Many Internet intermediaries operate two-sided networks, that is, they provide platforms to bring together two types of participants, or "sides," such as buyers and sellers. This paper develops a model that characterizes the intermediary's pricing in two-sided networks, the value created by these networks, and the allocation of that value across the two sides. It extends the two-sided networks literature by endogenizing the level of network effects as the result of relevant investments by the intermediary, which determine the design of the network. It shows that under certain assumptions about the available technologies, the design of the two-sided network is highly asymmetric independent of its ownership structure. The paper provides insight into design strategies for Internet platforms, and it discusses their welfare implications.
This paper analyzes the impact of e-commerce on markets where established firms face competition from Internet-based entrants with focused offerings. In particular, we study the retail brokerage sector where the growth of online brokerages and the availability of alternate sources of information and research services have challenged the dominance of traditional brokerages. We develop a stylized game-theoretic model to analyze the impact of competition between an incumbent full-service brokerage firm with a bundled offering of research services and trade execution and an online entrant offering just trade execution. We find that as consumers' willingness to pay for research declines, the incumbent finds it optimal to unbundle its offering when competing with the online entrant. We also find that the online entrant chooses a lower quality of trade execution when faced with direct competition from the incumbent's unbundled offering. The analytical model motivates a unique field experiment placing actual simultaneous trades with traditional full-service and online brokers, to compare order handling practices and the quality of trade execution. In keeping with our analytical results, our empirical findings show a significant difference in the quality of execution between online brokerages and their full-service counterparts. We discuss the relevance of our findings for quality differentiation, price convergence, and profit decline in a variety of markets where traditional incumbents are faced with changes in the competitive landscape as a result of e-commerce.