Sample frameDay 311·Product · Platform

Good morning. Two groups have to show up before either one is worth anything. Only one of them should be paying you.

Product.

Which Side to Subsidise

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The question

If you run anything that needs two groups to turn up before either of them gets any value — buyers and sellers, readers and writers, players and developers — can you name which of the two you're deliberately underpricing, say what the other side is paying extra for the privilege of reaching them, and tell me whether either of those numbers was ever a decision rather than something you inherited from whichever side signed up first?

The idea

Thomas Eisenmann, then an associate professor at Harvard Business School, wrote 'Strategies for Two-Sided Markets' with Geoffrey Parker of Tulane University's A. B. Freeman School of Business and Marshall Van Alstyne of Boston University's School of Management; Harvard Business Review published it in October 2006. The vocabulary is what you're here for. A platform serving two groups has a subsidy side, priced below what that group would bear on its own, and a money side, paying above the odds for access to the crowd the subsidy bought. Adobe is their clean case. Readers pay nothing for Acrobat Reader; the document producers who prize that audience paid $299. Reverse it, they argue, and the network collapses: free software wouldn't multiply the writers, and readers would never pay much to reach more of them. Note what this isn't. Day 69 tells you why a network is a moat once you have one; Day 46 tells you to price a share of what the buyer gets, and on a platform that instruction eats itself, because what each side is buying is the other side. Filling both sides is a launch problem; which one pays is a structural one, settled before you open. Three things settle which way round it goes: which group is more price-sensitive, which group has to supply the quality rather than merely demand it, and what a crowded side does to the people already standing on it.

The framework

01
Name the two sides, then say which one you're underpricing.
A platform prices one group below what that group would bear on its own, and charges the other above it — Eisenmann, Parker and Van Alstyne call these the subsidy side and the money side, and the whole design turns on getting them the right way round. Start with the cheap half of the test: price sensitivity. Which group walks away at a small fee, and which one would pay handsomely for access to a crowd of the first? The answer is usually obvious the moment it's asked out loud, and it usually hasn't been asked. Most platforms inherit their pricing from whichever side turned up first.
02
The side that has to supply the quality is the side that pays.
This is the counterintuitive one, and the article's own example carries it. Sony and Microsoft have historically priced game consoles at or below cost and taken a royalty from developers of as much as twenty per cent of a game's retail price — because developers carry enormous fixed costs before a single copy sells, and they'll only carry them where the installed base is big enough to amortise them. The PC industry runs the identical shape backwards: end users are the money side, paying above cost for the operating system, while application developers pay no royalty and get the development tools free. Same two groups. Opposite decision.
03
What does a crowded side do to the people already on it?
Day 69 covered the effect that runs across the two sides. The one that prices this decision is the same-side effect: it runs inside a single group, and it's often negative — sellers don't want more sellers. Covisint, the business-to-business exchange the car manufacturers organised, stalled partly because parts makers, worried about downward pricing pressure, simply refused to join it. Where a same-side effect is strongly negative, the authors suggest granting exclusive rights in a transaction category and charging a high rent for the concession — then policing what the winner does with that position, because a monopolist on one side drives the other side out.
04
A giveaway with a unit cost, and a giveaway that leaks.
Two things kill more subsidies than a wrong choice of side. The first is output cost: a free digital good costs you nothing per extra user, and a free physical one doesn't. FreePC gave away computers and internet access in 1999 to consumers who agreed to watch ads they couldn't minimise or hide, found that advertisers weren't keen on the most cost-conscious buyers in the country, and abandoned the offer having lost eighty million dollars. The second is leakage. Netscape subsidised its browser in order to sell web servers, and the site operators it delivered bought their servers from somebody else.

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