Competition, bargaining power and pricing in twosided markets

1
Competition, bargaining power and pricing in
two-sided markets

• Kimmo Soramäki
• Helsinki University of Technology
• Wilko Bolt
• De Nederlandsche Bank
• Norges Bank Oslo, 24 February 2008

2
Two-sided markets

• Rochet-Tirole (2006) define two-sided markets
  roughly as
• Examples software platforms, newspapers,
  shopping malls, payment cards, etc.

markets where one or several platforms enable
interactions between end-users, and try to get
the two (or multiple) sides on board by
appropriately pricing each side
3
Two-sided Platform vs Merchant

• Merchant purchases from sellers and resells to
  consumers
• Platform enables interactions between sellers and
  consumers

source Hagiu, A. 2007, Review of Network
Economics 6, 115-133
4
Related literature

• Surge in literature on 2sms models
• Rochet-Tirole (JEEA 03, RJE 06), Armstrong (RJE
  06), Caillaud-Jullien (RJE 03), Chakravorti-Roson
  (RNE 06), etc
• Models/markets
• membership buyers and sellers pay a fixed
  membership fee for an uncertain number of
  future transactions
• usage buyers and sellers pay a per-transaction
  fee
• Combination
• Questions
• Does competition in 2sms lead to lower prices for
  both sides?
• What is the optimal price structure?
• Does competition lead to convergence to marginal
  cost level?

5
This paper

• We develop a usage model of two-sided markets
  with perfect multi-homing. Bargaining plays a
  role when market sides prefer different
  platforms.
• We are interested in the profit-maximising usage
  fees set by homogeneous duopolistic platforms.
• We find that for sufficiently low cost level, in
  Nash-equilibrium all costs are borne by the side
  without bargaining power. The equilibrium price
  allows excess profits for both platforms.
• We argue that skewed pricing found empirically in
  many two sided markets, can perhaps be explained
  by which side chooses the platform when both
  sides are willing to transact on multiple
  platforms.

6
Recall Monopolistic Platform

• Rochet Tirole (2003) show optimal pricing for
  monopolistic platform with only usage fees
• Optimal price level (total price)
• Optimal price structure (price ratio)
• Optimal prices
• total price (p-c)/p1/e
• price structure p1/p2e1/e2where pp1p2 and
  ee1e2.

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Role of bargaining power

• When buyers and sellers are willing to transact
  on several platforms, how is the platform chosen?
  Both sides may have opposing preferences,
  depending on the prices
• We investigate the situation where one side
  chooses the platform
• example choosing payment instrument at a store
  -gt generally buyer chooses an instrument accepted
  by the merchant.
• both sides have an order of preference, but are
  willing to transact on a less preferred platform,
  instead of foregoing the transaction
• Similar to routing rules
• Hermalin-Katz (RJE 06) consider a strategic game
  of routing rules
• if you choose the network and I know you
  multi-home, I will strategically single-home on
  my preferred network

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The model

• 1. buyers are willing to transact on a platform
  if ubpb
• 2. if ubpb1 and ubpb2, buyers prefer platform
  with lower price
• 3. if ub pb1pb2, half prefer platform 1, and
  half prefer platform 2
• 4. the same holds for sellers
• 5. if buyers and sellers are willing to transact
  on both platforms, but prefer a different one
  choice is determined by bargaining power
  characterized by t

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Demand - example

• Lets start where platforms 1 and 2 have the same
  prices

,
initially 1 and 2 split this market

,

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Demand - example

• platform 1 reduces buyers price and increases
  sellers price

,
served by 1 if buyer chooses the platform, by 2
if seller chooses the platform
served by 1 alone
served by 2 alone
,
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Demand and profit
Platforms need to evaluate 9 price regions.
Demand
Profit (cmarginal cost)
12
Best-reply dynamics
starting point zero profits price demand is
split by the two platforms
45º
45º
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Best-reply dynamics
Monopolistic best reply - platform gets
monopolistic demand and profits - competitor
gets demand only from sellers with ps0 lt uslt psM
45º
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Best-reply dynamics
Undercutting phase undercutting by e optimal
overpricing by h - undercutting other platforms
buyer price will get all eligible buyers on
board - this allows the platform to increase
seller price to a point where the increased
margin offsets lost demand
h
e
45º
15
Best-reply dynamics
Corner price Undercutting and overpricing
continues until corner price is reached. Here
platforms split the demand
h
e
45º
16
Best-reply dynamics
c lt c
Two Nash-equilibria "Grab the dollar" -
game One of the platforms sets its seller price
below psC. Its margin is lower but it has
additional demand from sellers with psCltusltpsC.
The best response to this is pC. The platform
with lower seller price has higher profits -gt
"first mover advantage"
45º
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Best-reply dynamics
c gt c
Best reply to corner price in case of high
marginal cost Increase in buyers price, but
decrease in sellers price to level where the
platform gets demand from sellers with
psBRltusltpsC, i.e. sellers that are not willing
to transact on the other platform
45º
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Out-of carrier pricing
Nash equilibrium exists if a price control exists
to the right of the intersection
Undercutting continues below carrier
Without price controls undercutting continues
until a "flip" in prices is better no
equilibrium
pH
pM
pL
c-us
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Summary

• Competition is more complex in two sided markets
• Unequal "bargaining power" can lead to highly
  skewed prices
• Generally Nash-equilibrium prices allow excess
  profits for the platforms
• The results are robust to alternative utility
  specifications
• Future research on the model will include inter
  alia
• higher number of platforms
• social welfare considerations
• control of platforms
• membership decision, fixed costs and variable
  costs
• endogenous bargaining and multi-homing

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Policy implications for card payments?

• Perhaps too early, but
• Highly skewed prices may be an outcome of
  competition when one side of the market chooses
  platform when both sides multi-home
• Restricting end-user prices (e.g. not allowing
  negative prices) may lead to excess profits to
  schemes
• Duopolistic competition does not necessarily
  reduce prices to cost level
• With SEPA and more competition among schemes,
  prices for retailers should go up according to
  the model.

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and for interchange fees

• In competitive markets 4-party schemes should use
  the interchange fee to achieve the desired price
  structure (whatever they tell about cost based
  interchange fees)
• Highly skewed prices can only be achieved in
  4-party schemes by a high interchange fee
• Restricting interchange fees can give a
  competitive advantage to 3-party schemes (they
  can undercut more on the buyer side, and
  compensate it on the seller side).

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Takk
contact me at kimmo_at_soramaki.net