Strategies for two-sided markets

If you listed the blockbuster products and services that have redefined the global business landscape, you'd find that many of them tie together two distinct groups of users in a network. Case in point: The most important innovation in financial services since World War II is almost certainly the credit card, which links consumers and merchants. The list would also include newspapers, HMOs, and computer operating systems - all of which serve what economists call two-sided markets or networks. Newspapers, for ir stance, bring together subscribers and ac vertisers; HMOs link patients to a web of health care providers and vice versa; operating systems connect computer users and application developers. Two-sided networks differ from traditional value chains in a fundamental way. In the traditional system, value moves from left to right: To the left of the company is cost; to the right is revenue. In two-sided networks, cost and revenue are both to the left and to the right, because the "platform" has a distinct group of users on each side. The platform product or service incurs costs in serving both groups and can collect revenue from each, although one side is often subsidized. Because of what economists call "network effects," these platform products enjoy increasing returns to scale, which explains their extraordinary impact. Yet most firms still struggle to establish and sustain their platforms. Their failures are rooted in a common mistake: In creating strategies for two-sided networks, managers typically rely on assumptions and paradigms that apply to products without network effects. As a result, they make many decisions that are wholly inappropriate for the economics of their industries. In this article, the authors draw on recent theoretical work to guide executives negotiating the challenges of two-sided networks.