22 Mar 2011  Working Papers

Platform Competition under Asymmetric Information

Executive Summary — Research by Hanna Halaburda (Harvard Business School) and Yaron Yehezkel (Tel Aviv University) shows how pricing, profits, and market efficiency are affected in two-sided markets, such as with smartphone and video game platforms, when users and developers do not know the utility or costs associated with the platform until they join. Key concepts include:

  • Under competition, asymmetric information-where one party has more or better information than the other-may lead to a downward distortion of trade, even market failure, while under monopoly full efficiency is achieved.
  • The combination of the informational problem and the presence of competition creates the market inefficiency.
  • A third main result concerns multi-homing, the ability for a developer to create applications for multiple platforms. The incumbent platform earns higher profit under multi-homing, and multi-homing eliminates the incumbent's need to distort the quantity downward.
  • The model underscores why it is usually entrants, not incumbents, that bring major technological innovations to the market. Entrants are more likely to adopt a new, highly risky technology given the information problem.

 

Author Abstract

In the context of platform competition in a two-sided market, we study how uncertainty and asymmetric information concerning the success of a new technology affects the strategies of the platforms and the market outcome. We find that the incumbent dominates the market by setting the welfare-maximizing quantity when the difference in the degree of asymmetric information between buyers and sellers is significant. However, if this difference is below a certain threshold, then even the incumbent platform will distort its quantity downward. Since a monopoly incumbent would set the welfare-maximizing quantity, this result indicates that platform competition may lead in a market failure: competition results in a lower quantity and lower welfare than a monopoly. We consider two applications of the model. First, the model provides a compelling argument why it is usually entrants, not incumbents, that bring major technological innovations to the market. Second, we consider multi-homing. We find that the incumbent dominates the market and earns higher profit under multi-homing than under single-homing. Multi-homing solves the market failure resulting from asymmetric information in that the incumbent can motivate the two sides to trade for the first-best quantity even if the difference in the degree of asymmetric information between the two sides is narrow.

Paper Information