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The Upshot
MARKET REALITIES

How Jean Tiroles Work Helps Explain the

Internet Economy
OCT. 14, 2014

Claire Cain Miller

@clairecm

For anyone who has wondered how its possible to get so much stuff from
web companies free or at too-good-to-be-true prices whether Google
searching, Facebook socializing, Uber riding or Amazon shopping Jean
Tirole, the new Nobel Prize winner in economics, has an answer.
In 2002, two years before Google went public or Facebook was founded,
he wrote that Internet-era companies operate as two-sided platforms, with
consumers on one side and software developers or advertisers on the other.
Even if tech entrepreneurs have never read his work, they are referencing it
when they throw around words like platform and network effect.
He also said that industries should be regulated differently depending

on their distinct characteristics. Many Internet companies, for instance, give

their products away free, which means that antitrust law built on pricing is
irrelevant. But a result is they grow so fast that they can quickly become
monopolies.
Hes helping us think about what is one of the greatest challenges of
our time, how to deal with what feel like friendly monopolists, said Tim
Wu, a Columbia Law School professor who studies Internet policy and
antitrust. Amazon, Google and the others give us all this stuff for free or
lower prices, so we love them, but are they dangerous in ways we dont
always see?
In the 2002 paper with Jean-Charles Rochet, Mr. Tirole defined twosided markets, or markets that get both sides on board by charging more
to one set of customers in order to increase demand by others. It is why a
club pays Kim Kardashian to make an appearance while charging the other
guests to enter, or why Visa charges merchants but not consumers to make a
purchase.
In the tech industry, it explains why Google, Facebook and Twitter offer
their services free the more people who use them, the more advertisers
they can attract. Likewise, Amazon lowered the price of its new phone to 99
cents in part because smartphones succeed when they have a lot of apps
and developers wont want to build apps for Amazons phone unless a lot of
people are using it.
As Mr. Tirole wrote about another type of technology, video games,
Buyers of video game consoles want games to play on; game developers
pick platforms that are or will be popular among gamers.
Apples new mobile payment service, Apple Pay, is another example.
Mr. Tirole showed how credit cards are effective only if enough customers
have the card and enough merchants accept it, and credit card companies
have to balance the demands of both when they set fees. Apple succeeded
where other companies have failed in persuading banks to partner with it, in
part because it has so many customers. Banks offered Apple a lower rate for
credit card transactions than usual, hoping that Apple users will supply

them with more transactions.

I would be very, very surprised if Jean Tiroles work was not sitting at
the hearts of the people advising Apple and certainly MasterCard, Visa and
American Express about how to think about that world, said Joshua Gans, a
professor at University of Toronto who blogs about competition in the
digital age.
For regulators, tech companies have been a riddle in part because they
do not follow the behavior of typical monopolies: Many do not charge for
their products, and companies that offer entirely different products are
nonetheless competitors. For instance, Googles chairman, Eric Schmidt,
argued in a speech on Monday that Googles biggest competitor in search is
Amazon and in mobile is Facebook even though neither one is a search
engine.
Two-sided markets, like that of a search engine, have a tendency to
become monopolies, Mr. Tirole has written, but the dangers are different
and harder to see than in traditional monopolies like whether a
monopolys power prevents new start-ups from emerging. That is one of the
elements antitrust authorities considered during investigations of Google.
Inspired by him and others like him, our effort was to try to move
beyond the traditional understanding of something like an aluminum cartel
who just raised their process on aluminum and everything got more
expensive, said Mr. Wu, who was a senior adviser to the Federal Trade
Commission on antitrust matters.
It was really hard to understand market power and the traditional
obsession with prices when everything is free, he said. But of course
theyre not free. The costs are somewhere else.
For consumers, the costs include absorbing advertisers ad spending by
paying more for their products, being tracked and shown personalized ads,
and giving up privacy.
People say, Im a user of Facebook, but in reality what you are is a
supplier to Facebook, Mr. Gans said. They give you in-kind services and
then use the fact that youre there to sell their actual product to advertisers.

But Internet users dont tend to think of it that way, as Mr. Tirole and
Mr. Rochet wrote in a 2005 paper, Two-Sided Markets: A Progress Report:
In contrast with the buyer of a razor, who internalizes the impact of his
purchase on the demand and surplus attached to razor blades, our end-users
do not internalize the impact of their purchase on the other side of the
market.
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