03 Jun 2010  Working Papers

Platforms and Limits to Network Effects

Executive Summary — Why do platforms that restrict choice and charge higher prices seem to prosper alongside platforms offering cheap or free unlimited choice? In the online dating market, for example, eHarmony deliberately limits the number of candidates available to its customers. Headhunters show only a few candidates to the companies, and even fewer companies to the candidates. In the housing market, brokers limit the number of houses they show to potential buyers and sellers. In this paper, HBS professors Hanna Halaburda and Mikolaj Jan Piskorski challenge conventional understanding of platform competition and network effects by describing a two-sided matching environment and studying the indirect network effects in this environment. They show that the interplay between more choice and more competition influences the strength of network effects and attractiveness of a platform. Some agents may opt for a platform with few choices to avoid higher levels of competition. The researchers' model helps explain why platforms that limit their choice set coexist (and thrive) alongside platforms that offer greater choice. Key concepts include:

  • Excessive increases in the number of candidates decrease agents' expected payoffs, due to increased competition.
  • Some agents rationally opt for platforms that constrain choice even if they do not receive any additional service from such platforms, to avoid higher levels of competition.
  • The strength of network effects depends on the type of the agent and on the number of available candidates on both sides of the market.
  • A platform could use these factors to its advantage by offering fewer candidates to its members on both sides of the market. Agents may be willing to pay for participation in such a platform (and hence rationally decide to limit their choices) because they would face less competition.

 

Author Abstract

We model conditions under which agents in two-sided matching markets would rationally prefer a platform limiting choice. We show that platforms that offer a limited set of matching candidates are attractive by reducing the competition among agents on the same side of the market. An agent who sees fewer candidates knows that these candidates also see fewer potential matches, and so are more likely to accept the match. As agents on both sides have access to more candidates, initially positive indirect network effects decrease in strength, reach their limit and eventually turn negative. The limit to network effects is different for different types of agents. For agents with low outside option the limit to network effects is reached relatively quickly, and those agents choose the platform with restricted number of candidates. This is because those agents value the higher rate of acceptance more than access to more candidates. Agents with higher outside option choose the market with larger number of candidates. The model helps explain why platforms offering restricted number of candidates coexist alongside those offering larger number of candidates, even though the existing literature on network effects suggests that the latter should always dominate the former. Keywords: matching platform, indirect network effects, limits to network effects. 43 pages.

Paper Information