- not a new phenomenon. Energy companies rels. Indeed, they face a significant competitive and automakers, for example, link drivers of threat from large companies operating in adja- gasoline-powered cars and refueling stations in cent markets that have the ability to offer a a well-established network. However, thanks multiplatform bundle. In our final section, we largely to technology, platforms have become explore this challenge and offer prescriptions more prevalent in recent years. New platforms for firms that face it. As we’ll see, moving first have been created (Google, for example, links and getting big quickly aren’t necessarily the advertisers and Web searchers) and traditional right answers. businesses have been reconceived as platforms (for instance, retail electricity markets are Challenge 1: Pricing the Platform evolving into platforms that match consumers In competitive industries, prices are largely de- with specific power producers, allowing them termined by the marginal cost of producing an to express their preferences for cheaper coal or extra unit, and margins tend to be thin. In in- more costly renewable power). Yet for all the dustries with high barriers to entry, the price potential they’ve spotted, platform providers ceiling is set by customers’ willingness to pay, Thomas Eisenmann (teisenmann@ have struggled to establish and sustain their and margins are more likely to be fat. hbs.edu) is an associate professor at two-sided networks. Their failures are rooted For two-sided networks, pricing is a more Harvard Business School in Boston. in a common mistake. In creating strategies for complicated affair. Platform providers have to Geoffrey Parker (gparker@tulane two-sided networks, managers have typically choose a price for each side, factoring in the .edu) is an associate professor at Tulane relied on assumptions and paradigms that impact on the other side’s growth and willing- University’s A. B. Freeman School of apply to products without network effects. As a ness to pay. Typically, two-sided networks have Business in New Orleans. Marshall W. result, they have made many decisions that are a “subsidy side,” that is, a group of users who, Van Alstyne ([email protected]) is an asso- wholly inappropriate for the economics of when attracted in volume, are highly valued by ciate professor at Boston University’s their industries. the “money side,” the other user group. Because School of Management and a visiting In the following article, we draw on recent the number of subsidy-side users is crucial to 1 scholar at MIT’s Center for eBusiness in theoretical work to guide executives in negoti- developing strong network effects, the plat- Cambridge, Massachusetts. ating the challenges of two-sided networks. We form provider sets prices for that side below harvard business review • hbr.org • october 2006 page 3
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Strategies for Two-Sided Markets
the level it would charge if it viewed the sub- Pricing is further complicated by “same- sidy side as an independent market. Con- side” network effects, which are created when versely, the money side pays more than it drawing users to one side helps attract even would if it were viewed as an independent more users to that side. For example, as more market. The goal is to generate “cross-side” net- people buy PlayStation consoles, new users work effects: If the platform provider can at- will find it easier to trade games with friends tract enough subsidy-side users, money-side or find partners for online play. Economists users will pay handsomely to reach them. call this snowballing pattern a positive same- Cross-side network effects also work in the re- side network effect. (Same-side network ef- verse direction. The presence of money-side fects can also be negative. For a more detailed users makes the platform more attractive to explanation of how network effects attract or subsidy-side users, so they will sign up in greater deter users, see the sidebar, “The Dynamics of numbers. The challenge for the platform pro- Two-Sided Networks.”) vider with pricing power on both sides is to de- It is not always obvious which side—if termine the degree to which one group should either—the platform should subsidize and be encouraged to swell through subsidization which it should charge. During the dot-com and how much of a premium the other side boom, for example, nascent B2B exchanges ag- will pay for the privilege of gaining access to it. onized over whether to charge fees to buyers,
Examples of Two-Sided Networks Insights about the economics of two-sided higher volume of patients—agree to rates side. Real estate brokers avoid this free-rider networks apply to a variety of industries. In below those they could command if they problem by splitting the seller’s fee 50/50. Sub- cases where platforms—the products and were not affiliated with an HMO. sidies also disappear when a shared platform’s sevices that bring together groups of users— Networks served by shared platforms tend providers do not have pricing power on both are proprietary, there invariably is a clear to lack a subsidy side. It is hard for platform sides of the network, as in the case of gasoline- subsidy side and a clear money side. For ex- providers to recover subsidies if rivals share powered transportation. ample, doctors—in exchange for access to a the fees collected from the network’s money
NETWORKED MARKET SIDE 1 SIDE 2 PLATFORM PROVIDERS Rival Providers of Proprietary Platforms
PC operating systems Consumers Application developers* Windows, Macintosh Online recruitment Job seekers* Employers Monster, CareerBuilder Miami Yellow Pages Consumers* Advertisers BellSouth, Verizon Web search Searchers* Advertisers Google, Yahoo HMOs Patients* Doctors Kaiser, WellPoint Video games Players* Developers PlayStation, Xbox Minneapolis shopping malls Shoppers* Retailers Mall of America, Southdale Center Rival Providers of Shared Platforms
