Managing Networked Businesses

DEAS Seminar Series

December 8, 2005

Tom Eisenmann

Platform-Mediated Networks

Network User A

Network User B

Platform Provider

Definitions• Two interacting principals, called network users, access—

through one or more intermediaries called platform providers—a common platform that facilitates the users' exchange.

• Network effect: Evident when a network’s value to a user depends on the number of other users with whom they can interact

• A platform encompasses infrastructure (e.g., hardware, software, communications networks), standards that ensure compatibility between infrastructure elements, and rules (sometimes expressed in contracts) that specify transaction terms and the rights and responsibilities of network participants.

Example: eBay’s platform includes:

• Browser and Internet access (provided by 3rd parties)• Registration process• Website design (e.g., categories)• Rules for bidding• Bid tracking software• Dispute resolution processes• Links to PayPal (a payment platform owned by eBay)• Feedback system• Much more

Platform Roles: Sponsors and Providers

• Platform providers facilitate network users’ access to platform

• Platform sponsors do not deal directly with users; rather, they hold property rights that determine: – Who may change the platform’s technology – Who may serve as provider

• Platform sponsors often serve as platform providers, e.g., Apple Mac, Skype, eBay

Platform Sponsorship

• Unsponsored platforms evolve through the collective action of many parties– Examples: Internet, power grid

• Sole versus joint sponsorship– Sole sponsor examples: eBay, Skype, Macintosh– Joint: multiple parties share sponsorship through joint

ventures, consortia, or associations with procedures for securing agreement, e.g., IEEE sponsorship of 802.11; Java Community; realtor association

Proprietary vs. Shared Platforms

• Proprietary platforms have a single provider -- often its sole sponsor (e.g., Skype, Monster.com)

• Shared platforms have multiple providers– Jointly sponsored platforms are often shared (e.g.,

DVD; VISA; real estate association)

– A sole platform sponsor may license rights to serve as provider to multiple parties (e.g., Scientific-Atlanta set-tops; MBNA American Express card)

Categorization Based on Extent of Mutuality

Proprietary Shared

Unsponsored (None, by definition) •Internet•Gas-powered cars•Electric power grid

Jointly Sponsored

•NYSE•Careerbuilder

•DVDs, VHS•Wi-Fi•Universal Product Code•VISA•Java, Linux•Real estate association

Sole Sponsor •eBay•Macintosh•Monster.com•Skype•Federal Express

•Adobe PDF•Scientific-Atlanta set-top box•American Express card

We can categorize platforms based on:

• Extent of Mutuality: Sole vs. Joint Sponsorship; Proprietary vs. Shared

• Function: Connectivity, Complements, Matching

• Structure: One-, Two-, Three-Sided

Categorization Based on Platform Function

• Connectivity network: platform facilitates point-to-point exchange of information, physical goods, or passengers (e.g., fax; IM; Federal Express; railroads)– More points connected more valuable network

more points connected etc.

• Complement network: platform good is required to access variety of complements (e.g., console + games; credit card + merchant locations; fuel cell cars + refueling stations)– More/better complements more users of platform good more/better

complements etc.

• Matching network: platform helps match potential transaction partners (e.g., eBay; NYSE; nightclub; talent agent)– More buyers more sellers improved odds of suitable transaction

and/or reduced price volatility more buyers etc.

Categorization Based on Platform Structure

• “One-sided” networks: Most users regularly play both transaction roles, e.g., emailers send and receive; stock traders buy and sell

• “Two-sided” networks: Most users are permanent members of one distinct group — a “side” — which transacts with a second group, e.g., gamers and developers; job seekers and recruiters– Cross-side network effects are usually positive (e.g., job seekers prefer more

recruiters, and vice versa), but can be negative (e.g., TV ads)

– Same-side network effects can be positive (e.g., value from sharing DVDs with friends); negative (e.g., job seeker prefers fewer closely-matched rivals); or neutral (e.g., job seeker doesn’t care about seekers who are hunting for other types of jobs)

• “Three-sided” networks: Many media businesses facilitate interactions between viewers/readers, advertisers, and 3rd party content providers

Our domain does not necessarily encompass:

• Physical networks (e.g., gas utilities)• Social networks (e.g., your golf buddies)• “Ecosystems” comprised of large firms and

their most committed suppliers and customers (e.g., Wal-Mart, Toyota)

Why study platform-mediated networks?

• Comprise a large and growing share of global economy. Not just computers/media/telecom/Internet, but also:– Financial services, e.g., ATMs, credit cards, stock exchanges

– Transportation, e.g., package delivery, fuel cell cars

– Retail, e.g., shopping centers, bar codes

– Energy, e.g., grid + appliances, wholesale power markets

– Health care, e.g., HMOs

• Confront distinctive management challenges

Distinctive Challenges• Strategic decisions are very complicated due to:

– “Multi-sidedness” of most networks– Bifurcation of platform roles: sponsor and provider – Mixed motivations: cooperation, conflict

• Concepts are new: academic research on “two-sided” networks only began five years ago

• Mistakes are common and can be fatal– Yahoo, Amazon failed in U.S. auctions; eBay failed in Japan – Collusion by NASDAQ market makers led to $1 billion SEC fine and set

stage for ECN competition– With Macintosh, Apple “forfeited 20th Century’s biggest business

opportunity”– Priceline tried to extend “name-your-own-price” model to groceries,

resulting in $360 million loss

Distinctive Challenges, cont’d

• Business Model Design

• Winner-Take-All Dynamics

• Platform Envelopment

Business Model Pop Quiz: Sexism Aside, Why Do Nightclubs Offer “Ladies’ Night” Pricing?

