Platforms

Platform is the term that Rochet and Tirole gave to the structures that make the interactions between different groups in multi-sided markets possible. Newspapers, payment cards, and videogame consoles were considered to be platforms.

The word “platform” is defined by the Oxford English Dictionary as “The surface or area on which anything stands; esp. a raised level surface.”14 The term was used in computer science to refer to the hardware on which a software application could be run. Software had to be specifically developed for each hardware platform. This is very clear in the case of videogame consoles and in the case of computer operating systems, two of the mini-cases analyzed by Rochet and Tirole. It is understandable that they proposed the word “platform” to refer to the central role of the structure that makes interaction between different groups possible, even when hardware does not play such a role.

The term “platform” has been adopted in the industrial organization literature, with a flow of publications including the word platform in their title, such as: Platform Leadership,'5 Platform Economics,'6 The Age of the Platform,'7 Platform Ecosystems,18 Platform Scale,'9 Platform Revolution,20 Platform Capitalism,2' and The Business of Platforms.22 Such an enthusiastic adoption might be explained by a second meaning of the word in English. As early as the sixteenth century, a more abstract use of the term had emerged: “A plan, design; something intended or taken as a pattern, a model.”25 Platforms create patterns for the interaction of different groups.24

Multi-sided markets are created by entrepreneurs who invest in the structure that makes the interaction of different groups possible. This was the case with Jim Pavelich and Dave Price and the Palo Alto Daily News, with Frank McNamara and Diner’s Club, and with the heirs of Fusajiro Yamauchi and Nintendo. Platforms are an economic activity in themselves. Platforms provide services to the interacting groups that make use of the platform. Two major business models can be differentiated: transaction and non-transaction platforms.25

On one hand, in non-transaction platforms, the different groups do not conclude transactions among themselves, but transactions take place only between the groups and the platform. This is the case with newspapers and, in general, with all the platforms that rely on advertising. Advertisers contract with the platform to include ads in the newspaper. Readers contract with the platform to acquire the newspaper. No contract is concluded between the advertiser and the reader.

In transaction platforms, on the other hand, the different sides of the market interact directly with one another other, concluding contracts for the provision of the service. This is the case with videogames: videogame developers conclude contracts with the platform; players buy the console; and then a direct interaction takes place between game developers and players, as players acquire the games from the developers. A very relevant model of transaction platform is the matchmaker. The matchmaker does not develop a specific service (a newspaper, a payment card, a console), but merely facilitates the interaction of third parties interested in an interaction. There are lots of examples of traditional matchmakers: stock exchanges, real estate agencies, dating agencies, etc. These are all platforms.

It has been underlined that some platforms provide the common technological building blocks for third parties to develop new complementary products and services. These have been called “innovation platforms.”26 This is the case of videogame consoles and operating systems for computers, smartphones etc.

A common characteristic of all platforms is that they reduce transaction costs by making the interaction between third parties easier, safer, and cheaper. Transaction costs can be defined as the costs involved in a market exchange. Examples of transaction costs reduced by platforms in multi-sided markets are search costs, information costs, monitoring costs, communications costs, and bargaining costs. As a conclusion, by pooling together different groups of users, under specific terms and conditions defined by the platform, transaction costs are reduced and a benefit in the form of an indirect network effect is generated.

All of these business models require a substantial investment in order to create the structure that sustains the interaction (the newspaper, the payment card, the console). However, this is only part of the necessary investment and is rarely the key to the success of a platform in a multi-sided market. Furthermore, it is necessary to invest to attract the critical mass of users to trigger or ignite the network effects. All kinds of creative techniques are used to attract users to the platform, but it is mostly a matter of investment in the form of advertising and providing reductions in the price of the provision of the service, even setting the price below cost. The larger the critical mass that is pursued, the larger the investment. A small investment might be necessary to establish a local free newspaper in Palo Alto, but a much larger investment would be necessary to establish a videogame console on a global scale.

Finally, it is not sufficient to fund the creation of the platform and to invest in the attraction of large pools of users. For a platform to succeed, it is not sufficient to be able to reduce transaction costs and generate indirect network effects. As important as the benefit is the balanced distribution of such a benefit across the parties in the multi-sided market. It is the role of the platform to propose and to maintain such a balance. An appropriate balance will allow the multi-sided market to flourish and to be sustainable over time.

Benefits derived from the network effects must be carefully distributed among all the sides of the multi-sided market, making sure that they all have the incentive to join the platform and keep working with it. It is the role of the platform to understand the needs of the different sides and to ensure that they have the proper incentives to continue to use it and work with it.

If a newspaper tries to set very high prices for its readers, it will fail to build a large pool of readers and will not be able to attract enough advertisers to sustain the newspaper. If the newspaper tries to sell advertising at a very low price, but fills the newspaper with ads, readers will desert it. Innovation in the definition of the balance was exemplified by free newspapers like the Palo Alto Daily News. Zero-price services can actually be explained as being just one side of a multi-sided market, whereas the other side bears the full cost.

If a payment card sets very high fees for the purchaser in the form of an annual payment, it will attract few users and merchants will have little incentive to accept the card. High fees for the merchants will also discourage the use of the card, even though a large pool of purchasers might be attracted. In the case of payment cards, innovation in the definition of the balance was exemplified by rewards for purchasers.

If the platform tries to monopolize the benefits derived from the network effects, in the form of large fees from the beginning of the activity, the multi-sided market will not attract users and the platform will never ignite and grow. This is why it is common for platforms to start with discounted prices and even with the free provision of the service: examples include complementary newspapers, subsidized games, and payment cards with no fees for users.

However, for a multi-sided market to be stable, it is necessary to ensure the necessary reward for the investment of the platform. A multi-sided market will sometimes flourish, as the platform provides a valuable service to all sides, but the platform itself is not able to secure a profit (or sometimes even revenue) from its activity. Consequently, the multi-sided market never comes to exist, or it is terminated as the platform runs out of funds.

In conclusion, platforms have a central role in multi-sided markets. They are the creators and then curators of this multi-sided market. They identify the possibility to create the market. They invest to create the structures that make the market possible. They invest to attract large pools of users on all sides of the market (which is a fundamental barrier to market entry, as identified by antitrust authorities).27 Finally, they define the dynamic balance in the distribution of the benefits generated by the multi-sided market.

Public intervention in multi-sided markets has been common. Intermediaries are often mistrusted, as conflicts of interest are common. Regulation of media and payment cards is an example. Regulation is common in stock markets, real estate agents, and many other traditional matchmakers and is designed to create transparency and protect the rights of users.

From a regulatory perspective, platforms present specific challenges. Network effects require scale, so only a limited number of platforms are able to reach such a scale in a given multi-sided market. Oligopoly is the most common structure in multi-sided markets, and the oligopoly sometimes becomes a monopoly. Limits to the concentration of newspapers and other media have been common. Even if pluralism has traditionally been the main reason behind restrictions, the oligopoly structure of media, as multi-sided markets, has triggered such a concern. Market power of platforms in payment card markets has triggered the intervention of public authorities in many jurisdictions, notably by setting limits to the commissions.

At the same time, incumbents have often asked for regulation when their markets are being transformed into new multi-sided markets. This was the case that traditional newspapers made against free newspapers and merchants made against payment cards. The above are a few examples of how regulation has traditionally played an important role in multi-sided markets.

 
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