Linux application servers Enterprises Application developers IBM, Hewlett-Packard, Dell Wi-Fi equipment Laptop users Access points Linksys, Cisco, Dell DVD Consumers Studios Sony, Toshiba, Samsung Phoenix Realtors Association Home buyers* Home sellers 100+ real estate brokerage firms Gasoline-powered engines Auto owners Fueling stations GM, Toyota, Exxon, Shell Universal Product Code Product suppliers Retailers NCR, Symbol Technologies
*Denotes network’s subsidy side harvard business review • hbr.org • october 2006 page 4
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Strategies for Two-Sided Markets
sellers, or both, and how charges should be software. If readers were charged even a small split between fixed subscription payments and amount, Adobe Reader’s 500-million-person variable transaction fees. (See the sidebar “Simi- user base would be much smaller. Writers, lar Networks, Different Pricing” for an illustra- who greatly value this huge audience, pay a tion of how two seemingly similar networks fee for their software. If Adobe reversed its ap- may require very different pricing strategies.) proach, charging readers and subsidizing writ- To make the right decisions about pricing, ers, its network would collapse. Writers are executives of platform providers need to look less price sensitive, so free software would not closely at the following factors: dramatically boost their numbers. More to the Ability to capture cross-side network effects. point, readers would not pay much for access Your giveaway will be wasted if your network’s to a bigger base of writers. subsidy side can transact with a rival platform User sensitivity to quality. High sensitivity to provider’s money side. That’s what happened quality also marks the side you should subsi- to Netscape, which subsidized its browser to dize. This pricing prescription can be counter- individuals in the hope of selling Web servers intuitive: Rather than charge the side that to companies operating Web sites. However, strongly demands quality, you charge the side Web site operators didn’t have to buy Netscape’s that must supply quality. Such a strategy is evi- server in order to send pages to Netscape’s big dent in video games. To deliver compelling base of users; they could buy a rival’s Web quality, game developers incur enormous fixed server instead. costs. To amortize these costs, they must be as- User sensitivity to price. Generally, it makes sured that the platform has many users. Hence sense to subsidize the network’s more price- the need for a consumer subsidy. Platform pro- sensitive side and to charge the side that in- viders make sure game developers meet high creases its demand more strongly in response quality standards by imposing strict licensing to the other side’s growth. Adobe’s Acrobat terms and charging a high royalty. This “tax” is software follows this pricing rule. Acrobat pre- not passed through to consumers: Developers sents any electronic document in Portable charge the highest prices the market will bear, Document Format (PDF), a universal stan- regardless of the royalty rate. However, the roy- dard that can be printed or viewed exactly as it alty helps weed out games of marginal quality. appeared in its original application. The PDF Once the “tax” is added, titles with poor sales network consists of two sets of users—writers, prospects cannot generate enough contribu- who create documents, and readers, who view tion margin to cover their fixed costs, so they them—using different software. Readers are never get made in the first place. very price sensitive; they pay nothing for their Output costs. Pricing decisions are more straightforward when each new subsidy-side user costs the platform provider essentially nothing. This will be the case when the give- away takes the form of a digital good such as a The Dynamics of Two-Sided Networks software program or a cheap service such as Transactions in two-sided networks al- ber of users on one side of the network otherwise-idle computer time. However, when ways entail a triangular set of relation- makes it either more or less valuable to a giveaway product has appreciable unit costs, ships. Two user groups—the network’s users on the same side; and a cross-side as with tangible goods, platform providers “sides”—interact with each other effect, in which increasing the number must be more careful. If a strong willingness through one or more intermediaries of users on one side of the network to pay does not materialize on the money called platform providers. A platform em- makes it either more or less valuable to side, a giveaway strategy with high variable bodies an architecture—a design for the users on the other side. Cross-side costs can quickly rack up large losses. products, services, and infrastructure fa- network effects are typically positive, FreePC learned this lesson in 1999 when it cilitating network users’ interactions— but they can be negative (TV viewers provided computers and Internet access at no plus a set of rules; that is, the protocols, preferring fewer ads). Same-side net- cost to consumers who agreed to view Internet- rights, and pricing terms that govern work effects are often negative (sellers delivered ads that could not be minimized or transactions. These platforms exhibit preferring fewer rivals in a B2B ex- hidden. Unfortunately, few marketers were two types of network effects, which may change), but they may be positive (Mi- eager to target consumers who were so cost be either positive or negative: A same- crosoft Xbox owners valuing the fact that conscious. FreePC abandoned its offer after in- side effect, in which increasing the num- they can play games with friends). curring $80 million in losses.
