COMPETITION POLICY

IN TWO-SIDED MARKETS

Jean-Charles Rochet
(IDEI, Toulouse University)
and
Jean Tirole
(IDEI and MIT)
Prepared for the conference “Advances in the Economics
of Competition Law”, Rome, June 23-25, 2005 1
 1. INTRODUCTION

Examples of two-sided markets:

PLATFORM

BUYERS SELLERS

gamers videogame platform game developers

users operating system application developers
“eyeballs” portals, newspapers, TV advertizers
cardholders debit & credit cards merchants

Chicken and egg problem. Must get both sides on board/court each
side while making money overall. 2
Two-sided markets raise new questions:

 Price structure: receives attention from

managers:

impact of elasticities and externalities,

impact of platform competition,

impact of multi-homing (examples: payment cards, software,
real estate,…).

public policymakers (termination charges, IFs):

antitrust implications (legitimacy of cross-subsidies,
impact of tying,…).

3
OUTLINE OF THE PRESENTATION

1. INTRODUCTION

2. GENERAL PRINCIPLES OF TWO-SIDED MARKETS

2.1 Membership and usage
2.2 The choice of a business model
2.3 Regulation of interactions between end-users
2.4 Platforms’ competitive strategies.

3. AN ILLUSTRATION: THE PAYMENT CARD INDUSTRY

3.1 Some recent anti-trust cases
3.2 The role of Interchange Fees
3.3 Merchant acceptance under single-homing
3.4 Impact of multi-homing
3.5 Tying
4
4. CONCLUSION: ANTI-TRUST ASPECTS
2. GENERAL PRINCIPLES
2.1 Membership and usage

Two sides of the market: i ∈ {B, S}.

pB pS

5
2.2 The choice of a business model:

(1) Charge according to what each side can bear

Account for elasticities of demand on both sides: price structure should
aim at getting both sides on board, not to allocate costs "fairly".

Illustration : why did credit cards and debit cards adopt so markedly
different business models?

• Credit (Visa, MasterCard, Amex): high merchant discount, low

(negative) cardholder price.
• On-line debit: low merchant discount.

6

Other examples of asymmetric price structures:

7
* based on downloaded volume.
 OTHERS…

Social gatherings celebrities in social happenings, other participants

Conferences, academic speakers, professors audience

journals, universities

Shopping malls consumers (free parking, cheap gas,…) shops

(Legacy) Internet websites dial-up consumers

Real estate buyers sellers

LOOKING AHEAD: KEEP POSTED ON

Platform Two sides Instruments of cost allocation or cross-

subsidization

B2B buyers / sellers design of auctions, information flows,…

Internet backbone services consumers / websites termination (settlement) charges

8
2.3 Regulation of interactions between end-users

 Useful benchmark: the vertical view

Contrast two-sided market: platform has relationship with buyer;

hence, more protective of buyers' interests, less protective of
sellers' interests.

 Key difference: P willing to constrain S, as P can (partly) recoup

benefits on B side. Hence, P regulates interactions
whereas it would grant S commercial freedom
9
under the vertical view.
2.4 Platforms’ competitive strategies

(1) Key new factor: multi-homing.

Suppose for example that buyers single-home while sellers multi-home

Charge monopoly prices in multi-homing market and low prices (zero?) in

single-homing one.

Illustration #1: advertizers multi-home. Eyeballs don't (and even if they

do, rehearsal effect) 10
Illustration #2: Steering: the story of the decrease in merchant discounts

Platform 1

Platform 2

Cardholder Merchant

Merchant has "first-veto right" platforms court merchants

much more than under
cardholder single-homing
11
Price structure is now too favorable to merchants.
3. AN EXAMPLE: THE PAYMENT CARD
INDUSTRY
3.1 Recent antitrust cases

 Wal-Mart (1996-2003, USA)

 Interchange Fees 1 (2001, EU)

 Interchange Fees 2 (2003, Australia)

 Interchange Fees 3 (2001-2005, UK)

And many others…

12
THE WAL-MART CASE:

 Oct. 1996: Wal-Mart and other US retailers sued

VISA and MasterCard (violation of antitrust law)
HAC rule “tied” credit cards with off-line debit
cards, which charged a higher merchant discount
than ATM (on-line debit) cards.
Lawsuit certified as a class action with > 5 million
merchants. Damages evaluated over $7 billion.

 June 2003: VISA and MasterCard settled for over

$3 billion, and accepted to abandon HAC.

13
3.2 The role of Interchange Fees

cost cB cost cS
p−a
Issuer Acquirer

p + pB p + pS

Customer Merchant
sells good at price p
B
benefit b benefit bS

(costs and benefits are net i.e. w.r.t. a cash payment) 14

Consider a given type of merchants ( b S fixed) and focus
on consumer’s choice of payment mode.
Social welfare maximized if:
card payment ⇔ bB + bS ≥ c B + cS = c
or b B ≥ c B + c S − b S .

Competition on downstream markets leads to:

B B B
p =c +m
B B B
⇒ inefficient usage: b ≥c +m .
Efficiency restored with appropriate interchange fee

a* = b S − c S + m B ⇒ p B = c B − a + m B
B B B S S
customer uses card ⇔ b ≥ p = c +c −b . 15
3.3 Merchant acceptance under single-homing

If consumers have (at most) one card in their wallet,

merchant accepts card if and only if:

S S average perceived convenience

p ≤ b + benefit of cardholder

merchant
direct strategic
discount
benefit benefit
of merchant of merchant
(denoted v B )

16
Suppose that association sets the maximum interchange fee (IF)
that is compatible with merchant acceptance:
p S = c S + a SH + m S = b S + v B
SH S S S B
⇒ a = (b − c ) − m + v .

Social welfare is maximum for:

a* = (b S − c S ) + m B
SH B B S
a* < a ⇔ m <v −m .

17
 1st case: Cardholders single-home, low variable markups
Network’s choice leads to an interchange fee that exceeds
the socially optimal level:

Social welfare

Interchange
SH
a* a fee a

18
2nd case: Cardholders single-home, high variable markups
Association’s choice leads to constrained optimal provision of card
payments:

Social welfare

Interchange
SH
a a * −c +π
a* = b S
fee a
(equilibrium)

19
3.4 Cardholders multi-home

In this case merchants accept only the card that maximizes

their net total surplus (including their strategic benefit)

MH S S
⇒ a < b −c ≤ a*
(don’t internalize the banks’ variable profit)

⇒ Interchange fees are too low.

20
3.5 TYING
Extend our model:

 two types of cards: k = d (debit), k = c (credit)

 two kinds of networks: i = 1 (ATM) offers only d; i = 2 (VISA/

MasterCard) offers both d and c.
Single-homing for credit, multi-homing for debit.

Cardholders credit
VISA / (credit)
MasterCard Merchants
Cardholders
off-line debit (debit)

Cardholders
ATM Network
on-line debit 21
Without tying:

 Too-low IFs for debit (cardholders multi-home).

 Too high IFs for credit (cardholders single-home).

With tying:

 Fee for online debit unchanged.

 Higher fee for off-line debit, lower fee for

credit.

[Maximize volume under constraint that merchants

accept “bundle”]

⇒ May increase social welfare. 22

4. CONCLUSION: ANTI-TRUST ASPECTS

Need to renew anti-trust analysis for two-sided markets:

 high price-cost margin on one side does not imply

market power (even with low fixed costs).

 Conversely price below cost on one side does not

imply predatory behavior.

 Merger on one side increases competition on

other side.

 Tying has rebalancing benefits.

23