Hi, my name is Kartik Hosanager, and this session is on building two-sided markets. Two-sided markets are markets with two types of participants, where the benefit for one side depends on the number of participants on the other side of the market. This is also known as cross-side network externalities or cross-side network effects. Take credit card networks, for example. My value of joining a credit card network, such as Visa or MasterCard is a function of the number of businesses that accept that credit card. And for a small business, the value of being on that credit card network is a function of the number of customers who have such a credit card. And so, this is a great example of cross-side network effects. Take gaming consoles, as another example. Consider Xbox, or Sony PlayStation. As a consumer, when I buy these gaming consoles, my value from that console is a function of the number of interesting games that are available on the console. And for a game developer, the value of building a game for that console is a function of the number of people or consumers who use that console. Another example of cross-side network effects. Finally, consider Uber, which is an online taxi dispatch service. As a consumer I value being on a service, like uber if they're a lot of taxi cabs that are available on that network. And for a taxi cab driver, the value of joining Uber is a function of how many consumers are using Uber. These are all examples of cross-side network effects, where the value of one side depends on how many players or participants are on the other side. Technology platforms are also good examples of two-sided networks, or two-sided markets. Technology platforms may be thought of as hardware or software systems, which are partially programmable by outside developers. So consider for example, Apple's iOS platform for its iPhone, or Google's Android platform for Android phones. The platform provider Apple of Google, provides a core platform capability. Developers build on top of this platform, and therefore it is partially programmable, and they add additional functionality on top of the platform. Now, these kinds of platforms are good examples of two-sided markets because here again, the value for me as a consumer of buying an iPhone is a function of the number of apps available on it. And the value for a developer of building an app on the iPhone platform is a function of how many users use that platform. Gaming consoles, like Xbox and Sony PlayStation are, again, other examples of technology platforms. A variety of unique issues arise in the context of two-sided networks, the most important of which is how do you build liquidity in the market? For example, if you consider a gaming console, consumers are not willing to buy a gaming console unless there are enough developers on it. Developers are not willing to build on the gaming console because there are not enough consumers on it. So, this creates a chicken and egg problem, and you cannot solve the liquidity issue unless you address the chicken and egg problem in some interesting manner. So, we're going to talk a little bit about how an entrepreneur trying to build a two-sided market might address some of the liquidity challenges in such a market. Now, one interesting strategic lever available to an entrepreneur trying to build a two-sided market is that of pricing. Now, traditional pricing strategy seeks to set a price for a product so as to maximize revenues from the customers. Now, one way to do this is to conduct a survey, where you assess consumer response to different product prices. So in the survey, you might ask the customers whether they would buy the product if it was priced at $100, were they buy of it is priced at $80, $60, $40, and so on. And using their responses, you construct something that is similar to a demand curve, which essentially tells you what proportion of your customer base will adopt the product at any given price point. Now, we set a price that seeks to maximize revenues. In the example on your left, I have a demand curve for consumers on one side of my two-sided market. And I see as in the new market, if I set too high a price very few customers will adopt. And if my price is very low, I could get the entire customer base. And I eventually, set the price which is indicated here as the price P, which maximizes my overall revenues. On the right-hand side of your screen, you see the demand curve for developers. Here again, we're trying to understand how many developers will develop on our platform if we chose a certain price. And as you expect a low price gets a lot of developers, a high price gets you very few developers. And here again, I set a price that maximizes my revenues from developers. In this example, I've chosen prices that maximizes my revenues from consumers, and also maximizes my revenues from developers. But it turns out, this is not the pricing strategy that maximizes your overall revenues. An alternative pricing strategy that does better is to subsidize one side of the market, so as to increase profits from the other side. Consider the figure on your left side, where now we're trying to lower the price. Instead of the price we were previously charging, we're now charging consumers a price of zero. By doing so, we get all potential consumers interested in our product. Now, when we get all potential customers interested in our product, this fundamentally changes the demand curve on the other side. Developers are more interested in building on this platform because you've got more consumers. So on the right-hand side, you see the demand curve for developers has itself shifted to the right. And given that the demand curve for developers has shifted to the right, I can now charge a slightly higher price. And what you see is that when I charge the slightly higher price, I get additional revenues, which is what is marked in red. The additional revenues that I get from developers, more than offsets the loss of revenues from setting the price to consumers to zero. In other words, I've subsidized consumers so as to get more consumers into my gaming console. And by bringing more consumers, I've increased the willingness to pay for developers, and I'm able to charge them a higher price which effectively increases my revenues considerably. There exist many examples of this strategy. Consider Adobe Acrobat Reader, and Adobe Acrobat Writer or Distiller. Now, this is a software that is used to create and use PDFs. Most of us are probably used to downloading the Reader for free, so that we can open PDF files and read them. In contrast, if you want to create a PDF file then you pay for it by buying Acrobat Distiller or Acrobat Writer. So in this example, Adobe has decided to give the Reader for free. Meaning, subsidized one side of the market the consumers of information, and charge a slightly higher price to the other side of the market. These are the publishers who are creating the content that's