Network Effects & Two-sided
Markets
Unit 7
Cento Veljanovski
Case Associates
King‟s College PostGrad Diploma/MA Economics of Competition Law
9.30 Holiday Inn, Regent‟s Park, London, 21 April 2007
Case Associates – Competition & Regulatory Economists
www.casecon.com
Address three topics
1. general theory & definitions
2. network effects
3. multi-sided markets
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Three types of network effects
direct – utility of subscriber higher the more subscribers
indirect – value of network to subscriber based on number of
complementary services. This includes herding, bandwagon
effects and judging quality by network size
induced – value of network increased by cheaper on-net call
prices
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Other useful concepts
Demand-side
externality
public good
Supply-side
economies of scale
subadditive cost function = high fixed/small marginal costs
economies of scope
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Impact of network effects
creates reversal of normal supply and demand relationships,
even said to lead to repeal of the laws of supply and demand
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Normal market outcomes
upward or horizontal supply
schedule
downward demand schedule
price that clears market
stable outcome or
„equilibrium‟
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Market with network effects
demand schedule upward
sloping
supply schedule downward
sloping due to economies of
scale
outcome unstable
no determinate price
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Implications
possibility of (natural) monopoly supply
prices below marginal costs/indeterminate
dynamic instability
critical mass & tipping
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Tipping
„chicken-and-egg‟ problem
snowballing/positive feedback effects
path dependence
irreversibility
network unravelling – reverse feedback effects
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Conditions for tipping
uncooperative – „winner-takes-all‟ strategy
network incompatibility
customer lock-in/stranding
high switching costs
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Case studies
standards - VHS v. Betamax, and inefficiency?
Microsoft (2004) - foreclosure through inoperability?
mobile tariffs - induced network effects?
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Betamax again?
Standards „battles‟ played out and
are cited as examples of market
failure („wrong‟ standard; wasteful
competition) due to inertia,
incompatibility, bandwagon effects
etc.,
Or is this simply the market sorting
out good from bad?
Contrast views of technical
literature with that of Liebowitz.
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Pause – different views of competition
Neoclassical – perfect competition with static outcome
Schumpeterian – gales of creative destruction; serial monopoly
spurring innovation but constantly challenging firms
Austrian – discovery process; efficient at collecting and
disseminating information
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Multisided markets
Definition:
„markets in which one of several platforms enable
interactions between end-users, and try to get the two
(multiple sides) “on board” by appropriately charging
each sides‟
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Main elements of multisided market
demand of two or more groups
which is interrelated
intermediary coordinates their demands by providing platforms
example – credit cards: customer and merchant (see later)
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Implications - I
structure of prices as important as level
all sides of market must be analysed
prices demand-oriented rather than cost-oriented
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Implications - II
price discrimination
predatory pricing
cross-subsidisation
price-cost margins
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Credit card and interchange fees
nature of credit card networks
what is an interchange fee
economic justification for interchange fee
competitive concerns
assessment
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About the tutor
DR. CENTO VELJANOVSKI
BEc (Hons), MEc, D Phil, ACIArb
Dr Veljanovski is Managing Partner of Case Associates, Associate Research Fellow, Institute
of Advanced Legal Studies, University of London, IEA Fellow in Law & Economics, and
Member of the Economic Advisors‟ Panel, Infocomm Development Authority of Singapore
(IDA). He is a well-known economist with over thirty years' experience as an adviser to
companies on competition, regulatory and communications economics. Dr Veljanovski has
assisted a large number of fixed, mobile, internet and other communications operators in
regulatory proceedings, merger investigations and on competition issues. He has been
selected as one of the „most highly regarded’ competition economists globally and one of the
top five in Europe by the 2006 Global Competition Review survey. He regularly acts as an
Expert Witness in competition law, commercial and damage litigation, and on the
communications and media sectors most recently in the English High Court, Irish High
Court, Federal Court of Australia, Dutch District Court, Finnish Higher Administrative Court,
the UK Competition Appeals Tribunal, and the International Court of Arbitration.
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About CASE competition &
regulatory
economists
Case Associates provide economic analysis in antitrust
competition law and regulatory investigations.
cartels
Case use rigorous economic and quantitative
techniques to address the critical issues and marshal state aids
evidence to define relevant markets, assess alleged
monopoly abuses, anti-competitive practices, cartels, mergers
and evaluate the competitive impact of mergers.
regulation
Case have provided expert reports and testimony to
regulatory bodies in the UK, European Community, litigation
USA and Australia, on a wide range of issues in many
different sectors. market studies
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