By David S. Evans[*]
II. The Economics and Technology of Web-Based Businesses
A. The Economics of Multi-sided Platforms
Many of the key businesses that have arisen on the web are what economists call “multi-sided platforms.” A multi-sided platform provides goods or services to two or more distinct groups of customers who need each other in some way and who rely on the platform to intermediate transactions between them. Multi-sided platforms usually lower transactions costs and thereby facilitate value-creating exchanges. They tend to arise when there is some value available from getting multiple sides together but transactions costs or other obstacles stand in the way. eBay, for example, drastically lowered the cost of exchange between buyers and sellers of second-hand goods.
Multi-sided platforms usually perform each of three interrelated core functions to some degree. First, they serve as matchmakers to facilitate exchange by making it easier for members of each group to find each other. That can be for love (matchmaker.com) or money (eBay). Second, they build communities (or audiences) because this makes it more likely that members of a group will find a suitable match. Facebook provides value in part because people are more likely to find people they want to meet and because advertisers can reach a large audience. The value of the platform grows as the audience grows. Third, they provide shared resources and reduce the cost of providing services to multiple groups of customers. This is an especially important characteristic of software platforms discussed below.
One key feature of multi-sided platforms is the presence of the “indirect network effects” mentioned earlier. That means that the value that a customer on one side realizes from the platform increases with the number of customers on the other side. Consumers looking to buy something value a search engine more if it provides advertisements that are more relevant to their search, while companies value advertising on a search engine higher if they are more likely to reach potential consumers.
Another key feature is that multi-sided platforms must cater to multiple, distinct customer groups simultaneously. To establish a two-sided platform, for example, the founders must solve a chicken-and-egg problem: customers on Side A will not participate without customers on Side B, but customers on Side B will not participate without customers on Side A. YouTube had to pursue people who want to post videos, people who want to watch videos, and advertisers who want to reach these viewers. These features make the profit-maximizing calculus for a multi-sided platform more intricate than for a traditional business. A firm operating one of these platforms must consider the demands of all sides, the interrelationships between these demands, the costs directly attributable to each side, and the costs of running the platform.
Further complicating this calculus is the fact that the profit-maximizing prices for multi-sided platforms can result in users on one side getting a price that is less than the incremental cost incurred by a customer on that side, and even less than zero. The side that is “needed more” or that is “harder to get” may receive a price break; conversely, the side that gets the most value out of access to members of the other side likely bears more of the cost. As an empirical matter, many multi-sided platforms make their money from one side and make access to the platform available to another side for a price that does not cover the cost of provision. Facebook, for example, is free to users and makes money by selling advertising.
There are several major classes of industries in which most if not all of the businesses are based on multi-sided platforms. These include advertising-supported media including newspapers, magazines, radio, television; payments including credit and debit cards; exchanges including auction houses, commodity exchanges and financial exchanges; and dating and matchmaking such as singles bars and matchmaking services. Another major class consists of industries that have software platforms as their underlying technology. These include computer operating systems, mobile telephones, personal digital assistants, and video game consoles. They also include many web-based businesses.