Hanna Halaburda, Mikolaj Jan Piskorski, Jul 27, 2010
Existing economic wisdom offers unequivocal advice to managers seeking to establish new platform businesses: Invest to acquire users as quickly as possible and make sure that they have unrestricted access to each other. Since the value of participating in a platform often depends on the number of choices offered, a platform offering unrestricted access should quickly displace a platform that restricts choice. After all, Facebook would not stay around for very long if it amassed a large number of users, but would then only let them interact with a small number of others. It would be equally counterproductive for a game console to build a large user base, and ensure that a large selection of games exists, only to announce that every user can choose at most five games. In both cases, a less restrictive platform would quickly eclipse the one limiting choice.
However, in some markets we observe that unrestricted-choice platforms do not win over restricted-choice ones. If anything, platforms restricting choice perform better in that they are able to charge higher prices than the unrestricted-choice platforms. This is very salient, for example, in the on-line dating market, where most sites give its members unrestricted access to all members. However, some sites, such as eHarmony, give its members no more than 7 potential dating candidates at a time. And despite offering limited choice, eHarmony charges up to a 25 percent premium over its closest competitor, Match.
Similarly, labor markets feature platforms, such as Monster, that offer unrestricted access to everyone. However, these platforms have not eliminated headhunting firms. The later offer very few candidates to firms, and expose candidates to only a limited number of firms, and yet charge more than the unrestricted-choice platforms do. Finally, in the housing market, buyers and sellers have the choice of using the For Sale By Owner database (“FSBO”) or broker’s services. Even though FSBO could give people broader exposure to everyone on the platform, it has not displaced brokers, who show only a few houses to a buyer, and expose every house to a limited number of clients. Academic studies have shown that broker-mediated transactions and FSBO transactions result in similar house sale prices. Given that brokers do not generate higher sale prices, but charge a 6 percent commission, they are the more expensive market option.
These examples present a puzzle for us to solve: How can some platforms offer less choice and yet charge more to participate?
This article is a summary of a current working paper by the authors. This is a link to the full working paper.