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Competition & Strategy in 2-Sided Platforms

Marshall Van Alstyne Geoffrey Parker

Technology Smackdown

2010 Eisenmann, Parker & Van Alstyne

Technology Smackdown

2010 Eisenmann, Parker & Van Alstyne

Technology Smackdown

2010 Eisenmann, Parker & Van Alstyne

How does this really work?

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Can we explain convergence?

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Info Economics Research Agenda


Products & Network Effects Communications Markets Information & Productivity Economics of IP

Agenda
1. 2. 3. 4. Definitions & new economy concepts. 2-Sided Network Pricing Winner-Take-All Markets Envelopment
Goal: Rigorous analysis of tradeoffs as a guide to strategy.
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Platforms & Applications


Platform: Components used in common across a product family whose
functionality can be extended by 3rd parties (Boudreau 2007) characterized by network effects (Eisenmann, Parker & Van Alstyne 2009).

Examples:
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. Desktop OS: Unix, Mac, Windows PDAs: Palm, Psion, Newton Game Consoles: Wii, Xbox, Playstation Network Switches: Cisco, IBM, HP Multimedia: Adobe/Flash, MS/Silverlight, Google-Apple/HTML5 Payment Systems: Paypal, Google Checkout, Visa, Apple, Mobile Felica Mobile Devices: iPhone, Android, Symbian, Blackberry Enterprise Systems: Salesforce, Oracle, i2, IBM, SAP Social Networks: Facebook, MySpace, LinkedIn, Monster, Twitter Batteries: Sony, Panasonic, Sanyo, A123 Web Search: Google, Bing+Yahoo!, Baidu Ebooks: Amazon, iPad, Nook, Sony
2010 Eisenmann, Parker & Van Alstyne

Managerial Implications
But understand: Winners in a platform market generally have the best platform strategy, not necessarily the best product Best platform?
1. Open (but not too open) interfaces 2. Modular architectures (easy to build on/extend) 3. Compelling complements (generally result of vibrant ecosystem)

Best product? Best standalone value proposition, but while starting here is good, usually not enough to win a platform market
Source: Cusumano 2010

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Remember this contest?

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2010 Eisenmann, Parker & Van Alstyne

How about this one?

Between 1951-59 RCA spent $130 million in color TV battle with CBS with nothing to show for it.
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Cable vs. Telco

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Google vs. Microsoft

vs. Apple
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Skype vs. Verizon

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Network vs Computer
Network as the Computer Computer as the Network

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Question: What are network externalities?


Hint: they matter for pricing, winner-take-all markets, and strategy
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A network externality is a demand economy of scale.


Examples: phone, fax, IM, email networks.

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Supply vs. Demand Scale Economies


Standard Goods Price Demand Supply Cost Econ of Scale Demand Supply Demand Econ of Scale Demand Supply

Quantity Rising average costs More competitive supply Oil, Soda, Bread Falling average costs Monopolistic supply Utilities, Semiconductors
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Often falling avg cost Monopolistic supply OS, IM, MMOG

(Re)interpreting Network Externalities


Network Externalities are demand economies of scale. They imply at least some level of interaction as when I email you, or you FAX or IM me.

Phone

E-Mail

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FAX

IM

2010 Eisenmann, Parker & Van Alstyne

Reinterpreting Network Externalities


Where is the interaction when your neighbor rents Lord of the Rings? In fact, his rental may mean you have to wait!

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How did Sarnoff win the battle?

...backward compatibility to secure an installed base, and


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How did Sarnoff win the battle?

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A 2-sided network externality crosses markets from consumers to developers or developers to consumers

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Consider profits in two markets


Market One (Acrobat Reader) Market Two (Acrobat Distiller)

Initially, there are profits to be made in both markets.


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Consider profits in two markets


Market One (Acrobat Reader) Market Two (Acrobat Distiller)

But subsidizing market one can increase demand and profits in market two more than the loss in market one.
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2010 Eisenmann, Parker & Van Alstyne

Consider profits in two markets


Market One (Operating Systems) Market Two (Developers)

Initially, there are profits to be made in both markets.


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Consider profits in two markets


Market Two Market One (Operating System) (Applications Developers)

But subsidizing market two can increase demand and profits in market one more than the loss in market two.
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Who should get the subsidy?

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Readily identifiable platform markets


Product Category Mkt 1 Product Intermediary Mkt 2 Product

Portable Documents Credit Cards Operating Systems HMOs Ladies Nights TV Format Advertisements Computer games Auctions Real Estate

Document reader* Consumer credit* Complementary Applications Patient Treatment * Mens Admission Color UHF, VHF, HDTV* Content* Game Engine/ Player Buying* Home buyers*

Adobe Issuing bank Microsoft, Apple, Sun Kaiser, Harvard Pilgrim Bars, Restaurants Sony, Phillips, RCA Magazines, TV, Radio Games Publishers E-bay, Christies, Sothebys Multiple Listing Service

Document Writer Merchant Processing Systems Developer Toolkits* Doctors Expertise Womens Admission* Broadcast Equipment Advertisers Level Editors* Selling Home Sellers

34 * Indicates which market is discounted, free or subsidized.