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Strategies for Two-Sided Markets
Same-side network effects. Surprisingly, wards consumers’ queries to a single dealer in sometimes it makes sense to deliberately ex- any given geographic territory, have suc- clude some users from the network. Platform ceeded with this strategy. Autobytel has providers normally welcome growth in the earned a modest profit over the past three user base on either side, because it encourages years; more to the point, it survived the dot- growth on the other side. In addition to posi- com crash that extinguished many Internet tive cross-side network effects, however, plat- market makers with flawed strategies. form managers must assess the possibility of Users’ brand value. All users of two-sided negative same-side network effects, which can networks are not created equal. The participa- be quite strong. In most markets, sellers would tion of “marquee users” can be especially im- be happy to see fewer direct rivals; the same portant for attracting participants to the other can be true for buyers when goods are scarce. side of the network. Marquee users may be For example, many auto parts manufacturers, exceptionally big buyers, like the U.S. govern- concerned about downward pricing pressure, ment. Or they may be high profile suppliers, refused to participate in Covisint, a B2B ex- like anchor stores in malls. A platform pro- change organized by auto manufacturers. Cov- vider can accelerate its growth if it can secure isint stalled, as did many other B2B market the exclusive participation of marquee users in makers that failed to recruit enough sellers. In the form of a commitment from them not to the face of strongly negative same-side net- join rival platforms. For many years, this kind work effects, platform providers should con- of exclusive arrangement was at the core of sider granting exclusive rights to a single user Visa’s marketing campaigns (“…and they don’t in each transaction category—and extracting take American Express”). Of course, it can be high rent for this concession. The platform expensive—especially for small platforms—to manager then must make sure that sellers do convince marquee users to forfeit opportuni- not abuse their monopoly positions; other- ties in other networks. When the participation wise, buyers will avoid the network. Online of a few large users is crucial for mobilizing a car-buying services like Autobytel, which for- network, conflict over the division of value
Similar Networks, Different Pricing On first inspection, PC and video game net- reversed. End users are the money side, pay- ity by imposing strict licensing terms and works look similar. In both cases, end users ing well above cost for the platform’s essential charging a high royalty. This “tax,” absorbed by on one side wishing to link to software or element—its OS—which comes bundled with the developers, helps weed out games of mar- games on the other side buy a platform con- PCs offered by OEMs like Gateway. Applica- ginal quality. Developers cannot afford to offer sisting of an operating system (OS) bundled tion developers are the subsidy side. They pay titles with weak sales prospects, once the tax is with hardware—a PC or a game console. The no royalties and receive free software develop- added to their price. two businesses exhibit similarly positive ment kits from the OS vendors. By contrast, PCs are often purchased for cross-side network effects: End users favor Why do these similar two-sided networks work and are otherwise more likely viewed platforms that offer a wide variety of comple- have fundamentally different pricing struc- as household necessities than game con- ments. Developers favor platforms with more tures? Video game consoles users—typically soles are, so price sensitivity is lower. Over end users because this improves the odds teenagers—are both far more price sensitive their lives, PCs accumulate scores of applica- that they will recover the fixed, upfront costs and quality conscious than typical PC users. tions, ranging from the indispensable (such of creating complements. On average, each console owner buys just as word processing) to the disposable (for Notwithstanding these similarities, the PC eight games, which cost about $50 apiece. example, some casual games). Accordingly, and game industries use very different pricing Over the two- to three-year life of a console, we observe a huge range of price and qual- models. In video games, end users are subsi- these precious titles are consumed sequen- ity levels for applications. dized. Platform providers like Sony PlaySta- tially in intense bursts; gamers spend a great It’s true that both PC users and gamers tion and Microsoft Xbox historically have deal of time—40 to 100 hours—with each title. value variety and quality and that develop- priced consoles at or below cost. Game devel- To deliver compelling quality, game devel- ers in both networks value the ability to opers are on the network’s money side; they opers incur enormous fixed costs. To amortize reach a large installed base. However, gam- pay a royalty to console manufacturers of as these costs, they must be assured that the con- ers’ need for quality seems to be stronger, as much as 20% of a game’s retail price. In the PC sole has many users: Hence the need for a con- does game developers’ need for large num- industry, the money side and subsidy side are sumer subsidy. Console providers police qual- bers of consumers. harvard business review • hbr.org • october 2006 page 6
