Metcalfe's Law: the number of connections on a network increases proportional to the square of the number of users $$connections=\frac{n(n-1)}{2}$$

• $n=2⟹1$ connection
• $n=5⟹10$ connections
• $n=12⟹66$ connections

As $\underset{n\to \infty }{lim}\text{connections}=n^2$

Often a battle of standards

A Coordination Game

• Two Nash equilibria (A, A) and (B, B)
• Either just as good
• Coordination is most important

Path Dependence: early choices may affect later ability to choose or switch

Lock-in: the switching cost of moving from one equilibrium to another becomes prohibitive

Suppose we are currently in equilibrium (B, B)

Inefficient lock-in:

• Standard A is superior to B
• But too costly to switch from B to A

“First-degree” path dependency:

• Sensitivity to initial conditions
• But no inefficiency

Examples:

• language
• driving on left vs. right side of road

“Second-degree” path dependency:

• Sensitivity to initial conditions
• Imperfect information at time of choice
• Outcomes are regrettable ex post

Not inefficient: no better decision could have been made at the time

“Third-degree” path dependency:

• Sensitivity to initial conditions
• Worse choice made (A, A)
• Avoidable mistake at the time

Inefficient lock-in (A, A)

In the long-run, suppose, Technology B is superior

But in the short-run, Technology A has higher payoffs

Choosing A leads to inefficient lock-in

But what about uncertainty?

• What set of institutions will choose best under uncertainty?

Role for entrepreneurial judgment and “championing” a standard

• Someone who “owns” a standard has strong incentive to ensure it becomes widely adopted

Champions who forecast higher long-term payoffs can subsidize adoption in the short run

A multi-sided market or a “platform” is a managed marketplace where an intermediary matches together two different groups of users to exchange

• Platform itself is often a business, helping to match users together across groups for a fee

Simple example: newspapers

• Group A: readers
• Group B: advertisers

Linear business model: serve one segment of the market

• direct to consumers or business (next-stage of supply chain)

Owns one side of the transaction

Products have an inherent value

Compete in one dimension: on cost via economies of scale

Platform business model: facilitate transactions between multiple groups

• “be the market”

Owns infrastructure that adds value to both sides of the transaction

• on cost via economies of scale (high entry barriers)
• on customers via network effect
• may also provide features to either/both groups

Competition between platforms is often "winner-take-all"

Large initial costs and low initial value

Increasing value due to network effect

High barriers to entry to compete with existing platform

• trust, history, reputation, volume, size of network

Investigate Amazon's business practices

Break apart Amazon's brand (Amazonbasics) from Amazon's marketplace platform

Is Amazon subsidizing its brand from AWS revenues?

Consumers don't pay to search Google - enormous consumer welfare

• Google collects a lot of tracking information & data for advertisers

Google holds auctions to marketers to place advertisements on its results

Could Google be using its dominant market position to raise ad prices?

Google and Apple app stores are dominant platforms

• Apple & Google do not charge the consumer anything for using the stores
• App developers set prices to consumers, Google & Apple take percentage of developers' sales

"Walled gardens" where users are locked-into Android or Apple ecosystem

What is important in antitrust law?

• Protecting consumers? Protecting (some) businesses?
• Maximizing total economic surplus (Consumer surplus + producer surplus)?

What does market power look like/do?

• High prices, low output, low quality, few choice?