Exploring the Trade-offs between Functionality-rich Versus
Minimalist Design: A Two-sided Market Analysis
Soumya Sen
Dept. of Electrical & Systems Engineering
University of Pennsylvania
[email protected]
www.seas.upenn.edu/~ssoumya
Joint Work with:
R. Guerin, K. Hosanagar
9th December, 2010. University of Minnesota.
Background
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Success of new network technologies depends on:
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Design choices should reflect our understanding of these factors
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Technological factors
Economic factors (e.g. price, costs, demand)
Analytical frameworks
What are the ‘qualitative’ insights from the model?
Some Dimensions for Assessing Network Technologies:
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Topic 1:
• Network Technology Adoption/ Migration (NetEcon’08, ToN’10)
– How can a provider help its technology (service) to succeed?
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Topic 2:
• Network Infrastructure Choice (ReArch’09, WEB’10, ISR)
– What infrastructure should the new technology (service) be deployed on?
– Understanding Trade-offs between Shared and Dedicated networks
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S. Sen
Topic 3:
• Trade-offs between Functionality-rich versus Minimalist Designs
On the Adoption and Deployment of New Network Technologies: An Economic Perspective
2
Talk Outline
Exploring the Trade-offs between Functionality-rich Versus Minimalist Design:
A Two-sided Market Analysis
1. Research Motivation
2. Review of Two-sided Markets
3. Problem Formulation
4. Model
5. Solution Methodology
6. Results
7. Conclusions
S. Sen
On the Adoption and Deployment of New Network Technologies: An Economic Perspective
3
Research Motivation
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Networks are becoming akin to services
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Evolving from physical to virtual infrastructures
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Helped by progress in new technologies
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Network platforms to serve as software ecosystems
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Growing number of Internet intermediaries are providing different kinds of development platforms
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Application (Service) Developers
Consumers
Platforms providers have to provide built-in functionalities in the platform
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S. Sen
Google and Microsoft want to build web platform -the powerful layer of basic services on top of which
everyone else builds their web sites and services
Network Platforms are characterized by two customer segments or market sides
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–
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e.g. Virtualization, Cloud computing, IP Multimedia Subsystem platform
e.g., API, tool boxes, software modules
Availability of these software modules, APIs help to reduce app development costs of developers
But adding functionalities comes at a cost
A trade-off between functionality-rich versus minimalist design exists
Exploring the Trade-offs Between Functionality-rich Versus Minimalist Design: A Two-sided Market Analysis
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Related Work: Two-sided Markets (1)
nd
xc
Users
Service Providers
bd
Network Provider
pc
Platform Infrastructure
F
S. Sen
Exploring the Trade-offs Between Functionality-rich Versus Minimalist Design: A Two-sided Market Analysis
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Related Work: Two-sided Markets (2)
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Network externalities: Katz and Shapiro (1985), Farrell and Saloner (1985)
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Two-sided markets definition
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Two-sided platforms: Economides and Tag (2009) – focus on net neutrality debate
Pricing and Social Efficiency: Hagiu (2006)
Competition in two-sided markets: Armstrong (2004)
Pricing, subsidies: Armstrong and Wright (2004)
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Most closely related to our work:
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S. Sen
Cross-side externality: Bakos and Katsamakas (2008) – focus on design and ownership of platforms
Two-side externalities: Yoo (2002) -focus on B2B markets
Violation of Coase Theorem: Rochet-Tirole (2004)- “ A market is two-sided if, holding constant the total of prices faced
by the two parties, any change in the price structure would affect participation levels and the number of interactions
on the platform”
Bakos and Katsamakas (2008)
Two-side externalities: Yoo (2002)
Our focus on the interaction of how investments in functionalities by platform affect the application
development costs, and therefore the platform’s design
Exploring the Trade-offs Between Functionality-rich Versus Minimalist Design: A Two-sided Market Analysis
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Problem Formulation (1)
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Monopolist Platform Provider
Two-sides: Application Developers and Consumers
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Each market sides benefits from the participation of the other side
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•
•
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Cross-side externality benefits (e.g., Android, Xbox)
Platform provider invests in platform functionalities
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basic functionalities to `niche’ functionalities
Trade-offs between platforms with functionality-rich and minimalist designs
Charges flat-fees to both market sides