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Strategies for Two-Sided Markets
between platform providers and large users is ket is likely to be served by a single platform common. Microsoft learned this when Elec- when the following three conditions apply: tronic Arts (EA)—the largest developer of video • Multi-homing costs are high for at least games and thus a major potential money-side one user side. “Homing” costs comprise all the user of Microsoft’s Xbox platform—refused to expenses network users incur—including create online, multiplayer versions of its games adoption, operation, and the opportunity for the Xbox Live service. EA objected to Mi- cost of time—in order to establish and main- crosoft’s refusal to share subscription fees from tain platform affiliation. When users make a Xbox Live, among other issues. After an 18- “home” on multiple platforms, they increase month stalemate, EA finally agreed to offer their outlays accordingly. For example, the Xbox Live games. Terms of the agreement were vast majority of PC users rely on a single op- not made public, but at the time, Microsoft an- erating system—almost always Windows— nounced that it would halt the in-house devel- because using multiple operating systems is opment of new games that would compete expensive in terms of the additional hardware, with EA’s flagship sports titles. software, and training required. Similarly, dis- Failing to recognize that two-sided network tance limits the number of shopping malls that pricing follows different rules than conven- consumers can visit at any one time, which in tional businesses can sink even the most attrac- turn limits the number of malls. When multi- tive platforms. Apple provides a cautionary homing costs are high, users need a good rea- tale about misapplied pricing logic. Apple’s son to affiliate with multiple platforms. well-regarded Macintosh operating system has • Network effects are positive and strong— always commanded a price premium from at least for the users on the side of the net- consumers. When it launched the Mac, Apple work with high multi-homing costs. When also tried to extract rent from the other side of cross-side network effects are positive and its network, charging third-party developers strong, those network users will tend to con- $10,000 for the software development kits verge on one platform. A small-scale platform (SDKs) required to create Macintosh applica- will be of little interest to users unless it is tions. By contrast, Microsoft gave Windows the only way to reach certain users on the SDKs away for free. Tellingly, by the time of other side. The odds of a single platform pre- Microsoft’s antitrust trial, Windows had six vailing also increase when same-side network times as many applications as Macintosh. This effects are positive: for example, when users made Windows far more attractive to consum- of a software program need to share files with ers, despite its functional shortcomings. one another. • Neither side’s users have a strong prefer- Challenge 2: Winner-Take-All ence for special features. If certain users have Dynamics unique needs, then smaller, differentiated plat- The prospect of increasing returns to scale in forms can focus on those needs and carve out network industries can lead to winner-take-all niches in a larger rival’s shadow. American Ex- battles, so an aspiring platform provider must press, for example, earns high margins despite consider whether to share its platform with ri- having issued only 5% as many credit cards as vals or fight to the death. Companies some- Visa. American Express cards have no preset times get this decision wrong, as with Sony’s spending limit—a valuable feature for business futile battle to establish its Betamax videocas- travelers, made possible because cardholders sette standard. must pay their full balance every month. Visa Coping with platform competition is a two- cannot match this feature, because the loans it step process. First, executives must determine extends to cardholders put an upper limit on whether their networked market is destined their spending. In cases where special features to be served by a single platform. When this are not important, however, users will tend to is the case, the second step—deciding whether converge on a single platform. to fight or share the platform—is a bet-the- The DVD industry meets these three condi- company decision. The stakes are much higher tions. First, multi-homing costs are high for when a networked market has room for fewer consumers because it would be expensive to rival platforms. buy multiple players. Likewise, multi-homing Turning to the first step, a networked mar- costs are high for studios: Having to provide
