Insulated Platform Competition

Abstract

Does competition promote efficient platform pricing and market structures? We model imperfect platform competition using a new approach, Insulated Equilibrium (IE). Building on the observation that platforms often charge low prices to build a "critical mass", IE assumes platforms use "penetration pricing" to simplify the role of user beliefs. We show that competition’s impact on efficiency depends crucially on heterogeneity in users' valuations for network effects. The standard Flat Pricing approach (FP) cannot tractably incorporate such heterogeneity. We show that IE's sharp, general predictions are economically similar to FP's, when FP is tractable, and we show how the nature of product differentiation determines the welfare consequences of competition in calibrated models of the video game and newspaper industries.

The appendices for this paper are available at the following URL: http://ssrn.com/abstract=2601836.

Keywords: platform competition, insulating tariffs, Spence distortion, user coordination, penetration pricing, excessive entry

JEL Classification: D21, D43, D85, L13