Technical Workhop on the Economic of Regulation Piracy in two-ided market Paul Belleflamme, CORE & LSM Univerité catholique de Louvain 07/12/2011 OECD, Pari Outline Piracy in one-ided market o Baic model of piracy Piracy improve tatic efficiency o Extended model Effect of piracy in term of dynamic efficiency? Piracy in two-ided market o Competition between platform o Intermediated v. non-intermediated trade o Producer of copyrighted work may have lower incentive to invet in anti-piracy meaure if trade i intermediated. 2 1
Baic model of piracy (Yoon, 2002; Belleflamme, 2003 Single-product monopolit elling to a continuum of heterogeneou conumer. Conumer utility q p if buying one unit of the licened product at price p q(1-a c if acquiring one unlicened copy at cot c o 0 With if not conuming the digital good. q : Conumer tate parameter uniformly ditributed on [0,1] o : quality of licened copy ( original a: factor of quality degradation due to piracy, 0 a < 1 Note: Conumer are aumed to be heterogeneou w.r.t. to degradation cot but homogeneou w.r.t. copying cot of piracy 3 Baic model of piracy (cont d Conumer acquire unlicened copy iff q(1- a - c q - p q p - c q a pc c q(1- a - c 0 q (1- a q co Piracy exit only if price i large enough: q pc q co p c 1- a Kink in the demand function for licened product 1- p - c c for D( p a 1- a p c a 1- p for p c 1- a 4 2
Baic model of piracy (cont d Suppoe piracy i attractive (low c and/or low a max p p 1- p - c a.t. p c 1- a p * 1 2 (a c c 1- a c a(1- a 1 a (a p * c2 4a Firm clearly uffer from piracy p* lower than optimal profit in a world without piracy p* decreae if copie become more attractive (c or a decreae 5 Baic model of piracy (cont d Conumer benefit from piracy o Piracy lower the price for conumer of licened copie. o Piracy provide utility to conumer of unlicened copie. Expected conumer urplu (before conumer learn hi/her q p * -c a u (q(1- a - cdq (q - p * dq c (1-a o Decreaing function of c and a Total welfare i higher under piracy improved tatic efficiency 1 p * -c a 6 3
Model of piracy: extenion What about dynamic efficiency? Intenive margin: increae in quality (Bae & Choi, 2006 o Piracy lower profit lower incentive to invet in quality improvement o Net welfare effect of decreaing piracy? Depend on how piracy i curbed. Higher degradation rate higher quality and le authorized uage. Higher reproduction cot lower quality and more authorized uage. o Intuition Higher degradation rate pivot change in demand curve Higher reproduction cot parallel hift of demand curve 7 Model of piracy: extenion (cont d Extenive margin: creation of new good (Belleflamme & Picard, 2007 o Extenion of previou etting to 2 independent digital good o Increaing return to cale in copying technology demand for the 2 good are interdependent becaue copying i a common ubtitute o Price may be trategic ubtitute Duopoly may lead to higher price than multiproduct monopoly (tatic inefficiency of competition But may lead to higher incentive to create a new good (dynamic efficiency of competition 8 4
Effect of intermediated trade Two-ided platform o Conumer acce digital good through proprietary platform o Indirect network effect: platform more attractive for buyer (eller the more it i ued by eller (buyer o Example Video game: Wii, Xbox, Playtation Digital muic: itune, Amazon, Spotify, Deezer, E-book: Kindle, ipad, How doe it impact the effect of piracy? o Ueful etting: Belleflamme & Peitz (2010 o What thi paper doe: ae how the tructure of intermediation and the homing regime affect eller incentive to innovate. o Here: adaptation to piracy in videogame market 9 Model Abtract model of trade on a platform K eller; each ell a ma 1/K of product; draw their location from a uniform ditribution (learn it after invetment deciion; private information; linear tranport cot t 0 1 Platform 1 Platform 2 Ma 1 of buyer; draw their location from a uniform ditribution (private information; linear tranport cot t b 10 5
Model (cont d Comparion between o Intermediated trade: 2 for-profit platform o Non-intermediated trade: 2 free platform (benchmark In 3 different market tructure o Both ide of the market inglehome o Seller multihome, buyer inglehome o Buyer multihome, eller inglehome Quetion o Do eller have more or le incentive to invet in anti-piracy meaure under intermediated or non-intermediated trade? o Doe the anwer depend on whether eller have the poibility to multihome or not? 11 Model (cont d Timing for intermediated trade o Stage 1: Intermediarie imultaneouly et memberhip fee on both ide of the market (for eller, fee i per product + eller and buyer learn their location (thi i private information for them Seller are ex ante identical Thi tage diappear if trade i non-intermediated. o Stage 2: Seller and buyer decide which platform( to viit o Stage 3: Seller et the price of their good imultaneouly Aumption: Seller pricing deciion are independent. o Stage 4: Buyer make purchaing deciion Aumption: (i Outide option: acquire unlicened copy or refrain from conuming; (ii Conumption of unlicened copie require uing the platform; (iii For each product traded on thi platform, a buyer at platform i ha an expected urplu u, computed from baic model above. 12 6