Source: Parker & Van Alstyne 2000, 2005

2010 Eisenmann, Parker & Van Alstyne

A two-sided network has four network effects


A same-side effect for each side, i.e., preference regarding number of other users on own side A cross-side effect in each direction, i.e., preference regarding number of users on other side

Side 1

Side 2

Platform Provider

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Each network effect can be positive or negative


+ same-side : Player-to-player
contact in Xbox MMOG, enduser PDF sharing.

Side 1

Side 2

- same-side : competing suppliers


in Covisint auction, competing dates on Match.com

+ cross-side : merchants & Platform Provider


consumers for Visa, developers & end-users for Windows

- cross-side : Digital Rights


Management costs to consumers. Advertising clutter to viewers.

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Q: Why is price more important in network markets?

A: The entire demand curve can change with price.


Q: Why is price more strategic in 2-sided networks?

A1: Imagine competing on the subsidy side you need a source of subsidy at least as great. A2: You change the size of your (and their) user base!

To Model Complements
Market One
Price Price
p2 q1 q2

Market Two

p1

Quantity

Quantity

Q1 q1 Q1 p1 V1

Q2 q2 Q2 p2 V2

Use simple linear demand functions (but works for almost any functional form).

Source: Parker & Van Alstyne 2000, 2005

To Model Complements
Market One
Price Price
p2 q1 q2

Market Two

p1

Quantity

Quantity

Q1 q1 Q1 e21q2 p1 V1

Q2 q2 Q2 e12 q1 p2 V2

Just add network externality terms eij

Source: Parker & Van Alstyne 2000, 2005

Choosing which markets to charge


Pdeveloper Adobe Magazine

Pd0, Pc0

Pd0, Pc0

I IV

II
Pd0, Pc0

Pconsumer

III

ID

Region I -- Subsidize C, charge D Region II -- Charge C & charge D Region III -- Charge C, subsidize D Region IV Subsidize both (bad idea)

Source: Parker & Van Alstyne 2000, 2005

So which market is subsidized?


Consumer Market
Price

Developer Market
Price
p2

p1 q1

q2

Quantity

Quantity

Consider which market creates more surplus.

Source: Parker & Van Alstyne 2000, 2005

So which market is subsidized?


Consumer Market
Price

Developer Market
Price
p2

p1

q1

q2

Quantity

Quantity

Consider which market creates more surplus. Subsidize the one that creates more surplus in the cross market.
Source: Parker & Van Alstyne 2000, 2005

So which market is subsidized?


Consumer Market
Price

Developer Market
Price

p1

q1

p2 q2

Quantity

Quantity

Consider which market creates more surplus. Subsidize the one that creates more surplus in the cross market.
Source: Parker & Van Alstyne 2000, 2005

Rules
Subsidize consumer side when
Highly price sensitive
Acrobat Reader, streaming audio, streaming video

Presence is the stronger attractant


Ad markets, credit cards, auctions, search engines

Subsidize developer side when


Critical for adding value
Applications development, operating systems, computer games

Stronger attractant or gatekeeper


Trend setters, textbooks

Source: Parker & Van Alstyne 2000, 2005

Winner-Take-All Markets

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Technology Smackdown

Source: Fast Company.com 5/9/08 2010 Eisenmann, Parker & Van Alstyne

Technology Smackdown

Source: Fast Company.com 5/9/08 2010 Eisenmann, Parker & Van Alstyne

Technology Smackdown

Source: Fast Company.com 5/9/08 2010 Eisenmann, Parker & Van Alstyne

Technology Smackdown

Source: Fast Company.com 5/9/08 2010 Eisenmann, Parker & Van Alstyne

Technology Smackdown

Source: Fast Company.com 5/9/08 2010 Eisenmann, Parker & Van Alstyne

Homing vs. Switching Costs


1 SETUP + 1ONGOING

Mono-homing
2 SETUPS + 1 TERMINATION + 1 ONGOING

Switching
2 SETUPS + 2 ONGOING

Multi-homing

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When do Winner-Take-All Networks Emerge?


1. Large Supply/Demand Effects (FB vs gas engine) 2. Large Multi-Homing Costs (OS vs credit cards).
Windows

3. Anywhere access? (MMOG vs HMO). 4. Niche specialization is less feasible.


Cyworld Korea has pop
Cyworld US closed.

Attack & How to Control Adjacent Platform Layers


Taking over adjacent markets via Platform Envelopment

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Question: At the time of introduction, was MS Office best-of-breed in anything?


