6.3 One-Sided or Two-Sided Markets?
- Recognize and distinguish between one-sided and two-sided markets.
- Understand same-side and cross-side exchange benefits.
Understanding Network Structure
To understand the key sources of network value, it’s important to recognize the structure of the network. Some networks derive most of their value from a single class of users. An example of this kind of network is instant messaging (IM). While there might be some add-ons for the most popular IM tools, they don’t influence most users’ choice of an IM system. You pretty much choose one IM tool over another based on how many of your contacts you can reach. Economists would call IM a one-sided marketA market that derives most of its value from a single class of users (e.g., instant messaging). (a market that derives most of its value from a single class of users), and the network effects derived from IM users attracting more IM users as being same-side exchange benefitsBenefits derived by interaction among members of a single class of participant (e.g., the exchange value when increasing numbers of IM users gain the ability to message each other). (benefits derived by interaction among members of a single class of participant).
But some markets are comprised of two distinct categories of network participant. Consider video games. People buy a video game console largely based on the number of really great games available for the system. Software developers write games based on their ability to reach the greatest number of paying customers, so they’re most likely to write for the most popular consoles first. Economists would call this kind of network a two-sided marketNetwork markets comprised of two distinct categories of participant, both of which that are needed to deliver value for the network to work (e.g., video game console owners and developers of video games). (network markets comprised of two distinct categories of participant, both of which that are needed to deliver value for the network to work). When an increase in the number of users on one side of the market (console owners, for example) creates a rise in the other side (software developers), that’s called a cross-side exchange benefitWhen an increase in the number of users on one side of the market (console owners, for example) creates a rise in the other side (software developers)..
The Positive Feedback Loop of Network Effects
IM is considered a one-sided market (or one-sided network), where the value-creating, positive-feedback loop of network effects comes mostly from same-side benefits from a single group (IM members who attract other IM members who want to communicate with them). Discount deal sites like Groupon, however, are considered to be two-sided markets, where significant benefits come from two distinct classes of users that add value by attracting each other. In Groupon’s case, the more people that subscribe to receive the firm’s daily deal messages, the stronger the magnet that attracts potential advertisers who offer more deals, who in turn attract more subscribers (and so on). This dynamic has produced freak-show growth for the Chicago-based firm. Less than two years after Groupon was founded, Forbes declared the firm to be the fastest growing company in history.C. Steiner, “Meet the Fastest Growing Company in History,” Forbes, August 8, 2010. While the site has literally hundreds of competitors, few of the upstarts are formidable. The highly profitable Groupon ended 2010 with ten times the traffic of its nearest competitor.J. O’Dell, “By Traffic, Groupon Is Ten Times Bigger Than Its Nearest Competitor,” Mashable, December 2, 2010. Groupon isn’t out of the clear yet. Firms like Facebook and Google—each with an established ad sales force and already strong relationships with advertisers—are launching their own daily deal efforts, gunning for Groupon’s growth. But as for the me-too wannabe upstarts—they’ve got nothing.
It’s also possible that a network may have both same-side and cross-side benefits, too. Xbox 360 benefits from cross-side benefits in that more users of that console attract more developers writing more software titles and vice versa. However, the Xbox Live network that allows users to play against each other has same-side benefits. If your buddies use Xbox Live and you want to play against them, you’re more likely to buy an Xbox.
- In one-sided markets, users gain benefits from interacting with a similar category of users (think instant messaging, where everyone can send and receive messages to one another).
- In two-sided markets, users gain benefits from interacting with a separate, complementary class of users (e.g., in Groupon’s daily-deal business, deal subscribers are attracted to the platform because there are more vendors offering deals, while vendors are attracted to Groupon because it has the most customers to receive the deals).
Questions and Exercises
- What is the difference between same-side exchange benefits and cross-side exchange benefits?
- What is the difference between a one-sided market and a two-sided market?
- Give examples of one-sided and two-sided markets.
- Identify examples of two-sided markets where both sides pay for a product or service. Identify examples where only one side pays. What factors determine who should pay? Does paying have implications for the establishment and growth of a network effect? What might a firm do to encourage early network growth?
- The Apple iPhone Developer Program provides developers access to the App Store where they can distribute their free or commercial applications to millions of iPhone and iPod touch customers. Would the iPhone market be considered a one or two-sided market?