Key Issues in Platform Economics

Profitability and complexities of transactional and innovation platforms, the incentives and strategies driving bottlenecks in markets, antitrust challenges faced by tech giants, and successful company strategies in platform industries. Learn about vertical extension, market monopolization, and more in the evolving landscape of digital platforms.

• Platform Economics
• Tech Giants
• Antitrust Issues
• Company Strategies
• Vertical Extension

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Presentation Transcript

1. Business of Platforms: Bottom Line (11142022) 1

2. Platforms key issues Transactional and innovation platforms Why very profitable? Network effects & low investment Network effects: direct or indirect Importance of multihoming Choice on compatibility/interoperability Winner-takes-most under incompatibility Significant market share and profits inequality 2

3. Incentives to create bottlenecks Actions to protect and expand bottlenecks The importance of accumulating data Market failure in the market for sale of personal information 3

4. Variety of antitrust issues in platforms Monopolization Google search & ad markets; Google running the exchange and being a customer; Facebook; Apple apps store Prioritizing itself Google organic search; Amazon marketplace Tying Google mobile services on Android Companies created market failure In selling personal information, Google, FB 4

5. Companies strategies that were successful in platform industries 1. Vertical extension of the company 2. Discount pricing based on volume to take advantage of network effects 3. Discount pricing based on volume to take advantage of dominant position and disadvantage competitors 4. Subsidizing complementary goods 5. Control of bottlenecks 6. Exclusive contracts 5

6. 1. Vertical extension of the company Example: Microsoft 92+% market share in operating systems for PCs Over time, it added functions to the OS that used to be independent applications or middleware: Browser Windows Media Player Hard disk defragmenter Anti-spyware functionality Anti-virus functionality But MS did not enter into hardware for PCs until recently; is aware of its core competency 6

7. Advantages of extending the company vertically Offensive advantage Takes away value from complementary goods and adds value to own product Defensive advantage Avoids complementary goods firms creating a challenge to own product Netscape browser + Java might challenge Windows 7

8. Disadvantages of extending the firm vertically Strategy may be illegal as in the Microsoft cases in the US and EU But strategy very likely legal if market share is < 50% in US and < 40% in EU Vertical extension could distract from the core competency of the firm 8

9. Vertical extension a success? Very successful for Microsoft against Netscape whose share went from 100% to 0% But, so-and-so in audio players 9

10. 2. Discount pricing based on volume to take advantage of network effects Example: Cantor Fitzgerald in the secondary market for US government bonds; had 70+% share Offered per unit pricing very significantly above marginal cost to all traders except Salomon Brothers Salomon was offered marginal cost pricing plus a fixed fee Why? To get the very high liquidity of Salomon that had 40+% in primary market, and internalize the network effects 10

11. Success? Very successful for Cantor Kept dominant position despite an inefficient trading platform (broker matching vs. electronic trading) Primary dealers had to set up their own exchanges as a threat to constrain the per-unit pricing of Cantor 11

12. 3. Discount pricing based on volume to take advantage of dominant position and disadvantage competitors Example: Microsoft s per processor pricing before 1995 Offered Windows at a per unit price, say $30 Also offered Windows to a PC manufacturer, say Compaq, that produced say 1 mil. units, at a flat price of $24 mil. with the right to install in all units For Compaq, the last 200,000 units effectively had zero price Compaq had a strong incentive not to buy from competitors (IBM) 12

13. Advantages When marginal cost is very low, this strategy can rapidly increase market share (as it did for Microsoft) Great success for Microsoft that marginalized DOS competitor DR-DOS; increased the market share of Windows (that faced IBM s OS2) to 90+% 13

14. Disadvantages The strategy is likely to be illegal for a dominant firm in the US, EU, Japan, and Korea In 1995 (before the big antitrust suit) Microsoft agreed with USDOJ to stop using this strategy But it is a legal strategy for non- dominant firms 14

