Thursday, November 15, 2012

Two-Sided Markets



Two-Sided Markets

Apple, Google and Microsoft are examples of two-sided markets.
  • What is a two-sided market?
  • How are two-sided markets created?
  • How do two-sided markets collapse?


The Two-Sided Market

Two-sided markets typically are entities that connect actors consistently having the same roles in transactions, eg. consumers with a network of suppliers. This marketplace leads to a virtuous cycle between increases in overall value due to the scale, and that value attracting additional consumers and suppliers. Examples include Internet companies providing services and products this way such as Amazon, Google, Facebook, Microsoft and others.

Facebook is especially interesting since it started using the underlying network effects where a social network is more attractive as more people sign up, then evolved into a two-sided market by connecting users to suppliers in the form of advertisers and app makers.

A hallmark of the market is that consumers access it under the market's brand: its Internet domain name, its physical store, or its software or device.


Exponential Growth

Becoming a two-sided markets is attractive because the increasing returns with scale, and the ability to facilitate that scale by subsidizing the more price sensitive party. Consumers are typically very price sensitive, so Google can provide them with a free utility like the free gmail email service, and then charge advertisers to access those consumers. As advertisers pay, Google can evolve and expands its free services, in turn attracting more consumers. Additional consumers increases the willingness of advertisers to pay, and so on. The party that the network decides to charge is the money side, and that side pays for access to the network's other side.


Customer Control

A key aspect of the two-sided market is customer control. By withholding the customer's identity or charging details, a supplier in the market is less likely to be able to bypass the market entity in a break-out attempt to compete by bypassing the market.

Another strategy for the market is to disperse parts of a solution across several suppliers, so that one single supplier is unable to sell directly to the market's consumers.

It is also in the market entity's interest to not have one single supplier becoming dominant, in order to prevent that supplier from evolving into a competing network.


Customer Lock-In

Customers can also be locked in as a discouragement to leaving the network. This could be in the form of investments made, such as buying an iPhone discouraging a switch to Android, or relevant data saved with the network, such as friendships or pictures stored with Facebook, or simply efforts invested in the platform such as code written, high scores achieved or digital purchases.


Market expansion

As a two-sided market grows it tends to enter adjacent businesses where its technology built, its customer base or scale, or other combined-value synergies allows the market to compete favorably with incumbents. Amazon is a glowing example where a book delivery platform first expands to anything that can be shipped in a box or downloaded, then further to the very devices used by its consumers.


The Supplier's Decision

The supplier joins the network to access a larger market and revenue than otherwise feasible or possible independently. The long-term challenge is that the network is unlikely to allow the supplier to be too successful: with increased success the network will attract or encourage competing suppliers limiting that success, and the network can punish or reward its individual suppliers at will.


Partnering with a Market

Suppliers with a unique solution but lack of competency or ability to reach a broad market may partner with a market for mutual benefit. Such partnerships, however, tends to be short lived with a 2 – 3 year life, because the market entity quickly learns the technology, maintains customer control and absorbs the value provided by its partner frequently ending in litigation and the partner becoming irrelevant. There are numerous examples with especially Microsoft but also Google and Amazon of this pattern being repeated over time for different technologies adding value to the market.


How Markets Evaporate

To maintain a market it needs to evolve at least every 5 years. Microsoft is a great example that started with command-line Basic, evolved to Windows, Office, Internet browsers and now lately tablets in a continued effort to connect developers with paying computer users. Had Microsoft stayed with Basic, it would have become irrelevant today. So, one threat that could make users leave a market over time is evolved technology along the lines of cheaper-better-faster as perceived by the users. Users come to your market to satisfy a need, why it is important to early-on detect users being deflected to some upcoming competing market.

The value for users is illustrated by how Facebook disrupted MySpace. It became apparent that there was greater user value in communicating with other users that exposed their true identity, why Facebook became the more valuable option to users. Facebook also maintained a very high rate of innovation, where the few things that proved to work amounted to an additional value MySpace simply did not offer, one of which was evolving from a social network into a two-sided market.

There are plenty of examples how a two-sided market can kill a supplier's business overnight. The market itself, however, tends to gradually go away simply because its value consists of being accessed by many independent users, each with their own decision making. Maintaining customer control and managing your suppliers practically guarantees your further existence. Sudden disruption is only likely by government intervention or catastrophic event to facilities.


Conclusion

Becoming a two-sided market is extremely attractive to a company and its investors simply because of the exponential growth and the prospect of quickly growing a significant business that will live over a long period of time. Although some two-sided markets only last a few years, others have produced the world's youngest billionaires or  the richest person in the world!

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