Strategies for Two-Sided Markets
Reprint: R0610F
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: The most important innovation in financial services since World War II is almost certainly the credit card, which links consumers and merchants. The list would also include newspapers, HMOs, and computer operating systems—all of which serve what economists call two-sided markets or networks. Newspapers, for instance, bring together subscribers and advertisers; HMOs link patients to a web of health care providers and vice versa; operating systems connect computer users and application developers.
Two-sided networks differ from traditional value chains in a fundamental way. In the traditional system, 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 to the right, because the “platform” has a distinct group of users on each side. The platform product or service incurs costs in serving both groups and can collect revenue from each, although one side is often subsidized.
Because of what economists call “network effects,” these platform products enjoy increasing returns to scale, which explains their extraordinary impact. Yet most firms still struggle to establish and sustain their platforms. Their failures are rooted in a common mistake: In creating strategies for two-sided networks, managers typically rely on assumptions and paradigms that apply to products without network effects. As a result, they make many decisions that are wholly inappropriate for the economics of their industries. In this article, the authors draw on recent theoretical work to guide executives negotiating the challenges of two-sided networks.
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:
Consider these pricing strategies:
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:
Example:
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.
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.
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.
Thomas R. Eisenmann is the Howard H. Stevenson Professor of Business Administration at the Harvard Business School, where he studies the management of new ventures, co-chairs the Rock Center for Entrepreneurship, and teaches an MBA elective course, Product Management 101, in which students specify and supervise development of a software application. He also blogs at Platforms & Networks. Follow him on Twitter @teisenmann.
Geoffrey G. Parker (gparker@dartmouth.edu) is a professor of engineering at Dartmouth College and a research fellow at MIT’s Initiative on the Digital Economy. He co-authored Platform Revolution (W.W. Norton & Company, 2016), the April 2016 HBR article “Pipelines, Platforms, and the New Rules of Strategy” and the October 2006 HBR article “Strategies for Two-Sided Markets,” an HBR all time top 50. Follow him on Twitter @g2parker.
Marshall W. Van Alstyne (mva@bu.edu) is the Questrom Chaired Professor at Boston University School of Business. His work has more than 10,000 citations. He co-authored Platform Revolution (W.W. Norton & Company, 2016), the April 2016 HBR article “Pipelines, Platforms, and the New Rules of Strategy” and the October 2006 HBR article “Strategies for Two-Sided Markets,” an HBR all time top 50. Follow him on Twitter @InfoEcon.
Strategies for Two-Sided Markets
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