15. 4. Subsidizing complementary goods Example: Microsoft It chooses to make its product (OS) incompatible with others It subsidizes firms that produce complementary goods (by including in Windows features that are useful to application developers but not to users) Alternatively, MS subsidizes its division that sells complementary goods (Office) As a result The value of MS s product increases The entry hurdle of MS s rivals increases 15

16. Advantages of subsidizing complementary goods Offensive advantage The value of own product increases Defensive advantage The entry hurdle of rivals increases It can make a platform dominant Huge mistake of Apple not to adopt this strategy when Bill Gates pushed Apple to adopt it (before the creation of Windows) Refusal by Apple prompted MS to create Windows and made MS the key player in PCs 16

17. Disadvantages of subsidizing complementary goods It costs money that may not be recoverable for some time However, as Microsoft showed, subsidizing complementary goods can create dominance in the long run with very large benefits 17

18. 5. Control of bottlenecks Is crucial for creation and maintenance of dominant market position Sometimes innovation can eliminate the bottleneck Example: software services can eliminate the bottleneck of OSs 18

19. Old software model with OS bottleneck Apple OS X Linux OS Windows dominant Windows OS Application needs OS- specific APIs Windows Application Software Mac Linux Application Software Application Software 19

20. New software service model eliminates/reduces the bottleneck Apple OS Windows OS Linux OS Windows dominant Browser Open standards OS market structure irrelevant for service application market Based on browser s open standards Application as a Service 20

21. 6. Exclusive contracts Example: Microsoft Exclusive contracts with AOL and other ISPs on adoption of Internet Explorer Successful but illegal for a dominant firm 21

22. Some Big Upheavals in Platforms 1. Google in Internet search/advertising 2. iPod big success in digital audio 3. VHS killing Betamax 4. Internet Explorer displacing Netscape 5. Alternating current displacing direct current in electricity 22

23. Being first is no guarantee of long run success Examples Google in Internet search Arrived very late Used a different algorithm for search Based its revenue on advertising Apple s iPod Also arrived very late Hardware-software combination More liberal contract on legal copies (at the time) Facebook 23

24. Betamax/VHS: Sony s strategic error VHS video recorder (JVC/Matsushita) Came later than Betamax (Sony) Was widely licensed; low price Betamax was not widely licensed; high price Much bigger network effects of VHS After 5 years, Betamax withdraws from the USA Strategic error of Sony Originally video recorders were used for time- shifting (like Tivo) there were no network effects Only later movies for rental appeared -- crucial complementary good creating network effects Sony s managers missed the transition 24

25. Internet Explorer displaces Netscape Originally Netscape (based on Mosaic of the Univ. of Illinois) was dominant with 90+% market share Microsoft makes a huge effort to write better browser Internet Explorer (IE) from scratch IE3 was significantly better than Netscape Microsoft uses exclusive contracts and bundling in Windows to boost IE s market share 25

26. Alternating current displacing direct current in electricity Originally electricity generation and distribution was developed as direct current (DC) by Edison Significant municipal networks (New York City, Philadelphia) were created based on DC Light bulbs last much longer on DC Westinghouse pushed alternating current (AC) because its motors run much more efficiently on AC AC won because of the efficiency of its long- distance transportation (Niagara Falls to NYC) 26

27. Bottom line (1) 1. Incompatibility is key 2. Under incompatibility, winner-takes-most 3. Crucial to have the top market share 4. Competition for the market more important than competition in the market; make early sacrifices 5. Extend the firm vertically without going outside core competences 27

28. Bottom line (2) 6. Use price discrimination to a. take advantage of network effects b. take advantage of or create dominant position c. disadvantage competitors 7. Subsidize complementary goods to create a dominant platform 8. Try to keep control of bottlenecks; create new bottlenecks if possible 9. Use exclusive contracts if legal 28

29. New areas of platform innovation Banks and payment systems Healthcare systems Charging stations networks for cars Decentralized networks for production and storage of electricity Digital currencies 29