Bundling Components to Envelope Markets

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Independent Pricing: Spreadsheet

100 Word Processing Charge 50 Sell to mkt Make 25

100 50 Spreadsheet

Based on (defense) Nalebuff 2004, (attack) Eisenmann, Parker & Van Alstyne 2011

Independent Pricing: Word Processing

100 Word Processing 50 Charge 50 Sell to mkt Make 25

100 Spreadsheet

Based on (defense) Nalebuff 2004, (attack) Eisenmann, Parker & Van Alstyne 2011

Independent Pricing Word & Excel

100 Word Processing 50


Buy Excel

Buy Word

Buy Both

Charge 50 Sell to mkt Make 25


Incumbent Profits from both markets are 50

100 Spreadsheet

Based on (defense) Nalebuff 2004, (attack) Eisenmann, Parker & Van Alstyne 2011

Competitor WordPerfect (or Lotus) undercuts price


100 Word Processing 50

Charge 49 Sell to 0.51 mkt Makes ~25 Incumbent profits drop from 50 to 255

100 Spreadsheet

Based on (defense) Nalebuff 2004, (attack) Eisenmann, Parker & Van Alstyne 2011

Pricing Word & Spreadsheet as a Bundle

100 Word Processing

Charge $100 for 2 Sell to market Make 50 (same combined profits as before)

100 Spreadsheet

Based on (defense) Nalebuff 2004, (attack) Eisenmann, Parker & Van Alstyne 2011

Competitor WordPerfect (or Lotus) undercuts price but makes as much


Charges $49 Sells to .25 mkt Makes 12.25
Entrant profits cut by half Incumbent Bundled profits fall only half as much

100 Word Processing

100 Spreadsheet

Based on (defense) Nalebuff 2004, (attack) Eisenmann, Parker & Van Alstyne 2011

Side by Side Comparison


Independent Sales Product A
Product A

Bundled Sales

Product B
Incumbent profit: .5x.5=.25 Entrant profit: .49x.51.25

Product B Incumbent profit: 1*.5-.125=.375 Entrant profit: .5*.25=.125

Based on (defense) Nalebuff 2004, (attack) Eisenmann, Parker & Van Alstyne 2011

Rhapsody

Who are the players? Where are the network effects? What would you do?
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Real Audio & Envelopment


RA pioneers streaming audio (gives away player) Microsoft bundles WMP in Windows

$ Users Content

Real Audio

Microsoft

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Real Audio & Envelopment


RA pioneers streaming audio Microsoft bundles WMP in Windows RA switches strategy ( introduces subscription content)

$ Users Content

Real Audio

Microsoft

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Real Audio & Envelopment


Yahoo!

Portal Ads

Users

Content

RA pioneers streaming audio Yahoo! attacks, subsidizes users via portal advertising

Real Audio

Microsoft

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Real Audio & Envelopment


Apple Yahoo!

iPod Sales

Users

Content

RA pioneers streaming audio Apple subsidizes iTunes via iPod sales

Real Audio

Microsoft

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Real Audio & Envelopment


Apple + AT&T Apple Yahoo!

Cellphone Svc

Users

Content

RA pioneers streaming audio Mobile phone service bundles music in service agreement.

Real Audio

Microsoft

like playing 3D chess.

2010 Eisenmann, Parker & Van Alstyne

Defensive Strategies
Innovate (e.g., Adobe moving from document presentation to document management) Cede and redeploy preferably through platform envelopment! (e.g., RealNetworks move from streaming media to subscription media) Find a bigger brother (e.g., RealNetworks + Comcast, Cingular in response to envelopment threat from Yahoo et al. in subscription media) Sue (e.g., RealNetworks collects $760 million from Microsoft, forces unbundling in EU)

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10 1

Platform Envelopment Explains Convergence

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10 2

Coming Platform Applications

Smart Grid Energy Platform Standards (WSJ 5-18-09!) Electronic Medical Records (Google, Experimentation ) Cloud Computing & Business Model Microsoft, WebMD

2010 Eisenmann, Parker & Van Alstyne

Conclusions
Business models that give strategic advantage in network markets:
Design products for 1) proprietary complementarity, 2) price sensitivity, 3) developer value add, and 4) low marginal costs.

Winning Standards Battles: Winner-take-all platforms arise from both supply and demand economies of scale.
Find ways to manipulate 1) multi-homing costs, 2) same & crossside network effects, and 3) localization 4) bundling.

Platform envelopment is a means of bundling a competitors users or technology money side into your platform.
Explains convergence!
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Questions?
Information Complements, Substitutes & Strategic Product Design Parker & Van Alstyne 2000. http://ssrn.com/abstract=249585 Two Sided Network Effects Parker & Van Alstyne Management Science, Oct. 2005; 51(10), pp. 14941504. http://ssrn.com/abstract=1177443 Strategies for Two-Sided Networks Eisenmann, Parker & Van Alstyne Harvard Business Review Oct. 2006. Opening Platforms: How, When & Why Eisenmann, Parker & Van Alstyne Ch. 6 in Gawer, A. (ed) (2009) Platforms, Markets and Innovation, http://ssrn.com/abstract=1079712 Innovation, Openness & Platform Control Parker & Van Alstyne (2008)
http://ssrn.com/abstract=1079712

"Six Challenges in Platform Innovation and Open Licensing," Parker & Van Alstyne Communications & Strategies, no. 74, Q2 2009, p. 17-36. http://ssrn.com/abstract=1559013 Platform Envelopment Eisenmann, Parker & Van Alstyne; Strategic Management Journal (forthcoming 2011). http://ssrn.com/abstract=1496336 mva@bu.edu gparker@tulane.edu InfoEcon@Twitter.com