Functionality Rich Design:
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Pros:
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Cons:
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Attractive to developers
Indirect benefits to consumers
Allows platform to charge higher fees
Expensive to build
Minimalist Design:
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S. Sen
Pros:
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Cons:
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•
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Cheaper to build
Less attractive to developers
Indirectly less attractive to consumers
Lowers the platform’s profit potential
Exploring the Trade-offs Between Functionality-rich Versus Minimalist Design: A Two-sided Market Analysis
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Problem Formulation (2)
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Developers create Applications (services) and generate advertisement revenues
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Services can be differentiated but they use the same set of underlying functionalities
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Note: Competition among developer apps can be allowed in the model
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Can be captured through negative network externalities among developers
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These negative network externalities will be proportional to the number of other developers present
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Quantitative values change, but not the qualitative findings
Platform provider knows about this set of functionalities needed by the apps
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S. Sen
But may or may not provide all of them: The design decision (functionality-rich/minimalist)
Exploring the Trade-offs Between Functionality-rich Versus Minimalist Design: A Two-sided Market Analysis
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Problem Formulation (3)
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•
S. Sen
In innovating apps, Developers will:
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Use the functionality as is, if already provided by the platform
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Otherwise, write their own software code to enable that functionality for their service
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The latter comes at an application development cost for developers (presence of cost heterogeneity)
Consumers are application (service) users
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Benefit from the number of available applications (developers) on the platform (can be
heterogeneous)
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Are oblivious to who provided the code for the functionality (i.e. do not experience any difference in
the quality of platform provided verses developer provided functionalities)
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App downloads are transaction free
Exploring the Trade-offs Between Functionality-rich Versus Minimalist Design: A Two-sided Market Analysis
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Model Formulation
Timeline for a three stage sequential decision
process is considered:
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Design Stage
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Platform decides the level of functionalities, F
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Pricing Stage
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Platform decides on the flat fees (prices) to be
charged to the two sides, pc (consumers) and bd
(developers)
•
Adoption Stage
•
A xc fraction of consumers and a nd fraction of
developers join the network
•
Consumers and developers who join are those that
enjoy positive utility from joining the platform
Design Stage
Direction of solution
(Platform provider
chooses F)
Pricing Stage
(platform chooses flat
fees pc and bd)
Decision Timeline
S. Sen
•
Adoption Stage
(nd developers and xc
consumers join the
platform)
Exploring the Trade-offs Between Functionality-rich Versus Minimalist Design: A Two-sided Market Analysis
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Model : Platform Utility (1)
U p  pc xc  bd nd  C (F )
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Platform charges flat fees to both market sides
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–
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Platform provider incurs a functionality development cost, C(F)
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–
–
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S. Sen
Users pay subscription fees
Developers pay certification and licensing fees
Functionalities are added from most basic to `niche’ ones
C(F) is monotonically increasing in F
C(F) is convex (concave) if the marginal cost of adding sophisticated (niche) functionalities is
increasing (decreasing)
Consider F to be large, so the set of F is mapped onto an interval [0, Fmax] such that C(F) is
continuous on the interval
Exploring the Trade-offs Between Functionality-rich Versus Minimalist Design: A Two-sided Market Analysis
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Model : Developer Utility (2)
U d  xc  bd  ( K ( F )   )
•
•
α captures value that a consumer generates for the developer (cross-externality)
It accounts for advertising revenue (e.g. Facebook app iLike gets revenue from iTunes, Ticketmaster)
•
bd is the flat fee developers pay to the platform
–
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Android charges $25 market developer fee, Apple charges $99 licensing fee to distribute apps and $299 for ‘enterprise
programmers’ (iOS developer program)
•
•
•
