COMPETITION POLICY IN TWO-SIDED MARKETS

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1 COMPETITION POLICY IN TWO-SIDED MARKETS Jean-Charles Rochet (IDEI, Toulouse University) and Jean Tirole (IDEI and MIT) Prepared for the conference Advances in the Economics of Competition Law, Rome, June 23-25,

(IDEI and MIT) Prepared for the conference Advances in

2 1. INTRODUCTION Examples of two-sided markets: PLATFORM BUYERS SELLERS gamers users eyeballs cardholders videogame platform operating system portals, newspapers, TV debit & credit cards game developers application developers advertizers merchants Chicken and egg problem. Must get both sides on board/court each side while making money overall. 2

& credit cards game developers application developers advertizers merchants Chicken

3 Two-sided markets raise new questions: Price structure: receives attention from managers: impact of elasticities and externalities, impact of platform competition, impact of multi-homing (examples: payment cards, software, real estate, ). public policymakers (termination charges, IFs): antitrust implications (legitimacy of cross-subsidies, impact of tying, ). 3

multi-homing (examples: payment cards, software, real estate, ).

4 OUTLINE OF THE PRESENTATION 1. INTRODUCTION 2. GENERAL PRINCIPLES OF TWO-SIDED MARKETS 2.1 Membership and usage 2.2 The choice of a business model 2.3 Regulation of interactions between end-users 2.4 Platforms competitive strategies. 3. AN ILLUSTRATION: THE PAYMENT CARD INDUSTRY 3.1 Some recent anti-trust cases 3.2 The role of Interchange Fees 3.3 Merchant acceptance under single-homing 3.4 Impact of multi-homing 3.5 Tying 4. CONCLUSION: ANTI-TRUST ASPECTS 4

4 Platforms competitive strategies. 3. AN ILLUSTRATION: THE PAYMENT CARD INDUSTRY 3.

5 2. GENERAL PRINCIPLES 2.1 Membership and usage Two sides of the market: i {B, S}. B p S p 5

6 2.2 The choice of a business model: (1) Charge according to what each side can bear Account for elasticities of demand on both sides: price structure should aim at getting both sides on board, not to allocate costs "fairly". Illustration : why did credit cards and debit cards adopt so markedly different business models? Credit (Visa, MasterCard, Amex): high merchant discount, low (negative) cardholder price. On-line debit: low merchant discount. 6

Illustration : why did credit cards and debit cards adopt so markedly different business models?

7 Other examples of asymmetric price structures: 7 * based on downloaded volume.

8 Social gatherings celebrities in social happenings, OTHERS other participants Conferences, academic journals, universities Shopping malls speakers, professors consumers (free parking, cheap gas, ) audience shops (Legacy) Internet Real estate websites buyers dial-up consumers sellers LOOKING AHEAD: KEEP POSTED ON Platform B2B Internet backbone services Two sides buyers / sellers consumers / websites Instruments of cost allocation or crosssubsidization design of auctions, information flows, termination (settlement) charges 8

dial-up consumers sellers LOOKING AHEAD: KEEP POSTED ON Platform B2B Internet backbone services Two sides buyers / sellers

9 2.3 Regulation of interactions between end-users Useful benchmark: the vertical view Contrast two-sided market: platform has relationship with buyer; hence, more protective of buyers' interests, less protective of sellers' interests. Key difference: P willing to constrain S, as P can (partly) recoup benefits on B side. Hence, P regulates interactions whereas it would grant S commercial freedom 9 under the vertical view.

10 2.4 Platforms competitive strategies (1) Key new factor: multi-homing. Suppose for example that buyers single-home while sellers multi-home Charge monopoly prices in multi-homing market and low prices (zero?) in single-homing one. Illustration #1: advertizers multi-home. Eyeballs don't (and even if they do, rehearsal effect) 10

monopoly prices in multi-homing market and low prices (zero?) in single-homing one.