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Strategies for Two-Sided Markets
the same content in multiple incompatible for- of attrition, deep pockets matter. Again, just mats would increase inventories and distribu- ask Microsoft! tion costs. Second, cross-side network effects First-mover advantages can also be signifi- are strong for both sides of the network. Most cant in platform battles, but they are not al- consumers value access to a wide variety of ti- ways decisive. In fact, when the market tles, and studios realize scale economies when evolves slowly, late mover advantages may they can sell to more consumers. Third, oppor- be more salient. Late movers may, for exam- tunities for technical differentiation are mod- ple, avoid the pioneer’s positioning errors, be est, because DVD players connect to TV sets, better placed to incorporate the latest tech- which are standardized in ways that intrinsi- nology into product designs, or be able to re- cally limit DVD picture and sound quality. verse engineer pioneers’ products and beat For these reasons, the DVD market was them on cost. Google, which lagged Web- bound to be served by a single platform. Poten- search pioneers by several years, avoided por- tial platform providers anticipated this out- tals’ clutter in favor of a simple, fast-loading come and faced a choice: They could fight for home page. It also copied and then improved proprietary control of the platform or pool on Overture’s paid-listing model for generat- their technologies. Industry participants chose ing revenue from searches. the latter approach, jointly creating the DVD In a battle for platform control, first and late format in 1995 and avoiding a replay of the movers alike will feel strong pressure to amass VHS-Betamax standards battle. users as quickly as possible. In most cases, this Why share a network when proprietary urgency is appropriate. Positive word-of-mouth control promises monopoly profits once rivals favors the early mover. But racing to acquire are vanquished? The answer seems clear users can be a mistake under two circum- In traditional value enough if senior managers believe that their stances. First, executives must ask whether company’s platform is not likely to prevail. their business is readily scalable. For exam- chains, value moves from However, even those firms that have a fight- ple, platforms that must support complex left to right: To the left of ing chance of gaining proprietary control customer-service interactions—like stop-loss stand to realize benefits from sharing. First, orders or margin trades at an online brokerage the company is cost; to the total market size will be greater with a firm—typically require skilled professionals. shared platform. During a battle for domi- The need to recruit and train such personnel the right is revenue. In nance in a two-sided network, some users will can put the brakes on rapid growth. Second, two-sided networks, cost delay adoption, fearing that they will be due to their explosive growth potential, stranded with obsolete investments—like a platform-mediated networks are prone to and revenue are both to Betamax VCR—if they back the loser. Second, boom or bust valuation cycles. When they the left and the right. since the stakes are so high in battles for net- launch cash-draining “get big fast” strategies, work dominance, firms spend enormous therefore, top managers need to be sure that amounts on upfront marketing. Rivalry tends funding will be forthcoming should capital- to be less intense with a shared platform, re- market sentiment turn negative. ducing marketing outlays. Winning the battle. To fight successfully, you Challenge 3: The Threat of will need, at a minimum, cost or differentia- Envelopment tion advantages. Three other assets are im- You can do a great job addressing pricing and portant in establishing proprietary control: winner-take-all challenges and establish a suc- First, platform providers gain an edge when cessful new platform yet still face great dan- they have preexisting relationships with pro- ger. Why? Your platform may be “enveloped” spective users—often in related businesses. by an adjacent platform provider that enters Adobe, for example, leveraged its user base your market. Platforms frequently have over- for PostScript printing products when launch- lapping user bases. Leveraging these shared re- ing PDF. Second, high expectations generate lationships can make it easy and attractive for momentum in platform wars, so a reputa- one platform provider to swallow the network tion for past prowess helps a great deal. of another. The real damage comes when your Having vanquished rival PC operating sys- new rival offers your platform’s functionality tems, Microsoft is feared and respected as a as part of a multiplatform bundle. Such bun- ruthless and competent rival. Third, in a war dling hurts the stand-alone platform provider