Which side should be charged in a two-sided network?

• Assume marginal cost = 0• Case 1, with no network effect:

monopolist prices each product to maximize P x Q

• Case 2, with network effect, shows how demand for products “A” and “C” each would grow (vs. Case 1) if quantity consumed on the other side increased due to a zero price

• Side C should be priced at zero if:((P’A x Q’A) - (P*A x Q*A)) >(P*C x Q*C)

• Rule: Charge side that most highly values growth on the other side

• Nightclub pricing: “Men prefer quantity, women prefer quality”?!?

PA

P’A

P*A

QAQ*A Q’A

PC

P*C

Q*C QC

Case 2: Network Effects

PA

P’A

P*A

QAQ*A Q’A

PC

P*C

Q*C QC

Case 2: Network Effects

PA

P’A

P*A

QAQ*A Q’A

PA

P’A

P*A

QAQ*A Q’A

PC

P*C

Q*C QC

PC

P*C

Q*C QC

Case 2: Network Effects

PA

P*A

Q*A QA

PC

P*C

Q*C QC

Case 1: No Network Effect

PA

P*A

Q*A QA

PA

P*A

Q*A QA

PC

P*C

Q*C QC

PC

P*C

Q*C QC

Case 1: No Network Effect

Winner-Take-All: Two Questions• #1: Will a WTA outcome prevail, i.e., will almost all

network users affiliate with a single platform? – Strong network effects increase WTA odds

• If not, we will observe one of the following outcomes: – Multi-homing: most users on a given side affiliate with

multiple platforms, e.g., credit cards; media players – Mono-homing: most users on a given side affiliate with only

one of several competing platforms, e.g., video game consoles; online subscription music sites

• #2: If a single platform prevails, will it be proprietary to a single firm, or shared by multiple firms?

Market Structure Examples

NetworkSide 1Users

Side 1Structure

Side 2Structure

Side 2Users

Fax Sender/receivers WTA (Homogeneous network)DVDs Consumers WTA Movie studiosMobile FeliCa Cell phone users WTA Retail stores, etc.Real estate MLS Home buyers WTA Home sellersWindows desktop O/S PC users WTA Application providersOnline auctions Buyers WTA SellersPDF Readers WTA Document creatorsInstant messaging Sender/receivers Mixed-mode (Homogeneous networks)Credit cards Consumers Mixed-mode Mixed-mode MerchantsYellow Pages Consumers Mixed-mode Mixed-mode MarketersRecruitment sites Job seekers Mixed-mode Mixed-mode RecruitersVideo games Consumers Mono- Mixed-mode Game developersShopping mall Consumers Mono- Multi- StoresSubscription music Consumers Mono- Multi- Artists/labelsMultichannel TV (DBSvs. cable)

Consumers Mono- Multi- Programming networks

WTA Potential?

PDF: WTA

Credit Cards: Multi-Homing

Multi-Homing Cost

•High for document producers

•Low for readers

•Low for both sides, i.e., card holders and merchants

User Demand for Transaction Partner Variety

•High for both sides •High for both sides

User Demand for Differentiated Platform Functionality

•Low due to WYSIWYG; advanced functions can be provided selectively

•High: revolving vs. charge (i.e., pay-in-full with no preset limit)

If WTA, for Fighting vs. Sharing Compare Market Size x Market Share x Margin

If Fighting: If Sharing:

Market Size

•Fear of stranding delays adoption

•Maximal network effect

Market Share

•100% or 0%! •Depends on cost position, distribution, etc.

Margin •Monopoly pricing

•Upfront R&D, marketing cost

•Competition focused mostly on price?

Platform Envelopment

• Platform providers in separate but adjacent networked markets (A and B) share users

• Provider B enters A’s Market

• Provider B bundles products A and B, undercutting provider A’s “money side”

Side 1(subsidy)

Side 2 ($$)

Platform A

Platform B

Envelopment in Digital Music

• RealNetworks was dominant streaming media software provider in late 1990s– Player was free to consumers; content providers were the

“money side”

• Real Player was enveloped by Windows Media Player; WMP server software bundled into NT

• Real redeployed into Rhapsody subscription music• Yahoo! enveloped Rhapsody, bundling Yahoo! Music

with portal• Yahoo! Music is vulnerable to envelopment by Apple• iPod is vulnerable to envelopment by Cingular

Other Envelopment Examples

• Internet Explorer vs. Netscape• Cable- or IM-base VoIP vs. Skype, Vonage• Nokia NGage vs. Gameboy• Media Center PC vs. Scientific-Atlanta• LinkedIn vs. Monster Networking• DoCoMo FeliCa vs. credit cards• Future? Microsoft Word vs. Acrobat• Future? IBM vs. Akamai• Future? Google Office vs. Microsoft Office

Defensive Strategies

• Innovate (e.g., Adobe moving from document presentation to document management)

• Cede and redeploy — preferably through platform envelopment! (e.g., RealNetworks move from streaming media to subscription media)

• Find a “big brother” (e.g., RealNetworks + Comcast, Cingular in response to envelopment threat from Yahoo et al. in subscription media)

• Sue (e.g., RealNetworks collects $760 million from Microsoft)