It is two decades since Jean Tirole and Jean-Charles Rochet published “Platform Competition in Two-Sided Markets” (2003) and “Two-Sided Markets: A Progress report” (2006), and multi-sided markets are more relevant and prevalent than ever. Their work is concerned primarily with the efficiency of the transactions made within multi-sided markets, how standard measures of efficiency succeed, fail, or require adjustments in these markets, and the degree and nature of the impact of price structures upon the eventual value derived from the platform.

Multi-sided markets, of which two-sided markets are a largely interchangeable and easily explicable example, exist when a platform seeks to cultivate a market that requires multiple different parties, other than the platform, to participate. For a non-technical example, a shopping mall creates a two-sided market because it needs to attract both customers and shops. It often does this by pricing in a way that creates a cross-subsidy from one group to the other. For example, the shopping mall may start by offering free parking in order to bring in customers, which increases the attractiveness to shops. Once the market created by the platform has developed, the platform can remove (or even reverse the direction of) this cross-subsidy, creating a dynamic ‘see-saw’ effect.

The shopping mall in this example is the platform, which provides a distinct service to two or more sides of the market. The platform maximises its value by attracting multiple sides (usually buyers and sellers) to the platform. Although there is not an agreed-upon definition of a multi-sided market, researchers have generally identified three characteristics, summarised in Weyl (2010):

1. Multi-product firm: A platform provides a distinct service to two sides of the market, which can be explicitly charged different prices.

2. Cross network effects: Users’ benefit from participation depends on user participation on the other side of the market, which varies with market conditions.

3. Bilateral market power: Platforms are price setters (monopolistic or oligopolistic) on both sides of the market and typically set uniform prices.

Almost any platform that aggregates content is an easy example, whether it be games, music or videos. The concept of a buyer/seller or creator/consumer relationship being mediated by a platform, within its price structure, is simple enough. Practically, we often see other categories of end-user, such advertisers, also present turning our two-sided market into something more complex. This is unsurprising, networks foster complexity, and platforms are necessarily at the centre of a network whose externalities have a recombinant effect with its internal price structure.

Tirole distinguishes between usage costs and membership costs, and usage externalities and membership externalities. Gains, positive externalities, for end users arise from usage, not membership, i.e., when both sides transact - not simply when both sides exist. The volume, per Tirole’s definition, of these interactions is determined by the price structure. An inefficient price structure will reduce end users’ gains. In cases where users can shift between platforms “multi-homing” inefficient price structures are more likely to be iterated away from. When consumers are locked into a single platform, inefficiency has extreme network effects.  

One can take the following insights from Tirole’s work:

• The profit of a platform, and the net surplus generated, in a multi-sided market, is dependent upon the volume of transactions, which in turn is determined by how the charges are distributed between end users, the price structure.

• Captive buyers skew the price structure in the favour of seller, however, “When the buyers’ demand for usage is exponential, the monopoly distortion can be perfectly corrected, and the first-best level of transactions obtains.”

• When there are significant frictions, including an asymmetry of information, in the bargaining between end-users, meaning that Coasian bargaining does not apply, the platform must subsidize the interactions to reach its optimal volume/profit/surplus.

• When determining its optimal price to maximise profits, using the Lerner Condition, the platform must factor “opportunity costs” rather than costs.

Tirole and Rochet today

Although Weyl (2010) made a significant refinement to the Tirole and Rochet model, it remains the theoretical starting point for any academic discussion of multi-sided markets. Schmalensee (2014) describes it in terms of expanding how one thinks about an asset and redefining it as a platform, a significant insight into the economic theory of the firm.

If there is a critique, it is the attempt to frequently link the theoretical model to real-world technological platforms. Tirole and Rochet frequently use videogame consoles as an example, because at the time this market functioned as a relatively simple two-sided market. That is, without a large pool of developers willing to create the games, and players willing to buy the appropriate right consoles to run these games, the market cannot exist and the platform provider building the gaming console is worthless. In recent years, consoles generally have moved away from the model they operated under at the time of writing to a more complex and diverse array of models, many of which are more than two-sided. Consoles traditionally were sold at a loss and the losses recouped primarily by charging developers. Although the example seems dated, the theory appears to have accurately described the subsequent market evolution. Price structures changed to reduce the barriers to entry, adjusted for opportunity cost, and generally restructured naturally to better subsidize the transactions.

Weyl (2010) and Schmalensee (2014) improve and/or remark upon some simplifying assumptions of the original Tirole and Rochet work. They do not change the original theoretical insights. As noted by Schmalensee, ‘There is something of a paradox here. Adapting standard quantitative tools…to handle MSPs generally produces something that is very complex and data-intensive….[o]n the other hand, recognizing that a business is an MSP often yields very useful qualitative insights immediately.’ The description of multi-sided markets has fundamentally changed the way that economists think about the boundaries of the firm. It also has dramatic implications for how entrepreneurs approach the problem of maximising firm value, as they now have to consider other product-market participants. This is particularly relevant to the transformation of the energy sector and creates new market structures and platforms. Much like Tirole and Rochet’s original insight, the traditional view of energy markets will no longer suffice for the modern, digital, and Net Zero world.