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Strategies for Two-Sided Markets
when its money side perceives that a rival’s Microsoft has not been the only threat. bundle delivers more functionality at a lower Real’s Rhapsody subscription music service is total price. The stand-alone platform provider now threatened with envelopment by Yahoo cannot respond to this value proposition be- and ultimately by Apple. In 2005, Yahoo intro- cause it cannot afford to cut the price on its duced a subscription music service—including money side and it cannot assemble a compara- downloads to portable music players—for $5 ble bundle. per month. Yahoo could afford to price ag- Networked markets—especially those in gressively, because bundling subscription which technology is evolving rapidly—are music into its portal would increase user re- rich with envelopment opportunities that tention rates and, through cross-marketing, can blur market boundaries. This blurring is boost revenue from its other services. Like- called “convergence.” For example, mobile wise, Apple might choose to offer a subscrip- phones now incorporate the functionality tion version of iTunes, drawing on the very lu- of music and video players, PCs, and even crative iPod—its money side—to subsidize an credit cards. Likewise, eBay—having acquired envelopment attack. Real cannot match it ri- PayPal and the voice-over-Internet protocol vals’ bundles because it does not own a portal (VoIP) start-up Skype, as well as equity in or sell an MP3 player. Craigslist—is on a collision course with Goo- But Real is not without options. Its defense gle, which also offers a payment service (Goo- against Microsoft and, more recently, Yahoo gle Checkout), VoIP (Google Talk), and a list- and Apple shows what a focused firm can do to ing service (Google Base). survive envelopment. In many cases, a stand-alone business facing Change business models. Real’s response to envelopment has little choice but to sell out to Microsoft’s envelopment attack was to switch For two-sided networks, the attacker or exit the field. Some, however, its money side. Ceding the streaming media manage to survive. RealNetworks, the pioneer business, Real leveraged existing relationships pricing is a complicated of streaming media software, is—at least so with consumers and music companies to affair. Platform providers far—a case in point. launch Rhapsody in 2003, charging $10 per Real’s original business model was ideally month for unlimited streaming to any PC have to choose a price for suited to the needs of its two-sided network: from a library of a half-million songs. Real now Consumers downloaded its streaming media profited from consumers, rather than subsidiz- each side, factoring in the player for free, and content companies paid for ing them. Another common way for specialists impact on the other side’s its server software. As a result, the company like Real to reinvigorate their business models quickly dominated the new market and earned is to offer services as a systems integrator— growth and willingness modest profits in 1999 and 2000. But as early helping enterprises knit together diverse sys- to pay. as 1998, Real’s streaming media franchise was tems and technologies. Indeed, Real was doing under attack from Microsoft. Like Real, Mi- precisely that for a number of big music com- crosoft freely supplied its Windows Media panies even before it launched Rhapsody. Player (WMP) to consumers. But Microsoft And it’s no accident that IBM—the dominant also bundled its streaming software at no addi- provider of computing platforms through tional cost as a standard feature of its NT the mid-1980s—has more recently focused Server—a multipurpose operating system that on systems integration. Facilitating transac- also incorporated file, print, e-mail, and Web tions across a two-sided network requires plat- servers, among other functions. form providers to coordinate users’ activities. Since content companies—Real’s money Hence, managing a platform builds system in- side—needed a multipurpose server anyway, tegration skills that can be exploited. they could buy NT and receive a “free” stream- Find a “bigger brother.” When bullied on ing media server. As content companies em- the playground, a little guy needs a big friend. braced this attractive proposition, consumers Real has found allies through partnerships switched with them, because Microsoft’s with cable TV system operators and cellular streaming media servers worked only with its phone companies. Subscription music— own media players, and vice versa. By 2003, which requires a broadband connection— 42% of Internet users in North America identi- makes cable modem service stickier: Once fied WMP as their primary media player, com- consumers commit to a music service, they pared with 19% for Real’s player. face switching costs. Changing vendors would
