Based on the research of Rajib L Saha and Ravi Mantena.
An analysis of how asymmetries in platform technology affect incentives for collaboration
Technology-enabled platforms match and facilitate interactions between multiple sets of users. Such platforms are ubiquitous in the modern economy and include personal computers and mobile operating systems (platforms between application developers and application users), online advertising networks (between Web properties and advertisers), job boards (between job seekers and recruiters), real estate brokerages (between property buyers and sellers), and electronic marketplaces and payment systems (between merchants and consumers).
A core property of such platforms (more broadly referred to as two-sided markets or two-sided networks) is that the value to participants on each side depends on the number of participants on the other side of the platform – a property economists refer to as network effects (or more precisely, cross-market network effects because the value comes from the number of participants on the other side, not their own side). For example, Google’s advertising platform connects advertisers and content sites. The value of the platform to advertisers depends on the number of content sites available to potentially advertise on, and vice-versa.
According to Professor Rajib L. Saha of the Indian School of Business and Ravi Mantena of the Simon Business School, University of Rochester, the value of the platform to users is driven not just by the number of participants on the other side, but also on how well the platform facilitates the transactions (i.e., effectiveness of the platform technology). For instance, the utility of Google to advertisers and content sites depends on how effectively Google’s contextual mapping and consumer profiling technologies establish the right connections to enhance click-through rates and the fit between the advertised products/ services and the content sites. According to their research, asymmetries in the technological capabilities of rival platforms have a significant impact on the competitive and collaborative interactions between such platforms.
The Basic Model of Utility
Mantena and Saha have developed a model that captures the net utility of a platform to heterogeneous agents on both sides of a two-sided market. The model incorporates both cross-market network effects and the impact of technology on the value derived by participants of a platform. It can be used to study platforms that perform matching, or enable interactions such as social media, economic transactions, and game play. The model assumes that a user will join a platform only if their net utility from joining is positive (the Individual Rationality [IR] constraint), and higher than the net utility from joining the competing platform (the Incentive Compatibility [IC] constraint).
Using a concept called Fulfilled Expectations Nash Equilibrium (FENE), Mantena and Shah study the outcomes of the following two forms of competition on the platform:
(1) Pure Competition: In this case, the platforms compete for the same markets of users on both sides, but do not collaborate with each other in any way.
(2) Co-opetition: In this case, the platforms collaborate with each other in some form even though they compete for the same markets. They identify conditions under which platforms can be better off collaborating, even though they compete for the same market.
To understand pure competition, the study models a duopoly scenario where platforms are vertically differentiated by their technologies, i.e., one platform’s technology is unambiguously superior to the other platform’s. It also assumes that agents on either side single-home, i.e., join only one platform. Pure competition can result in one of the following two market outcomes:
- Competitive Equilibrium: This takes place when both platforms are economically viable with positive demands on both sides. In such a scenario, a small difference in technology can lead to a drastic difference in platform profits and market shares. When technologically inferior platforms try to close the technology gap, they may be able to increase their absolute profits to some extent by capturing some of the extra value created, but relative market shares and profits remain highly lopsided. Take for example the case of Yahoo! and Google advertising platforms. Though Yahoo! has been constantly updating its technology, its profitability is nowhere close to Google’s. For the inferior platform, closing the technology gap is insufficient if a perception gap still persists in the market.
- One-platform Equilibria: This takes place when one platform completely dominates or monopolises the market and the second platform receives no demand even though, in some cases, it may have superior technology. This kind of outcome typically involves cross-subsidisation, with the platform using profits from one side of the market to subsidise the other. The dominance of Adobe’s PDF format is an example of such an equilibrium. Adobe allows free usage of its document reader and charges only for the document creation software, and the format has successfully dominated its segment for over two decades. But dominance is a risky strategy compared to co-existence, as success of the dominant platform depends critically on its ability to convince customers of the inevitability of its dominance.
To understand platform co-opetition, the study models duopoly competition where competing platforms collaborate by interconnecting their networks such that users of one platform can transact with users of the other. As a result, users on both platforms have access to the entire network, and competition is primarily focused on technology and prices. The researchers aptly label such situations “co-opetition” as it involves aspects of both cooperation and competition between the platforms.
When platforms interconnect with each other, the value to each user increases due to their access to a larger network. This also results in higher social welfare. The creation of inter-bank ATM networks in the 1980s is an example of co-opetition among banks. When ATMs interconnected, the number of ATMs, the number of customers accessing them, and the average number of ATM transactions, all increased.
When platforms collaborate through interconnection, each platform’s market and profit shares depend on the details of the interconnection, and on its ability to differentiate its technology. The interconnection can take one of the following forms.
- Direct Network Access: This takes place when platforms provide direct access to each other’s user base. In this scenario, the platforms are substitutes as well as complements to each other, and access to a larger network results in higher demand. As the network size is no longer a source of differentiation between the platforms, platform technologies become the sole differentiator.Collaboration is feasible when both platforms enjoy higher profits compared to the pure competition case, or when the joint profit is higher and the high-technology platform is sufficiently compensated by the low-technology platform. Higher technology asymmetry between the platforms makes collaboration more likely, as values from the expanded network can be leveraged for higher profits. However, as technology matures and the technology asymmetry between the platforms starts to disappear, the platforms no longer find it optimal to collaborate. Therefore, collaboration in such industries may be time limited. Direct network access can also bring in more profits for the dominant platform, when compared to one-platform equilibria. For this reason, the dominant platform may prefer a co-opetitive existence. For example, after enjoying proprietary control over the PDF format for over 15 years, in 2008, Adobe allowed anyone to use, sell, and distribute PDF compatible implementations.
- Mediated/ Indirect Network Access: In this scenario, platforms provide each other’s users mediated access to their networks instead of providing direct access. Therefore, while a user on a particular platform can still interact with users on the other platform’s network, the value from this interaction is impacted by the technologies of both platforms, not just by the technology of one’s own platform.In cases where technological asymmetry is significant, the inferior platforms attempt to interconnect to increase their profits, but the superior platforms are less interested to do so here, as compared to the direct access case. For example, in 2004, Real Networks attempted to make its Harmony service compatible with the iPod so that it could tap into Apple’s customer base. But Apple immediately upgraded the firmware on its iPods to make them incompatible with Real’s network. In cases where platform technologies are comparable, even the weaker platforms are averse to interconnection. For example, in the eBook market, Apple, Amazon, and Barnes & Noble each has a competitive platform (i.e., the eBook format), and none of them is attempting to make its platform compatible with the others and succeed in the short run.
In the context of pure competition between platforms, a small difference in technology translates to a much bigger difference in profitability, and a dominant platform may be able to shut out its inferior rival. However, when a significant technology asymmetry exists between the platforms, competing platforms may be able to increase their profitability through collaboration.
Co-opetition (i.e., collaborating while competing) between rivals generally expands the market, improves customer surplus, and increases profits by generating higher utility to all users. Direct interconnection is a more promising type of collaboration as platforms can increase customer value while preserving and enhancing the degree of differentiation between the two platforms, and therefore improve their profitability as well.
About the Researchers:
Rajib L. Saha is an Assistant Professor of Information Systems at the Indian School of Business.
Ravi Mantena is a Clinical Associate Professor of Computers and Information Systems at the Simon Business School, University of Rochester, New York.
About the Research:
Mantena R., & Saha R. L. (2012). Co-opetition between differentiated platforms in two-sided markets. Journal of Management Information Systems, 29(2), 109-140.
About the Writer:
Pratibha Nanduri is a freelance writer with the Centre for Learning and Management Practice at the Indian School of Business. She is an MBA graduate from the Osmania University.