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When Does a Platform Create Value by Limiting Choice?

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Abstract

We present a theory for why it might be rational for a platform to limit the number of applications available on it. Our model is based on the observation that even if users prefer application variety, applications often also exhibit direct network effects. When there are direct network effects, users prefer to consume the same applications to benefit from consumption complementarities. We show that the combination of preference for variety and consumption complementarities gives rise to (i) a commons problem (users have an incentive to consume more applications than the social optimum to better satisfy their preference for variety); (ii) an equilibrium selection problem (consumption complementarities often lead to multiple equilibria); and (iii) a coordination problem (lacking perfect foresight, it is unlikely that users will end up buying the same set of applications). The analysis shows that the platform can resolve these problems by limiting the number of applications available. By limiting choice, the platform may create new equilibria (including the socially efficient allocation), destroy Pareto-dominated equilibria, and reduce the severity of the coordination problem faced by users.

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File URL: http://www.netinst.org/Casadesus-Masanell_Halaburda_10-04.pdf
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Bibliographic Info

Paper provided by NET Institute in its series Working Papers with number 10-04.

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Length: 54 pages
Date of creation: Sep 2010
Date of revision:
Handle: RePEc:net:wpaper:1004

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Web page: http://www.NETinst.org/

Related research

Keywords: platform governance; direct network effects; indirect network effects; complements; tragedy of the commons; equilibrium selection; coordination; foresight.;

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References

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  1. Jean-Charles Rochet & Jean Tirole, 2003. "Platform Competition in Two-Sided Markets," Journal of the European Economic Association, MIT Press, vol. 1(4), pages 990-1029, 06.
  2. Casadesus-Masanell, Ramon & Ruiz-Aliseda, Francisco, 2009. "Platform competition, compatibility, and social efficiency," IESE Research Papers D/798, IESE Business School.
  3. Dixit, Avinash K & Stiglitz, Joseph E, 1975. "Monopolistic Competition and Optimum Product Diversity," The Warwick Economics Research Paper Series (TWERPS) 64, University of Warwick, Department of Economics.
  4. Chou, Chien-fu & Shy, Oz, 1996. "Do consumers gain or lose when more people buy the same brand," European Journal of Political Economy, Elsevier, vol. 12(2), pages 309-330, September.
  5. Katz, Michael L & Shapiro, Carl, 1985. "Network Externalities, Competition, and Compatibility," American Economic Review, American Economic Association, vol. 75(3), pages 424-40, June.
  6. Caillaud, Bernard & Jullien, Bruno, 2003. " Chicken & Egg: Competition among Intermediation Service Providers," RAND Journal of Economics, The RAND Corporation, vol. 34(2), pages 309-28, Summer.
  7. E. Glen Weyl, 2010. "A Price Theory of Multi-sided Platforms," American Economic Review, American Economic Association, vol. 100(4), pages 1642-72, September.
  8. Church, Jeffrey & Gandal, Neil, 1992. "Network Effects, Software Provision, and Standardization," Journal of Industrial Economics, Wiley Blackwell, vol. 40(1), pages 85-103, March.
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Cited by:
  1. Claussen, Jörg & Kretschmer, Tobias & Mayrhofer, Philip, 2010. "Incentives for Quality over Time – The Case of Facebook Applications," Discussion Papers in Business Administration 12500, University of Munich, Munich School of Management.

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