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Strategies for Two-Sided Markets
force them to configure new music players tion, a significant barrier in many diversified and recreate playlists. Real also bundles its companies. Sony, for example, has struggled to Rhapsody Internet radio product with Sprint’s coordinate strategy across its consumer elec- wireless phone service and streaming video tronics, video game, movie, and music busi- with Cingular’s service. Cellular phone compa- nesses. Once the industry’s trailblazer with nies are attractive allies for Real, because they products like the Walkman, Sony has seen can mount their own envelopment attacks if Apple usurp this role. Mistakes like this on the Apple ever enters the subscription music mar- part of established companies are precisely ket. Cellular carriers can afford to subsidize why former upstarts like Google, eBay, and digital music playback on their phones, since Yahoo have grown into giants. doing so would be likely to reduce cell phone • • • churn rates. That would present a big threat to Despite the ubiquity of network industries Apple’s money side. and the attractions of owning a successful plat- Sue. Firms facing envelopment are wise to form, the strategic implications of two-sided consider legal remedies, because antitrust law networks have gone largely unexplored. In the for two-sided networks is still in dispute. Anti- past, this lack of understanding was less prob- trust law was conceived to constrain the be- lematic because executives usually had the havior of traditional manufacturing firms and luxury of formulating strategies for two-sided does not fully reflect the economic impera- networks through trial and error. Markets tives of platform-mediated networks. For this today are less forgiving. Many opportunities reason, dominant platform providers that for platform creation arise in high-tech sectors offer bundles or pursue penetration pricing with short product life cycles. Opportunities run the risk of being charged with illegal tying also abound in traditional industries recon- or predation. Exploiting this opportunity, Real ceived as two-sided networks. And, thanks to brought Microsoft to antitrust court and then the Internet, firms have easy access to both in 2005 received a $760 million payment from sides of new markets. In this environment, if Microsoft to end the lawsuit. Sun Microsys- you draw attention to a platform opportunity tems and Time Warner—Netscape’s current and don’t get it right the first time, someone owner—reaped similar bounties after they else will. Thinking carefully through the stra- challenged Microsoft’s anticompetitive be- tegic issues we’ve outlined here will give you a havior in court. head start. The threat of envelopment means that vigi- lance is crucial for a focused platform provider. 1. See Geoffrey Parker and Marshall W. Van Alstyne, Formulating strategy for platform-mediated “Two-Sided Networks: A Theory of Information Product Design,” Management Science (2005) and Jean-Charles networks is like playing three-dimensional Rochet and Jean Tirole, “Platform Competition in Two- chess: When market boundaries blur, envelop- Sided Markets,” Journal of the European Economic Associa- ment attacks can come from any direction. tion (2003). However, focused firms are not without advan- tages when competing with large, diversified Reprint R0610F companies. Big firms can be slow to recognize Harvard Business Review OnPoint 1463 envelopment opportunities and even slower to To order, see the next page mobilize resources to exploit them. Also, envel- or call 800-988-0886 or 617-783-7500 opment requires cross-business-unit coopera- or go to www.hbr.org
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Strategies for Two-Sided Markets
Further Reading ARTICLE The New Rules for Bringing Innovations to Market by Bhaskar Chakravorti Harvard Business Review March 2004 Product no. 6247 The article provides detailed information about how Adobe successfully orchestrated widespread adoption of its Acrobat Portable Document Format (PDF) software. In addi- tion to subsidizing readers and charging content creators, Adobe subsidized software developers by giving its code to them. This encouraged developers to design valuable features—which in turn made Acrobat more attractive to content creators and readers. In- creasing use by end users encouraged even further product enhancements. And, it moti- vated distributors to sell Acrobat or make it available through Web sites. Ultimately, all players benefited from one another’s adop- tion of Acrobat.
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