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 / Fall 2003 / Issue 32(originally published by Booz & Company)


Managing the Maze of Multisided Markets

Both Sides on Board
Frank McNamara faced the classic chicken-and-egg problem that keeps every platform wannabe up at night. Diners Club needed cardholders to get merchants to sign up. Meanwhile, consumers were reluctant to carry the card unless a lot of merchants accepted it. Mr. McNamara and his partners started small, giving the card away to a few hundred residents of Manhattan (hoping they were hungry). Sometimes cards were simply stuck under apartment doors. Then they went from restaurant to restaurant, asking for 7 percent of the check if people paid with the card. Initially, just 14 eateries signed up.

But mighty oaks from little acorns do sometimes grow: By its first anniversary in 1951, Diners Club had about 300 merchants and 40,000 cardholders in the fold. Little more than a decade later, Diners Club could boast 1.5 million cardholders and 150,000 establishments accepting their plastic. Mr. McNamara may not have become the Bill Gates of credit cards, but he accomplished something that would have made investors in many a high-tech startup envious: Diners Club was profitable from its first year. Starting small in platform markets and scaling up sometimes has advantages.

When American Express decided to break into the business in 1958, it didn’t have the luxury of ramping up slowly. So it built both sides of the platform by piecing together some small existing card programs, such as one operated by Gourmet magazine. American Express subsequently followed a “marquee” strategy for getting both sides engaged, that is, sign up highly valued customers on each side to attract more on the other. From the merchant’s perspective, marquee customers included free-spending business travelers not inclined to comparison shop. From the cardholder’s perspective, it meant high-end stores whose presence in the network conferred status on the big spender.

Malls, which are the sort of platforms that make it cheaper and easier to bring together stores and shoppers, often follow a marquee strategy, too. They lure “anchors,” for example, a department store with cachet such as Saks Fifth Avenue or Nordstrom, to attract other stores, as well as a critical mass of shoppers.

Attracting complementary participants to a multisided market and keeping them there requires the right pricing structure as well as the right price levels. Pity the managers of the B2B e-commerce pioneers who thought all they had to do was turn on the switch and watch their Web sites hum with transactions. Or the mobile phone network operators, who invested tens of billions of dollars in spectrum for enhanced services such as streaming video without making sure that they could provide the right price incentives to get both content providers and subscribers on board.

To see how complex and unintuitive optimal pricing in a platform business can be, imagine creating a mobile phone platform that you hope to scale up by offering third-generation (3G) broadband content to subscribers. Should you price low to lure phone subscribers and rely more on the revenue from charging the content providers for access to your millions of customers? Should you charge the subscribers and give the content providers an easy ride? Or should you do something in between?

Traditional market research, which predicts prospective customers’ reaction to varying price points, won’t help much because demand by multiple groups of platform customers is interdependent. You thus have to figure out how much each side values the other, then calculate the prices that will make sure that both sides show up in the right numbers — and, of course, make sure the revenues will still be adequate to generate a profit.

Although pricing is important, it is only one element in the design and implementation of a platform strategy. Apple Computer Inc., for example, lost its commanding lead in user-friendly computer operating systems because it picked the wrong platform model. The company sold its computers and its operating system as a package, making the platform available to software developers and computer users. Bill Gates was one of those developers. Indeed, Microsoft was the largest supplier of applications software for Apple computers in the mid-1980s. Long before the company focused its attention on building the Windows platform, Mr. Gates realized that he could sell more Apple applications if Apple sold more operating systems. Hence, he wrote Steve Jobs a now-famous letter, in effect advising him to move from a two-sided to a three-sided platform model by licensing the operating system to independent vendors eager to make Macintosh clones.

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