Consumer Demand in Two- Sided Markets

Consumer demand in two- sided markets

Gunnar Niels (with Adriaan ten Kate)

CRESSE Conference

5-7 July 2019

Two working papers

• ‘Consumer Demand in Two-Sided Markets and the Platform-Specific Nature of Externalities’ (with Adriaan ten Kate)

• substitution (complements) in use versus economic substitution (complements) • definition of critical mass • pricing strategies • supply-side complements versus two-sided markets

• ‘Transaction versus non-transaction platforms: A false dichotomy in two-sided market definition’

2 Demand system: monopoly platform (I)

• extraordinary demand functions

• (2a) DA = GA(PA,QB) • (2b) DB = GB(PB,QA)

• ordinary demand functions

• (3a) DA = FA(PA,PB) • (3b) DB = FB(PA,PB)

• externalities defined as elasticities

• (4a) γAB = (∂GA/∂QB)(QB/QA) • (4b) γBA = (∂GB/∂QA)(QB/QA)

Strictly confidential 3 Demand system: monopoly platform (II)

• ordinary and extraordinary elasticities

• (5aa) εAA = ε̃AA/(1 – γAB γBA) • (5ab) εAB = γAB ε̃BB/(1 – γAB γBA) = γAB εBB • (5ba) εBA = γBA ε̃AA/(1 – γAB γBA) = γBA εAA • (5bb) εBB = ε̃BB/(1 – γAB γBA)

• positive, moderate externalities (γAB γBA < 1) → demand more elastic

• well-known result in two-sided markets

• strong externalities (γAB γBA > 1) → own elasticity becomes positive

• linked to concept of critical mass (see below)

4 Definition of critical mass (I)

• for any pair of prices (PA,PB)

• if all customers on side A expect volume QB = FB(PA,PB) on side B

• and all customers on side B expect volume QA = FB(PA,PB) on side A

• fulfilled-expectations equilibrium demand (FEED): all customers’ decisions to join happen to bring about expected volumes

• Nash equilibria of one-shot non-cooperative game (‘join’ or ‘don’t join’) between all customers on both sides • externalities make payoffs inter-dependent

5 Definition of critical mass (II)

• equilibria unstable if F-demand upward-sloping in prices (γAB γBA > 1)

• small increase in QA or QB makes demand explode further

• critical mass: for any pair of prices (PA,PB) there is critical mass when there is a pair of volumes (QA,QB) solving equations (2) such that the resulting F-functions are positively sloped at those prices

• related to volumes on both sides (not critical mass on one side only) • dependent on prices • similar to one-sided network effects where critical mass is upward-sloping part of FEED curve (Ten Kate & Niels, 2006, ‘Fulfilled-Expectations Equilibria in Network Demand’, Review of Network Economics, Vol. 5(3), pp. 320-36)

Strictly confidential 6 Demand system: competing platforms

• platform-specific elasticities

• (9aa) εAiAi = ε̃AiAi/(1 – γAiBi γBiAi) (for i = 1, … , N) • (9ab) εAiBi = γAiBi ε̃BiBi/(1 – γAiBi γBiAi) = γAiBi εBiBi (for i = 1, … , N) • (9ba) εBiAi = γBiAi ε̃AiAi/(1 – γAiBi γBiAi) = γBiAi εAiAi (for i = 1, … , N) • (9bb) εBiBi = ε̃BiBi/(1 – γAiBi γBiAi) (for i = 1, … , N)

• cross-platform elasticities

• (10aa) εAiAj = ε̃AiAj /(1 – γAiBi γBiAi) (for i ≠ j = 1, … , N) (10ab) εAiBj = γAiBi ε̃BiBj /(1 – γAiBi γBiAi) (for i ≠ j = 1, … , N) (10ba) εBiAj = γBiAi ε̃AiAj /(1 – γAiBi γBiAi) (for i ≠ j = 1, … , N) (10bb) εBiBj = ε̃BiBj /(1 – γAiBi γBiAi) (for i ≠ j = 1, … , N)

7 Elasticity matrix for demand system with competing platforms

Side A Side B

Side-specific Cross- cross- platform elasticities cross-side elasticities Ai (i = 1,…, N) Platform- Own-price specific elasticities cross-side elasticities

Cross- Side-specific platform cross- cross-side elasticities Bi elasticities (i = 1,…, N) Platform- specific Own-price cross-side elasticities elasticities

8 Substitutes and complements on same side and other side

Side A Side B

Substitutes in Economic use substitutes

Substitutes in Economic use complements

Economic Substitutes in substitutes use

B Economic Substitutes in complements use

9 Platforms compete on both sides simultaneously

• platform-specific nature of externalities are key

• more women in nightclub 1 benefits men in nightclub 1, not men in nightclub 2 • main driver behind skewed pricing (not internalising externalities) • different sides are economic complements on same platform but economic substitutes on different platforms

• side B on platform 2 may be closest competitor to side A on platform 1

• women in nightclub 2 may be closest substitute (highest UPP after merging) to men in nightclub 1

10 Two-sided market definition (I)

• transaction versus non-transaction platforms → relevant distinction?

• Filistrucchi et al. (2014) • Just Eat/Hungryhouse (CMA, 2017), AmEx (Scotus, 2018)

• hypothetical platform monopolist sets profit-maximising prices simultaneously on both sides

• realistic starting assumption: ‘inside products’ include both sides • but even if you start with one side, the other side of other platforms can still be closest substitute, so you include both sides • same for transaction and non-transaction platforms

Filistrucchi, L., Geradin, D., Damme E. van, and Affeldt, P. (2014), ‘Market definition in two-sided markets: theory and practice’, Journal of Competition Law and Economics, Vol. 10 (2), pp. 293-339.

11 Two-sided market definition (II)

• other features of transaction and non-transaction platforms

• zero or negative externalities in one direction • zero price on one side • different competitors on either side → no reason for different approach transaction v non-transaction

• what is a transaction, anyway?

• transaction can be observed and charged for • spectrum from transactions to ‘mere’ interactions (e.g. click-throughs) • myriad of charging structures

• two-sided market definition is complex enough – focusing on whether a platform is transaction or non-transaction does not help

12 Contact: [email protected]

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