Pricing Theory In Two-Sided Markets With Its Application To The Software Industry

Lots of active entities nowadays play an important role in the economy, to name a few, Alibaba in E-business, China Union Pay in payment industry, Microsoft in Operating System, Wen Hui Goup in newspapers and media, and Heng Long Real Estate in shopping malls. Despite their different business focus, some common characteristics lie behind: they all face demands from more than two different types of markets, where the users interact with each other; there is also a platform earning its profit from coordinating all the markets.These are the subjects this dissertation studied on, which are known as Two-Sided Markets (TSMs). The theory on Two-Sided markets analyzes the economic networks having two distinct user groups that provide each other with network benefits. Example markets include credit cards, comprised of cardholders and merchants; HMOs (patients and doctors); operating systems (end-users and developers), travel reservation services (travelers and airlines); and video games (gamers and game developers). Benefits to each group exhibit demand economies of scale, also called cross-group externalities in the dissertation. Consumers, for example, prefer credit cards honored by more merchants, while merchants prefer cards carried by more consumers.The theory of TSMs was raised up in 1980s with its root deep in the management issues and economic phenomena. It was utilized by economists when making an argument about antitrust issues of Microsoft and Visa against the US government and EU consulting firms created innovative business models for numerous startups in Silicon Valley under the guidance of it. Moreover, it helped in the discussion of competition between old vs. new media. There will be expected a huge impact on China as well since we are more and more involved in the globalization. Confronted with complex and ever changing competition environment, Chinese entrepreneurs should find some tools to help them making decisions. And this dissertation proved that the theoretic framework of TSMs is no doubt a perfect fit.This dissertation caught up with the forefront of the economic and management theory, offering a thorough analysis on the Blue Ocean of strategy research with a normal economic research methodology. The main theme is to use the comparative analysis with the traditional theoretical benchmarks, which gives a better explanation for the specific TSMs phenomena. Thus the script of this dissertation is: Based on lots of industries'practices, the micro structure of TSMs is illustrated, i.e. complementary demand among markets and cross-group externalities, in comparison with the tradition relevant definition. And the main theme is the pricing scheme for TSP firms. In this dissertation, the traditional one-sided market, market with network externalities, and the social optimum are the benchmark settings to give a better understanding about characteristics of platform firms'pricing. Particularly, the cross-subsidization is analyzed due to its ubiquitous existence in contrast with the traditional motivation and performance that firms subsidize. And given the non-negative pricing constraints on subsidized market, the bundling strategy is discussed on its impact for the TSMs. Among the factors that affect platform firms pricing, market structure is the one. Because the competition exists in more than one market and there are influences among one another, the pricing structure changes may not follow the results according to the traditional theory. And one more step further, the strategic effects of the competition strategy may have their new characteristics. As for the competition strategy, the pricing and the strategy per se should be different from the traditional results and the reasons. Besides the research on general TSMs issues, software industry is analyzed under the framework of the TSMs. And the different viewpoint should provide new explanation for software platforms'pricing scheme and the industry performance, efficiency, and social welfare. The major findings are resulted from a relative uniform model system, which are:(a) Platform managers must choose the right price to charge each group in a two-sided network and ignoring network externalities can lead to mistakes. It is found out that the Lerner Indexes in different markets are lower than the inverse elasticity. And the monopoly platform firms probably decrease their price when the marginal cost increases. And the platforms subsidize the market that provides more externalities and the subsidy can even lead to negative price. Furthermore, both pure and mixed bundling can better coordinate the demand among markets and enhance the participation, which may not reduce the social welfare.(b) If subsidization exists in the TSMs, platforms competition may result in a reduction in the degree of subsidy, i.e. a price increase in the subsidized market. As for the strategic effects of cost reducing investment, the prediction can be wrong if applying traditional one-sided market analysis.(c) Contrast to the frequent appearance of horizontal differentiation, this dissertation deals with the characteristics of vertical differentiation and founds out that: the platform firm of high quality tends to decrease the quality, and engages in price competition more aggressively, which results in a lower degree of differentiation compared with the traditional results. And the model gives a proper explanation for the competition in media markets and E-commerce.(d) After applying TSMs framework, this dissertation reveals that the pricing mechanism for software platforms represent the relative strength of the externalities between application market and user markets. And it is also found out that the Application Programming Interfaces is the mechanism that software platforms use to coordinate the production of application software. And integration of killer apps is an important way to get both sides on board, especially for the platforms in their preliminary period.Related to the above findings, there are four main contributions as follows. (a) The research on the strategies to"get both sides on board". The"Chicken and Eggs"problem is the puzzle that relates with all markets with network externalities. The analysis of TSMs is no exception. In this dissertation, it is revealed that platform firms can provide bundles to the subsidized markets, which are restrained by non-negative pricing, in order to enhance the participation on both sides. And the more the conservative price of the bundled product is, the more effects it will bring to the platforms. Another strategy is about the integration of killer apps production. And it is proved that in the period that the apps markets are far from developed, the platforms have the incentives to integrate the killer apps production, thus attracting more users to adopt their software platforms products.(b) Given cross-subsidy in the equilibrium, the analysis of competition effects on price and the characteristics of the strategic effects. The detailed results have been illustrated in the above. In addition, the previous literature on TSMs competition focuses almost on the price or quantity competitive measurement, not in the strategic level. And the latter is explorative analyzed in this dissertation, in which it is found out that more complex signaling effects exist for cost reduction investment for TSPs than the traditional firms in one-sided market.(c) The analysis of interaction between two side users in software industry: the consumption of application software, or apps. In the general TSMs models, the interactions between two side users are always abstracted without loss of generality. But under the background of the specific software industry, the complementary relations between software platforms products and the apps are the key for the users in this industry. And explicit expression of apps consumption provides the models used in this part of the dissertation a good approximation for explaining the platforms pricing scheme.(d) Performance analysis of Two-Sided Software platforms in software industry. The characteristics of apps markets have impact on the strategy of software platform firms. And the complementary or substitute relationship among different types of apps and the significance difference will result in different platforms'strategies, market efficiency, and the social welfare. The resulting analysis framework can be applied to one type of TSMs, which have one market users comprise a complementary supplier from the other market users'point of view. And it also provides some insights for China software producers on how to utilize the coordinative efforts offered by the platform firms.