Topics: Network effect, Externality, Networks Pages: 5 (1442 words) Published: April 22, 2014
IE5551 Group Project
Two-sided network effect within Information Technology

1. Introduction
How is it possible that firms are willing to give away information and related products, apparently expecting neither future consumer exploitation nor tying?

1) Two-sided market:
Two sided markets, also called two-sided networks, are economic platforms having two distinct user groups that provide each other with network benefits. Two-sided networks can be found in many industries, include credit cards, search engines, operating systems and so on. And well-known companies which adapt two sided market include eBay, Facebook, Tencent, American Express and so on. (example: Consumers prefer credit cards honored by more merchants, while merchants prefer cards carried by more consumers.)

Two-sided network includes cross-side network effects and same-side network effects. They all can be positive or negative. Quite often in a two-sided network, members of at least one group exhibit a preference regarding the number of users in the other group; these are called cross-side network effects. Each group’s members may also have preferences regarding the number of users in their own group; these are called same-side network effects.

Two sided markets are useful in analyzing the competition between two parties. And it is also useful in free price strategies to attract customers from other user groups. Two-sided platforms, by playing an intermediary role, produce certain value for the both parties that are through it interconnected, and therefore those sides may both be evaluated as customers.

Competition in two-sided network industries is fierce, platform leaders can driving out weaker rivals through competition. And as a result, mature two-sided network industries are usually dominated by a handful of large platforms.

2) Example of two-sided market
Example markets include credit cards, composed of cardholders and merchants; HMOs (patients and doctors); operating systems (end-users and developers); night clubs (men seeking women, and often buying them drinks); yellow pages (advertisers and consumers); video game consoles (gamers and game developers); recruitment sites (job seekers and recruiters); search engines (advertisers and users); and communication networks, such as the Internet. Examples of the well known companies employing two sided markets include such organizations as American Express, eBay, Facebook, Mall of America, Match.com, Monster.com, Sony, Skype, Google and others. Benefits to each group exhibit demand economies of scale. Consumers, for example, prefer credit cards honored by more merchants, while merchants prefer cards carried by more consumers. They are particularly useful for analyzing the chicken-and-egg problem of standards battles, such as the competition between VHS and Beta. They are also useful in explaining many free pricing or "freemium" strategies where one user group gets free use of the platform in order to attract the other user group.[1][2][3][4][5]

3) Which side to receive subsidize

A key contribution of a two-sided network model is determining which side receives a discount. Different firms choose different beneficiaries. Platform managers must choose the right price to charge each group in a two-sided network and ignoring network effects can lead to mistakes. Which market represents the money side and which market represents the subsidy side depends on this critical tradeoff: increasing network size versus growing network value.

Adobe initially priced without taking network effects into account when it launched PDF and charged for both reader and writer software. When Adobe changed its pricing strategy and made its reader software freely available, its managers uncovered a key rule of two-sided network pricing. They subsidized the more price sensitive side, and charged the side whose demand increased more strongly in response to growth on the other side. It turned out...
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