How Two-Sided Platforms Set Prices to Succeed
Cross-Side Network Effects
Hello everyone! Today I want to talk about something really important in today's business world - two-sided platforms and how they decide their prices.
Garvit Sahdev enjoys understanding the ideas that shape our world. The Thoughtful Tangle is an initiative to share this journey and experience with friends who love to do the same. He selects one idea and dives deep into it to understand its basics, relevance, impact, and opportunities around it.
What exactly is a two-sided platform? Simply put, it's a business that brings together two different groups of users who need each other. Let me give you some examples from India:
Zomato/Swiggy: These companies connect hungry customers with local restaurants across India.
Paytm: This payment platform connects shoppers with merchants who accept digital payments.
UrbanClap (Urban Company): This service connects people needing home services with local professionals like plumbers, beauticians, and electricians.
These platforms are everywhere in our lives now! But here's the thing - how these platforms set their prices can make or break their success. Get it wrong, and the whole business can fall apart. Get it right, and they can take over entire markets.
The Unique Pricing Challenge
Normal businesses have it relatively easy when it comes to pricing. They figure out how much it costs to make something, add a profit margin, and that's their price. They can easily test different prices to see what works best.
But platform businesses? They face a much trickier situation. They need to answer four really important questions:
How sensitive is each side to price changes?
How much does adding users on one side increase the value for users on the other side?
How should the total price be split between the two sides?
Should they charge upfront fees, usage fees, or both?
Unlike regular businesses, platforms can't just run simple A/B tests on pricing. Why? Because changing the price for one group affects how many people from that group join the platform, which then affects how valuable the platform is for the other group!
Cross-Side Network Effects
This brings us to something called "cross-side network effects." This fancy term simply means that what happens on one side of the platform directly affects the other side.
Let me explain with an example:
Imagine Zomato decides to charge restaurants higher commission fees. Some smaller restaurants might leave the platform because it's too expensive. When restaurants leave, customers have fewer food options to order from. When customers have fewer options, the platform becomes less useful to them. Some customers might switch to other food delivery apps. With fewer customers, the platform becomes even less valuable to the remaining restaurants. Some more restaurants might leave... and you can see how this negative cycle continues!
This is called a feedback loop. A small price change can create a big ripple effect that goes back and forth between the two sides of the platform.
Because of this, platforms often focus on getting as many users as possible, rather than making the most profit from each user. They might even decide to offer the service for free (or nearly free) to one side to attract more users, which makes the platform more valuable to the other side.
For example, Ola and Uber initially offered very low prices to riders and incentives to drivers to build up both sides of their platforms across Indian cities. RuPay (India's domestic card network) charges merchants lower fees than international card networks to encourage wider adoption by both shoppers and stores.
Conclusion
Setting the right prices for a two-sided platform is like walking on a tightrope. Charge too much on one side, and you might lose users, making the platform less valuable for everyone. Charge too little, and you might not make enough money to keep the business going.
The most successful platforms understand that balanced pricing is not just about making money - it's about creating and maintaining a healthy ecosystem where both sides benefit from participating.
In my next blog, I'll dive deeper into some specific pricing strategies that successful platforms use to maintain this delicate balance. We'll look at concepts like subsidizing one side, using different fee structures, and how platforms can change their pricing as they grow.
Thank you for reading! I hope this helps you understand the fascinating world of platform businesses a little better.
Thanks for reading The Thoughtful Tangle! Subscribe to continue reading deeply researched stories about the interesting concepts that shape our world. ❤️