11 Illustration #2: Steering: the story of the decrease in merchant discounts Platform 1 Platform 2 Cardholder Merchant Merchant has "first-veto right" platforms court merchants much more than under cardholder single-homing Price structure is now too favorable to merchants. 11

"first-veto right" platforms court merchants much more than under

12 3. AN EXAMPLE: THE PAYMENT CARD INDUSTRY 3.1 Recent antitrust cases Wal-Mart ( , USA) Interchange Fees 1 (2001, EU) Interchange Fees 2 (2003, Australia) Interchange Fees 3 ( , UK) And many others 12

13 THE WAL-MART CASE: Oct. 1996: Wal-Mart and other US retailers sued VISA and MasterCard (violation of antitrust law) HAC rule tied credit cards with off-line debit cards, which charged a higher merchant discount than ATM (on-line debit) cards. Lawsuit certified as a class action with > 5 million merchants. Damages evaluated over $7 billion. June 2003: VISA and MasterCard settled for over $3 billion, and accepted to abandon HAC. 13

credit cards with off-line debit cards, which charged a higher merchant discount than ATM (on-line debit)

14 3.2 The role of Interchange Fees cost c B Issuer p a cost c S Acquirer p + p B p + p S Customer benefit b B sells good at price p Merchant benefit b S (costs and benefits are net i.e. w.r.t. a cash payment) 14

15 Consider a given type of merchants ( fixed) and focus on consumer s choice of payment mode. Social welfare maximized if: card payment or Competition on downstream markets leads to: inefficient usage: B S B S b + b c + c = c B B S S b c + c b p = c + m B B B b B c B + m B Efficiency restored with appropriate interchange fee a* = b c + m p = c a + m S S B B B B b. S. customer uses card B B B S S b p = c + c b. 15

usage: B S B S b + b c + c = c B B S S b c + c b p = c + m B B B b B c B + m B Efficiency restored with

16 3.3 Merchant acceptance under single-homing If consumers have (at most) one card in their wallet, merchant accepts card if and only if: p S b S + average perceived convenience benefit of cardholder merchant discount direct benefit of merchant strategic benefit of merchant B (denoted ) v 16

+ average perceived convenience benefit of cardholder merchant discount

17 Suppose that association sets the maximum interchange fee (IF) that is compatible with merchant acceptance: S S SH S S B p = c + a + m = b + v a SH = ( b S c S ) m S + v B. Social welfare is maximum for: a* = ( b c ) + m S S B SH B B S a* < a m < v m. 17

18 1st case: Cardholders single-home, low variable markups Network s choice leads to an interchange fee that exceeds the socially optimal level: Social welfare a * SH a Interchange fee a 18

19 2nd case: Cardholders single-home, high variable markups Association s choice leads to constrained optimal provision of card payments: Social welfare a SH (equilibrium) a * S a* = b c + π Interchange fee a 19

optimal provision of card payments: Social welfare

20 3.4 Cardholders multi-home In this case merchants accept only the card that maximizes their net total surplus (including their strategic benefit) MH S S a < b c a (don t internalize the banks variable profit) * Interchange fees are too low. 20

(including their strategic benefit) MH S S a < b c a (don t

21 3.5 TYING Extend our model: two types of cards: k = d (debit), k = c (credit) two kinds of networks: i = 1 (ATM) offers only d; i = 2 (VISA/ MasterCard) offers both d and c. Single-homing for credit, multi-homing for debit. Cardholders credit Cardholders off-line debit VISA / MasterCard (credit) Merchants (debit) Cardholders on-line debit ATM Network 21

22 Without tying: With tying: Too-low IFs for debit (cardholders multi-home). Too high IFs for credit (cardholders single-home). Fee for online debit unchanged. Higher fee for off-line debit, lower fee for credit. [Maximize volume under constraint that merchants accept bundle ] May increase social welfare. 22

23 4. CONCLUSION: ANTI-TRUST ASPECTS Need to renew anti-trust analysis for two-sided markets: high price-cost margin on one side does not imply market power (even with low fixed costs). Conversely price below cost on one side does not imply predatory behavior. Merger on one side increases competition on other side. Tying has rebalancing benefits. 23

Lliçó d'economia. Universitat Pompeu Fabra, Facultat de Ciències Econòmiques i Empresarials, October 11, 2006. Jean Tirole

Lliçó d'economia. Universitat Pompeu Fabra, Facultat de Ciències Econòmiques i Empresarials, October 11, 2006. Jean Tirole Platform Industries: How Telecoms, Software, Credit cards, Media, and Videogames Differ from Other Markets, and What it Means for the Future of the Economy Lliçó d'economia Universitat Pompeu Fabra, Facultat