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Freeman Magazine - Spring 2008

RESEARCH

Perspective: Strategies for two-sided markets

by Geoffrey Parker

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 in a network. HMOs, for instance, link patients to healthcare providers. Search engines join Web surfers and advertisers.

Products and services that bring together groups of buyers and suppliers in two-sided networks are platforms. They provide infrastructure and rules to facilitate transactions, and they can take many guises. Sometimes platforms rely on physical products, as with consumer credit cards and merchant authorization terminals. At other times they are places providing services, like shopping malls, websites such as Monster.com and eBay, and even nightclubs.

When successful, these platforms catalyze a virtuous cycle: More demand from one user group spurs more demand 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 will be willing to pay Microsoft a licensing fee to produce new games. And as user bases grow, margins fatten.

But 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: (1) pricing the platform, (2) anticipating winner-take-all dynamics and (3) protecting the platform from envelopment by adjacent platforms.

What is the key challenge to pricing in two-sided networks? Making sure you don’t choke off network effects. Two-sided networks often have a “subsidy side,” that is, a group of users who, when attracted in volume, are highly valued by the “money side,” the other user group. Because the number of subsidy-side users is crucial, the platform provider sets prices for that side below the level it would charge if it viewed the subsidy side as an independent market. Likewise, the money side pays more than it would be charged if it were viewed as an independent market.

Adobe’s Acrobat software followed this pricing rule when establishing the PDF standard. Readers are very price sensitive; they pay nothing for their software. Writers, who greatly value the 500 million user base, paid a fee for the software. If Adobe had reversed its approach, charging readers and subsidizing writers, its network would have collapsed.

If you seize a platform opportunity but don’t get it right the first time, someone else will. By mastering the unique strategic challenges of platforms, you’ll gain a head start over your competition.

Geoffrey Parker is an associate professor of business at the Freeman School and director of the Entergy-Tulane Energy Institute.

Adapted by permission of Harvard Business Review from the article "Strategies for Two-Sided Markets" by Thomas Eisenmann, Geoffrey Parker and Marshall W. Van Alstyne, October 2006. Copyright ©2006 by the Harvard Business School Publishing Corporation; all rights reserved.

Last Updated 11/19/08