Tying in Two-Sided Markets with Multi-Homing

1. Tying in Two-Sided Marketswith Multi-Homing by Jay Pil Choi Michigan State University

2. Two-Sided Markets (Platform Market Competition) • Indirect Network Effects or Inter-Group Network Externalities • Examples: • Night Clubs with Men and Women • eBay with Sellers and Buyers • Credit Card Payment Systems with Merchants and Consumers • Game Consoles with Game Developers and Consumers, etc.

3. Multi-Homing • Participation in Multiple Platforms (or Purchase Multiple Products) in order to Reap Maximal Network Benefits • Multi-homing is prevalent in several industries that have been scrutinized by antitrust authorities.

4. Recent Antitrust Cases of Tying in Two-Sided Markets • Visa and MasterCard Case: “Honor All Cards” tying rule that forced merchants who accept their credit cards also to accept their debit cards. • Microsoft Case: Tying Practice of requiring Windows operating system users to accept its Windows Media Player.

5. Number of Installed Media Players **Source: Survey Report on Media Player

6. The Questions • Do Inter-Group Network Externalities in Two-Sided Markets Require New Insight and Render Previous Analyses of Tying Less Applicable? • Are There Additional Motives for Tying in Two-Sided Markets? • Implications for Antitrust Analysis • The Role of Multi-homing

7. Previous Workon the Two-Sided Market • Demand Coordination in Two-Sided Markets • Armstrong (forthcoming) • Rochet and Tirole (forthcoming) • Antitrust Analysis in Two-Sided Markets • Evans (2003) and Wright (2003)

8. Previous Work on the “Leverage Theory” of Tying • Whinston (1990) • Choi and Stefanadis (2001) • Carlton and Waldman (2002) -Tying of complementary products in the presence of network externalities can be used to preserve and create monopoly positions

9. Tying in Two-Sided Markets • Rochet and Tirole (2003) - An Economic Analysis of the “Honor All Cards” Rule in the Visa and MasterCard Case - Tying is shown to be a mechanism to rebalance the interchange fee structure and raise social welfare.

10. Tying in Two-Sided Markets • Amelio and Jullien (2006): Tying is a mechanism to introduce implicit subsidies (i.e., relax non-negative price constraint). • Carrillo and Tan (2006): Incentives to Vertically Integrate

11. A Simple Model of Two-Sided Markets (with Single Homing on the End Users) Content Providers Competing Platforms (Media Player, RealPlayer) End Users

12. Notation • pi and qi: intermediary i’s charge to content providers and consumers, respectively, where i =A, B. • c and d : the intermediaries’ costs of serving each content provider and final consumer • mi and ni : the number of content providers and consumers who participate in platform i • b: additional utility for consumers generated by each additional content provider • p: additional profit for content providers generated by each additional consumer

13. Consumers • Hotelling Model of Product Differentiation • Two Platform, A and B, are at the Two Extreme Points of a Line. • Consumer’s Choice of Platforms: bmA- qA - tx vs. bmB- qB - t(1- x) • nA = nB = 1-nA

14. Content Providers • Free Entry in the Market for Content Provision. • Fixed Cost of Creating (Encoding) Content: q  F(q) • Profit for Content Providers on Platform i: p ni- pi - q • The Number of Content Providers on Platform i: mi = F(pni - pi)

15. Platform Competition w/o Tying • The Symmetric Equilibrium Price for Content Providers: p* = c- b + , where h = • The Symmetric Equilibrium Price for Consumers: q* = (d + t) - pF - bpF

16. Platform Competition w. Tying • Assume that Intermediary A is also a Monopolist in a Related Market (M). • The Good M (Operating Systems) is Necessary for Consumers to Participate in the Two-Sided Market (Streaming Multi-Media). • Tying Leads to the Monopolization of the Two-Sided Market.

17. Platform Competition w. Tying • The Price for Content Providers: * = c- b + , where = • The Equilibrium Bundle Price for Consumers: * = v + b F(p- *) -t

18. Welfare Analysis of Tying • Three Effects of Tying on Social Welfare (1) Less Variety in the Market (-) (2) Savings in Duplication Costs (+) (3) The Availability of Content (?)

19. Example with a Uniform Distribution • Assume that q is uniformly distributed on [0,1]. • The Number of Content Providers: m*= F(p- p*) = = F(p- *) = ( > m*)

20. Social Welfare Analysis • W = = DW = - W =

21. Model with Multi-Homing on Both Sides • Multi-homing prevalent in the digital media and the payment card industries. • In the digital media, many users have more than one media layer and many content providers offer content in more than one format • The same for payment cards

22. The Case of Tipping: Beta vs. VHS VHS vs. Beta Shares

23. No Tipping and Multiple Competing Networks: Payment Cards in U.S.

24. Tying with Multi-Homing • Consider an equilibrium in which bothcontent providers and consumersmulti-home. • Assume that each platform has available content of measure 1. • Exclusive content of measure l • Nonexclusive content of measure (1-l)

25. Unique Content (l) Common Content (1-l)) A B End Users

26. Consumer’s Multi-Homing Decision

27. A B 0 1 A Only Consumers Who Multi-Home B Only Tying with Multi-Homing

28. Consumer’s Multi-Homing Decision

29. Platform A’s Profit Maximization • Two Options on the Content Provider Side • Attract only exclusive content providers at the price of pNA • Attract both exclusive and nonexclusive content providers at the price of pnA

30. Platform A’s Profit Maximization • Consumer Side (assuming multi-homing on the content provider side)

31. Platform Competition w. Tying andMulti-Homing • Assume that Intermediary A is also a Monopolist in a Related Market (M). • The Good M (Operating Systems) is Necessary for Consumers to Participate in the Two-Sided Market (Streaming Multi-Media). • Tying Does Not Necessarily Lead to the Monopolization of the Two-Sided Market.

32. Platform Competition w. Tying andMulti-Homing • Given that all consumers already have A, nonexclusive content providers have less incentive to duplicate for B • With exclusive content for format B, there could be additional benefit of multi-homing.

33. Welfare Analysis of Tying with Multi-Homing • Tying induces more consumers to multi-home and makes platform-specific exclusive content available to more consumers. • Cost savings with non-duplication of the same content • Overall increase in the “transportation costs”

34. Welfare Analysis of Tying with Multi-Homing • With multi-homing, tying is welfare-enhancing in this simple model • Without multi-homing allowed, tying reduces social welfare • The importance of explicitly considering the role of multi-homing in the antitrust analysis of network industries.

35. Limitations and Extensions • Exogenous amount of exclusive content available for each format • Exclusivity can be endogenously created through the use of exclusive contracts. • Innovation Incentives and Dynamic Efficiency.