The Idea in Brief
If you listed the blockbuster offerings that have redefined the global business landscape, you’d find that many tie together two distinct groups of users. HMOs, for instance, link patients to health-care providers. Search engines join Web surfers and advertisers.
When successful, these platforms catalyze a virtuous cycle: More demand from one user group spurs more from the other. For example, the more video games developers (one user group) create for the Microsoft X-Box platform, the more players (the other user group) snap up the latest X-Box. Meanwhile, the more players who use X-Box, the more developers willing to pay Microsoft a licensing fee to produce new games. And as user bases grow, margins fatten.
But as Eisenmann, Parker, and Van Alstyne contend, managing platforms is tricky: Strategies that make traditional offerings successful won’t work in these two-sided markets. To capture the advantages that platforms promise, you must address three strategic challenges.
The key challenge? Get pricing right: “Subsidize” one user group while charging the other a premium for access to the subsidized group. Adobe’s Acrobat PDF market comprises document readers and writers. Readers pay nothing for Acrobat software. Document producers, who prize this 500-million-strong audience, pay $299.
If you seize a platform opportunity but don’t get it right the first time, someone else will. By mastering platforms’ unique strategic challenges, you’ll gain a head start over your competition.
The Idea in Practice
To ensure your platform’s success:
Get Pricing Right
Consider these pricing strategies:
- Subsidize quality- and price-sensitive users. For example, if PDF document readers were charged even a tiny amount, Adobe Acrobat Reader’s immense user base would be much smaller, reducing document producers’ interest and their willingness to pay a premium for access to readers. Readers, much more price sensitive than document producers, wouldn’t pay for access to a bigger base of writers.
- Secure “marquee” users’ exclusive participation in your platform. Providing incentives for marquee users (for instance, anchor stores in a mall) to participate exclusively in your platform (the mall) can attract more users from the other user group (retailers who lease space in malls with prestigious anchor stores). Result? Your platform’s growth accelerates.
Cope with Winner-Take-All Competition
The prospect of fat margins in two-sided markets can fuel an intense desire among rivals to become the only platform provider. To deal with the competition:
- Decide whether the two-sided market you’re eyeing will eventually be served by a single platform. The answer’s “Yes” if using more than one comparable platform would be costly to users and if special features don’t increase value to users.
The DVD industry meets these criteria: Owning multiple DVD players would be expensive 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 would negate any DVD player’s unique picture and sound capabilities.
- Decide whether to share the single platform or fight for proprietary control. Sharing has benefits: Total market size expands and rivalry lessens, reducing market outlays. That’s why DVD industry contenders opted to pool their technologies. They jointly created the DVD format in 1995, avoiding a replay of the costly video players’ VHS-Beta standards clash.
Want to fight for proprietary control? You’ll need deep pockets, a reputation for past prowess, and preexisting relationships with prospective users. When launching Acrobat, for instance, Adobe marketed to its existing user base for PostScript printing products.
Avoid Envelopment
Many platforms have overlapping user groups, tempting some related platform providers to swallow others’ users. Mobile phones, for instance, now incorporate music and video players, PCs, and credit cards. To avoid being swallowed, consider changing your business model.
Example:Under attack from Microsoft, RealNetworks (which pioneered streaming media software) ceded the streaming media business. It leveraged existing relationships with consumers and music companies to launch Rhapsody—a $10-per-month subscription music service that offers unlimited streaming to any PC from a library of a half-million songs. It now profits from consumers versus subsidizing them.
If you listed the blockbuster products and services that have redefined the global business landscape, you’d find that many of them tie together two distinct groups of users in a network. Case in point: What has been the most important innovation in financial services since World War II? Answer: almost certainly the credit card, which links consumers and merchants. Newspapers, HMOs, and computer operating systems also serve what economists call two-sided markets or two-sided networks. Newspapers, for instance, join subscribers and advertisers; HMOs link patients to a web of health care providers, and vice versa; operating systems connect computer users and application developers.
Products and services that bring together groups of users in two-sided networks are platforms. They provide infrastructure and rules that facilitate the two groups’ transactions and can take many guises. In some cases, platforms rely on physical products, as with consumers’ credit cards and merchants’ authorization terminals. In other cases, they are places providing services, like shopping malls or Web sites such as Monster and eBay.
Two-sided networks can be found in many industries, sharing the space with traditional product and service offerings. However, two-sided networks differ from other offerings in a fundamental way. In the traditional value chain, value moves from left to right: To the left of the company is cost; to the right is revenue. In two-sided networks, cost and revenue are both to the left and the right, because the platform has a distinct group of users on each side. The platform incurs costs in serving both groups and can collect revenue from each, although one side is often subsidized, as we’ll see.
In traditional value chains, value moves from left to right: To the left of the company is cost; to the right is revenue. In two-sided networks, cost and revenue are both to the left and the right.
The two groups are attracted to each other—a phenomenon that economists call the network effect. With two-sided network effects, the platform’s value to any given user largely depends on the number of users on the network’s other side. Value grows as the platform matches demand from both sides. For example, video game developers will create games only for platforms that have a critical mass of players, because developers need a large enough customer base to recover their upfront programming costs. In turn, players favor platforms with a greater variety of games.
Because of network effects, successful platforms enjoy increasing returns to scale. Users will pay more for access to a bigger network, so margins improve as user bases grow. This sets network platforms apart from most traditional manufacturing and service businesses. In traditional businesses, growth beyond some point usually leads to diminishing returns: Acquiring new customers becomes harder as fewer people, not more, find the firm’s value proposition appealing.
Fueled by the promise of increasing returns, competition in two-sided network industries can be fierce. Platform leaders can leverage their higher margins to invest more in R&D or lower their prices, driving out weaker rivals. As a result, mature two-sided network industries are usually dominated by a handful of large platforms, as is the case in the credit card industry. In extreme situations, such as PC operating systems, a single company emerges as the winner, taking almost all of the market.
Platforms serving two-sided networks are not a new phenomenon. Energy companies and automakers, for example, link drivers of gasoline-powered cars and refueling stations in a well-established network. However, thanks largely to technology, platforms have become more prevalent in recent years. New platforms have been created (Google, for example, links advertisers and Web searchers) and traditional businesses have been reconceived as platforms (for instance, retail electricity markets are evolving into platforms that match consumers with specific power producers, allowing them to express their preferences for cheaper coal or more costly renewable power). Yet for all the potential they’ve spotted, platform providers have struggled to establish and sustain their two-sided networks. Their failures are rooted in a common mistake. In creating strategies for two-sided networks, managers have typically relied on assumptions and paradigms that apply to products without network effects. As a result, they have made many decisions that are wholly inappropriate for the economics of their industries.
In the following article, we draw on recent theoretical work1 to guide executives in negotiating the challenges of two-sided networks. We begin by looking at the factors that senior managers must consider in designing their platforms’ business models. The key decision here is pricing. As we’ve noted, providers of platforms for two-sided networks are able to draw revenue from both sides. In most cases, though, it makes sense to subsidize certain users. The crucial strategy question is, Which side should you subsidize, and for how long?
