Quantity vs. Quality and Exclusion by Two-Sided Platforms
Executive Summary — It is common for two-sided platforms to deny participation to some potential customers, who would otherwise be willing to pay the platforms' access and/or transaction fees. Videogame console manufacturers such as Microsoft, Sony, and Nintendo, for example, restrict access to a select set of game developers and exclude many others by including security chips in their consoles, even though the latter would also be willing to pay the per-game royalties levied by the manufacturers. Apple routinely excludes certain application developers from its highly popular iPhone store. Professor Andrei Hagiu builds a simple model formalizing profit-maximizing two-sided platforms' choice of exclusion policies, which is fundamentally determined by a tradeoff between quality and quantity. Key concepts include:
- A simple model captures the incentives that two-sided platforms have to exclude some participants who would be willing to pay the platform's access fees. Platforms' exclusion incentives are fundamentally determined by a tradeoff between quality and quantity.
This paper provides a simple model of two-sided platforms, in which one side (W) values not just the quantity (i.e. number) of users on the other side (M), but also their average quality in some dimension. In this context, platforms might find it profitable to exclude low-quality users on side M, even though some would be willing to pay the platform access prices. Platforms are more likely to engage in exclusion of low-quality M users when W users place more value on the average quality and less value on the total quantity on side M. Exclusion incentives also depend on the proportion of high-quality users in the overall M population and on their cost advantage in joining the platform, relative to low-quality M users. The net effect of these two factors is ambiguous: it generally depends on whether they have a stronger impact on the gains from exclusion (higher average quality) or on its costs (lower quantity). Keywords: two-sided platforms, exclusion, quality and quantity, indirect network effects. JEL classifications: L1, L2, L8. 27 pages.