Model (cont d Reduced-form repreentation of buyer-eller interaction o Net gain from trade before invetment in anti-piracy meaure For buyer: u 0 For eller: p 0 o Net gain from trade after invetment For buyer: u 1 u 0 D u For eller: p 1 p 0 D p Derived from baic model of piracy preented above o In thi model: eller uffer, while conumer benefit from piracy o That i, profit increae and conumer urplu decreae when anti-piracy meaure are implemented. o D u 0 D p 13 Main reult Seller may have lower incentive to invet in anti-piracy meaure if trade i intermediated (i.e., if for-profit platform compete by charging memberhip fee. Why? o Due to for-profit intermediation, eller partly internalize decreae in conumer urplu reulting from a reduction of piracy. When? It depend on o Market tructure ( do eller or buyer have the poibility to multihome? 14 7
Two-ided inglehoming Both ide inglehome (reaonable approximation for videogame market Surplu (gro of any opportunity cot of viiting platform i o Suppoe 0 k K eller have inveted, o meaure k = k/k of product benefit from an innovation v i n i i bp 1 - M if eller ha inveted i Number of buyer n bi p 0 - M otherwie and of product on the platform i v b n i i (ku 1 (1-ku 0 - M b o Indifferent type b 12 1 2 (n 1 - n 2 (k u 1 (1-ku 0 M 2 1 b - M b 2t b 12 1 2 (n 1 b - n 2 b p 0 M 2 1 - M 2t Memberhip fee et by intermediary i and 12 1 2 (n 1 b - n 2 b p 1 M 2 1 - M 2t 15 Buyer and eller platform choice Ue two-ided inglehoming and full participation to derive the number of buyer and product on the 2 platform: i n b 1 2 (2n i -1 u (M j b - M i b 2t b n i 1 2 (2n i b -1 p (M j - M i 2t with u k u 1 (1-ku 0, p kp 1 (1-kp 0 o For given memberhip fee An additional product attract u /t additional buyer b An additional buyer attract additional product p /t o No tipping provided that network effect are not too trong: ( u /t b ( p /t 1 t b t u p 16 8
Buyer and eller platform choice (cont d Solving: n b i 1 2 u (Mj - M i t (M j b - M i b 2(t b t - u p n i 1 2 p (M j b - M i b t b (M j - M i 2(t b t - u p o On each platform, both number decreae with the platform memberhip fee on both ide! Platform i problem i i max M i i (M b,m b - C b n b (M i i - C n 17 Pricing by for-profit platform Firt-order condition in ymmetric equilibrium Value of an additional eller to the intermediary M b 1 M b 2 M b C b t b - M 1 M 2 M C t - p ( u M t - C u t b ( p M b - C b Like in Hotelling model Value of an additional buyer to the intermediary 18 9
Pricing by for-profit platform (cont d Nah equilibrium memberhip fee M * b C b t b - p and M * C t b - u Equilibrium partition: equal plit of buyer and product Equilibrium net urplue 1 2p v * 1 u - (C t 1 2p 0 u - (C t v * b 1 u 2 p - (C b t b if eller ha inveted otherwie o Increaing in the net gain of the other ide and, to a leer extent, in the net gain of the own ide 19 Seller invetment incentive Seller invet in none or all of hi product. Per product net urplu (uppoing 0 k < K eller invet If no invetment : If invetment : V (k 1 2p 0 u (k - (C t V (k 1 K 1 2p 1 u (k 1 K - (C t Incentive to innovate under intermediated trade I m V (k 1 -V (k 1 (p -p 1 (u - u K 2 1 0 K 1 0 Non-intermediated trade: each eller interact with ½ of the buyer I n 1 2 Comparion: (p -p 1 0 I m - I n 1 K (u 1 - u 0 1 K D u 20 10
Seller invetment incentive (cont d Propoition 1. In the two-ided inglehoming model, for-profit trading platform give tronger invetment incentive for eller if and only if the invetment increae the buyer urplu (i.e., if D u > 0 Intuition o If invetment increae buyer urplu, then platform charge lower fee to eller. o Thi provide an extra incentive to invet w.r.t. free platform (where thi price effect i abent. o For anti-piracy meaure, the oppoite applie a the invetment reduce the buyer urplu Lower incentive to invet in anti-piracy meaure when trade i intermediated by for-profit platform. 21 Competitive bottleneck with multihoming eller Propoition 2. In the competitive bottleneck model in which eller are on the multihoming ide, for-profit trading platform give tronger invetment incentive for eller if and only if the change of the buyer urplu i larger than the change of the eller urplu (i.e., if D u > D p Intuition o More demanding condition than if inglehoming. o Why? Platform do not compete for eller when they multihome. So, a larger p now lead to larger eller memberhip fee. With anti-piracy meaure, D u < D p and o, incentive to invet are weaker under intermediated trade. 22 11
Competitive bottleneck with multihoming buyer Propoition 3. In the competitive bottleneck model in which buyer are on the multihoming ide, for-profit trading platform give tronger invetment incentive for eller if the joint buyer and eller urplu increae (i.e., if D u +D p > 0 Intuition o Le demanding condition than if inglehoming. o Why? Platform compete here more fiercely for eller. With anti-piracy meaure, not clear 23 Competitive bottleneck (cont d Summary: higher incentive under intermediated trade if (1 buyer and eller inglehome D u 0 Intuition (2 buyer inglehome/eller multihome D u D p (3 eller inglehome/buyer multihome D u D p 0 o A the intenity of competition for eller increae, for-profit platform are more likely than open platform to provide better eller invetment incentive. o Condition become le demanding when nature of platform competition move From (2 to (1 From (1 to (3 24 12
Dicuion To which extent are thee market two-ided? o Who et the price of the media? The platform a a dealer or the producer themelve? If the market i two-ided o Do platform et memberhip or uage fee (or a combination? o Do uer have to acce the platform to conume pirated copie? o Who invet in anti-piracy meaure? Seller? Platform? Both? o Homing deciion? 25 13