Quantity vs. Quality: Exclusion by Platforms with Network Effects
Executive Summary — Many well-known platforms regulate access and transactions even though excluded users would be willing to pay the "price of admission." For example, Apple routinely excludes certain application developers from its highly popular iPhone store, and videogame console manufacturers such as Microsoft, Sony, and Nintendo restrict access to a select set of game developers. Exclusion is oftentimes a necessary strategic instrument, which allows platforms to trade off the quantity versus the "quality" of users. Andrei Hagiu's paper builds a simple strategic model that formalizes the choices of possible exclusion policies and discusses the potential gains and losses of exclusion. Key concepts include:
- This model captures the incentives that platforms (one-sided and multi-sided) have to exclude some participants who would be willing to pay the price of access.
- As soon as at least one side of the market values a quality attribute of at least one other side, the platform may find it optimal to sacrifice quantity to a certain degree in order to increase the average quality of agents on the second side.
- Platforms' incentives to exclude are determined by several key parameters: users' preferences for quality (which unambiguously increase the incentives to exclude); the proportion of high-quality users in the overall population; and the relative cost advantage of high-quality users (the last two factors have ambiguous effects on the incentives to exclude).
This paper provides a simple model of platforms with direct network effects, in which users value not just the quantity (i.e. number) of other users who join, but also their average quality in some dimension. A monopoly platform is more likely to exclude low-quality users when users place more value on average quality and less value on total quantity. With competing platforms, the effect of user preferences for quantity is reversed. Furthermore, exclusion incentives depend in a non-trivial way on the proportion of high-quality users in the overall population and on their opportunity cost of joining the platform relative to low-quality users. The net effect of these two parameters depends on whether they have a stronger impact on the gains from exclusion (higher average quality) or on its costs (lower quantity).