When apps have network effects, platforms orchestrate their markets differently
Platform Papers is a monthly blog about platform competition and Big Tech. Blogposts are written by prominent scholars based on their research. The blog is linked to platformpapers.com, an online repository that collects and organizes academic research on platform competition.
Platform owners need to manage third-party complementors to create value for customers and capture value for themselves. However, managing product categories on digital platforms can come with unique challenges not typically faced in traditional retail settings. One such challenge that has emerged on digital platforms over the past decade is the presence of products that have direct network effects. When third-party complements like social networking apps or massively multiplayer online games have direct network effects, the value they create for a user depends on the number of other users adopting and their level of engagement with the product. This creates a challenge for the platform owner because, in the presence of direct network effects, the value the products create for users and the performance the category creates for the platform owner can be very sensitive to the market structure; thus, the platform owner will want to manage such complementary products carefully.
To illustrate this challenge, consider a product category on a digital platform with products that do not have meaningful network effects. For instance, these could be single-player games that could be played also offline. In such a category, the platform owner will be agnostic as to the category’s market structure if users find the products that they want, the costs of offering those products through the platform are negligible, and no complementor has excessive bargaining power. Under such conditions, a category with 100 users each adopting a separate product could produce as much value for users and for the platform as a category with 100 users all adopting the same product.
Now consider a category on a digital platform for which products have meaningful direct network effects. For instance, this could be a category of massively multiplayer games. When the category has a low concentration of adopters, each product may fail to build enough installed base to create value for its users. You do not gain much value from a multiplayer game that lacks other players. Therefore, in the presence of product-level direct network effects, the platform owner does not want the share of users to be too diffuse across products because no product will have enough installed base to create sufficient value for users.
High concentration can also create problems for the platform owner because the market could tip towards a dominant complementor who may stymie innovation in the category or challenge the platform owner’s rules. Unlike the product without direct network effects, a large installed base in the presence of direct network effects becomes a strong competitive advantage that can deter competition and enhance the bargaining power of the complementor. Complementors may even begin to challenge the platform owner’s rules, as in the case of Epic’s lawsuit against Apple.
In a recent paper published in the Strategic Management Journal, we examine how Apple manages game developers with direct network effects in the App Store. We find that in the presence of direct network effects, value creation in a product category is indeed sensitive to the category’s revenue concentration. Specifically, when category concentration is low, user satisfaction falls as demonstrated by significantly lower app ratings, but as the category becomes more concentrated, new product innovation and entry of new developers declines and user growth stalls. Successfully managing the categories means balancing these sets of tradeoffs.
How Apple manages product categories in the presence of direct network effects
One way in which Apple manages product categories is through the selective promotion of apps via the Editors’ Choice Awards. These awards, which Apple uses sparingly (only 0.04% of games in our sample receive the award), are typically given shortly after an app’s launch and are highly sought after by developers because they are associated with a significant increase in adoption.
Using awards makes an app more visible and enticing and allows Apple to nudge users towards the app and help it build a user base. The returns to such awards are higher for games with direct network effects as the initial boost can create a virtuous cycle that drives adoption and growth, which is why we find Apple is more likely to award a game with direct network effects than those without. Apple also pays attention to the developer’s track record, favoring those with strong prior performance. No use stoking network effects if the developer lacks the means to grow the installed base.
Apple pays attention to the market structure of the category and appears to strive for balance. Apple is more likely to award a game with direct network effects when the category’s concentration is low. Pushing users to the same game(s) builds the installed base and creates value for players. When the category becomes concentrated, Apple uses awards to curtail the dominance of the leading developer(s). We find that Apple is significantly less likely to award a dominant developer in a concentrated category, in fact, Apple is more likely to award a challenger’s new game. In essence, Apple strives for a “Goldilocks” market structure—not too diffuse but not too concentrated. For Apple, the “porridge is just right” when multiplayer games have enough players to create high utility but enough competition among them to provide enough choice for players and keep complementor power in check.
Managerial and policy implications
Our research provides a novel perspective on how platform owners manage complementor products when these products have their own network effects. In the presence of network effects, it can be difficult to strike a balance between sufficient adoption and a market that tips toward a winner-take-all scenario. When given rarely and early in the product’s life cycle, using awards or other selective promotions can be an effective mechanism to shepherd users to products so to achieve the platform owner’s preferred market structure. This departs from their traditional use as a means of highlighting the best products or awarding good performance.
While such tactics may create value for users, micromanaging market structure can draw the ire of regulators and policymakers, especially when the platform owner is viewed as undermining successful complementors. However, using soft nudges like awards may be viewed with less skepticism than other, more draconian measures that overtly limit the performance of a dominant complementor. Importantly, our work highlights the difference between networked products and non-networked products. Regulators need to appreciate these differences when assessing the effect of platform owner tactics on consumer welfare.
Agarwal, S., Miller, C. D., & Ganco, M. (2023). Growing platforms within platforms: How platforms manage the adoption of complementor products in the presence of network effects? Strategic Management Journal, 44(8), 1879-1910.
Today’s blog has several touchpoints with prior Platform Paper blogs. For example, for an excellent overview of how platforms can orchestrate their ecosystems through effective governance, see this blog by Melissa Schilling. Or, see last month’s blog by Chiara Farronato on when winner-take-all dynamics are and aren’t likely to occur in platform markets (bonus: it features dogs!). Finally, for further discussion on network effects and freemium online multiplayer games, see one of my earlier blogs.
Moreover, several interesting papers have been added to the Platform Papers references dashboard this month. Here are a couple of highlights:
Platforms have various tools in their toolkit when it comes to managing their ecosystems (including badges and awards as illustrated by today’s blog). Besides setting prices on both sides of the market, platforms can make investments in a platform’s standalone value, add social features to take advantage of same-side network effects, or develop integration tools and boundary resources to facilitate third-party content creation. In a paper published in the Journal of Management Information Systems, Edward Anderson, Geoff Parker and Burcu Tan develop a simulation model exploring which of these tools platforms should focus on at different points in their life cycle. While pricing is something platforms must constantly tweak, the importance of the other tools varies over time. Their importance also differ with the platform’s monetization model (who’s getting charged, who’s being subsidized and to what extent). The authors tweak the model for different types of platforms; mobile platforms, social media, the sharing economy, and business-to-business platforms.
There’s plenty of evidence regarding digital platforms’ disruptive forces on traditional industries. Empirical studies have mostly looked at the cross-elasticities between ridesharing platforms and taxi’s and between Airbnb and hotels (consistently finding that such cross-elasticities exist). A recent paper published in Marketing Science adds to the body of evidence by studying the effects of market entry by for-sale-by-owner platforms (e.g. people selling their own homes online) on real estate agents’ listing prices. The author, Qiyuan Wang, finds that the introduction of a Chinese FSBO platform leads to a 2.8% decrease in listing prices, a percentage comparable to the commission rate typically
charged by agents. Moreover, the impact of reduced listing prices charged by the vendors extends to the final sales price of the properties.
That’s all for now. See you next month!
Platform Papers is curated and maintained by Joost Rietveld.