Proprietary vs. Open Two-Sided Platforms and Social Efficiency
Executive Summary — The rising popularity of the open-source software movement has prompted many governments around the world to enact policies promoting open-source software systems at the expense of proprietary systems. Oftentimes, these policies seem to stem from a presumption (shared by some economists) that open software platforms are inherently more efficient than their proprietary counterparts. But is that so? This paper provides a simple model of two-sided platforms that clearly shows how this common intuition breaks down in two-sided markets. Key concepts include:
- Proprietary platforms may induce higher levels of product variety, user adoption, and total social welfare than open platforms.
- Proprietary platforms are sometimes more socially desirable than open platforms, which runs against the common intuition that open platforms are more efficient.
- Analysis of socially desirable benefits in two-sided markets follows a very different logic from that in one-sided markets, and may lead to counterintuitive conclusions. More in-depth research on the subtler aspects of platform governance in two-sided markets (cooperatives, associations, etc.) should inform both policymakers and business practitioners.
This paper identifies a fundamental economic welfare tradeoff between two-sided open platforms and two-sided proprietary (closed) platforms connecting consumers and producers. Proprietary platforms create two-sided deadweight losses through monopoly pricing but at the same time, precisely because they set prices in order to maximize profits, they partially internalize two-sided positive indirect network effects and direct competitive effects on the producer side. We show that this can sometimes make proprietary platforms more socially desirable than open platforms, which runs against the common intuition that open platforms are more efficient. By the same token, inter-platform competition may also turn out to be socially undesirable because it may prevent platforms from sufficiently internalizing indirect externalities and direct intra-platform competitive effects. Keywords: Two-Sided Markets, Platforms, Indirect Network Effects, Product Variety, Social Efficiency. 43 pages.