ultimately going to be read. Another such example is Yellow Pages. In many countries, Yellow Pages are offered for free to consumers. And in contrast, businesses pay a high fee to get prominent placement on these Yellow Pages. Here again, consumers value the information they get from Yellow Pages, and that's provided for free to them. And by doing so, and getting lots of consumers using Yellow Pages, these companies are able to charge higher prices to the merchants that want to place themselves prominently on the Yellow Pages. Nonetheless, if you're designing a two-sided market, its useful to ask which side of the market should I offer subsidies to? To determine which side to subsidize it's useful to go back, and see what was the impact of providing a pricing subsidy. In the previous example, we observed that when we reduce the price on the consumer side to zero, the demand among consumers increase by a large amount. The second impact was that it shifted the demand among developers. Based on these two observations, we have two differed strategies to determine which side of the two-sided market to subsidize. The first strategy, is to subsidize the price sensitive side. Notice in that example when I reduce the price for consumer by a small amount, the demand among consumers increase by a large amount. And so in other words, consumers were highly price sensitive that a small change in price results in a large change in demand. Therefore, by making it free, we might address the liquidity challenges on this side of the market considerably. The other observation we had was that by providing a price subside, and observing an increase in demand on the consumer side. We also observe that the demand curve on the developer side shifting significantly to the right. And so, the other strategy might be based on the extent of this shift in demand curve. In other words, we want to subsidize the side that generates the greater value to the other side of the network. In other words, by subsidizing consumers, developers' willingness to pay increase dramatically, and therefore that's an interesting strategy because we get significant network value. In short, subsidize is the side that is worth more to the other side. We see examples of both these strategies in practice. Recollect the example of Adobe Acrobat Reader and Acrobat Writer. Acrobat Reader is offered for free to consumers, whereas Writer is priced at a premium to publishers and professionals that want to create high-quality documents. Here again, the price sensitive side is offered the product for free, and the side that is willing to pay a higher price, that's the one that's charged a premium amount. Another example of this strategy is Uber. Uber is a taxi dispatch service that connects consumers on one side with taxi cab operators on the other side. During the early days of Uber the price of the product was higher, and it was positioned for premium taxi cabs. The result of that was you had a smaller share of consumers who were on the platform. And because you had a lower or smaller customer base, you have also ended up with fewer taxi cabs on the network. After a few years, Uber decided to lower the price point and offer really low-cost taxi cabs. By doing so, they significantly increased the number of consumers on the platform. And when the number of consumers on the platform increased, a lot of drivers wanted to be on the Uber platform and drive for Uber, and that increase the supply of taxi cabs on the market as well. Another example I mention is to subsidize the site that provides the greater value to the other side of the network. We see this on a day-to-day basis in the way clubs and bars price their cover charges. So for example in lot of clubs, women get in for free, and men have to pay cover charges to get in. The presence of more women at a club increases the price that men are willing to pay to enter the club. And this is a great example of subsidizing one side, in order to charge a premium to the other side. This is an example on a lighter note, but nonetheless it's a very genuine example of a firm trying to address liquidity challenges in a two-sided market by offering subsidies to one side. The pricing is not the only mechanism available to entrepreneurs to address the chicken and egg issue in building a marketplace. There exists many other strategic options. One of them is to try and obtain supply from other marketplaces, or other sources. For example, consider AirBnB, which is a website that connects consumers looking for short term rental opportunities with home owners that are looking to rent out their properties for short term stays. AirBnB had the classic chicken and egg problem. Consumers are not interested in the website, if there aren't enough listings. And homeowners are not interested in renting out their properties in AirBnB unless there are enough consumers. To address this challenge, AirBnB scraped some of the listings from Craigslist, in order to build an initial supply of listings. By doing so, AirBnB was able to attract renters, and therefore address some of the early liquidity challenges on the marketplace. Eventually, once they attracted enough consumers, homeowners also started using AirBnB to rent out their homes. Another strategy is to leverage influencers who have a large base of followers. To address liquidity challenges, an entrepreneur might consider hiring paid advisors who are influencers in that market. Who can get the word out to a large base of followers, and bring them on board. And once they have brought, one side of the market on board, you can now focus on the other side. Yet another strategy, especially for transactions that do not require real-time fulfillment, is manual matching of supply and demand. So in instances, where one side of the market might be able to place orders on your website, and then you might manually match them to the other side by calling potential suppliers or providers. And finally, you might be able to leverage one side to market to the other side of your marketplace. For example, consider Etsy, which is a marketplace for handmade and vintage products. Many Etsy sellers have their own small storefronts in different cities, and they bring many buyers to the Etsy platform. In short, two-sided marketplaces have many unique considerations due to network effects, and due to the challenges associated with building liquidity. But there exists many strategies that are available to the entrepreneur, ranging from pricing, to leveraging influencers, to getting one side of the market to do the marketing for you in some ways. And in fact, there exists many successful marketplaces out there, so we can borrow hacks and ideas from these successful marketplaces. Having said that, much of our upcoming discussion on digital marketing, including topics such as search engine optimization and social media marketing, are just as applicable to two-sided markets as they are for any other entrepreneur.