K(F) captures the baseline app development cost when F functionalities are provided by the platform
(developers have similar baseline expertise in developing apps)
φτ captures the heterogeneity among developers in development cost for apps (e.g., fixed costs, employee
benefits)
All system parameters are normalized w.r.t. τ
Assume   [0,1]
Development cost, K(F)
– More built-in functionalities, lower is this cost
– K(F) is monotonically decreasing in F
– K(F) is concave (convex) if the marginal cost of developing sophisticated (niche) functionalities is
increasing (decreasing)
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Developer utility when same side externalities are considered
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U d  xc nd  bd  ( K ( F )   )
S. Sen
Exploring the Trade-offs Between Functionality-rich Versus Minimalist Design: A Two-sided Market Analysis
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Model : Consumer Utility (3)
U c  q  nd  pc
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q captures stand-alone benefits the platform provides to consumer
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•
β captures the value that a developer generates for the consumer (cross-externality)
θ captures the heterogeneity among consumers in how much they value the available apps,  [0,1]
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pc is the flat fee consumers pay to the platform
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All system parameters are normalized
•
•
In some platforms, consumers may value the stand-alone qualities or brand name more
We consider the following alternative utility function to account for the case where users are
heterogeneous in their evaluation of stand-alone benefits, while valuing their cross-externalities equally
e.g. most players of games platform value the available number of games but can be more subjective
about the console characteristics and hardware features (captured by q)
•
U c  q  nd  pc
S. Sen
Exploring the Trade-offs Between Functionality-rich Versus Minimalist Design: A Two-sided Market Analysis
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Model: C(F) and K(F)
S. Sen
Exploring the Trade-offs Between Functionality-rich Versus Minimalist Design: A Two-sided Market Analysis
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Model : Examples (1)- Amazon Web Services
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Amazon Web Services provides a variety of functionalities
with available APIs
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EC2 (computing), SimpleDB (database) Amazon S3 (storage), CloudFront
(content delivery)
API complexity is a proxy for platform’s cost of building-in
the functionality
Forum Activity levels is a proxy for usefulness of the
functionalities
Functionalities that are most useful to developers are most
difficult for platform to provide, `niche’ functionalities can
be added at decreasing marginal cost to the platform.
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Note the correlation in EC2, FPS, SimpleDB, RDS, SQS, SNS, DevPay
Source: http://www.elastician.com/2010/06/aws-by-numbers.html
S. Sen
Exploring the Trade-offs Between Functionality-rich Versus Minimalist Design: A Two-sided Market Analysis
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Model : Examples (2)- IMS Platform
S. Sen
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IP Multimedia Subsystems Platform provides a way for delivering integrataed voice, video,
data services in a reliable standardized services
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Low level APIs are developed by the platform first at high marginal costs, but low-level APIs
are too complex for app developers to work with, and involves complexity of learning the
platform architecture
•
As High-level APIs are made available by the platform, the developers costs decrease
significantly
Exploring the Trade-offs Between Functionality-rich Versus Minimalist Design: A Two-sided Market Analysis
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Solution Methodology: Adoption Stage
pc
ˆ
  1  xc 
 nd*
Design Stage
(Platform provider
chooses F)
ˆ  nd  x  bd  K ( F )
Consumers and developers are assumed to be:
• Rational
• Incentive compatible
• Make simultaneous adoption decision, given
pc, bd and F
•
(platform chooses flat
fees pc and bd)
At equilibrium:
pc  (1  x ) n
*
c
*
d
bd  xc*  nd*  K ( F )
S. Sen
Pricing Stage
Decision Timeline
•
Direction of solution
*
c
Adoption Stage
(nd developers and xc
consumers join the
platform)
Exploring the Trade-offs Between Functionality-rich Versus Minimalist Design: A Two-sided Market Analysis
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Solution Methodology: Pricing Stage
Interior Solution:
*
*
max
U

p
x

b
n
 C(F )
p
c
c
d
d
*
*
xc , n d
Design Stage
s.t.0  x  1,0  n  1
*
d
(    )((   )  4  K ( F ))
16 
(3   )(   )  4  K ( F )
bd* 
8
2
pc* 
 
2
(   ) 2  4 K ( F )
*
nd 
8
xc* 
Pricing Stage
(platform chooses flat
fees pc and bd)
Decision Timeline
Proposition 1: The optimal price levels (p*c, b*d) and the
optimal adoption levels of consumers and developers
(x*c, n*d) of the two-sided market, which maximizes the
platform provider’s profit are given by:
(Platform provider
chooses F)
Direction of solution
*
c
Adoption Stage
(nd developers and xc
consumers join the
platform)
Only Boundary constraints need to be satisfied, second order conditions are satisfied
S. Sen
Exploring the Trade-offs Between Functionality-rich Versus Minimalist Design: A Two-sided Market Analysis
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Solution Methodology: Design Stage
Proposition 2: The optimal level of built-in functionalities (F*)
for the platform which maximizes its profit is given by:
Design Stage
C ( F * )
K ( F * ) (   ) 2
*
*
 nd ( F ) 

*
K ( F )
2
8
Second order condition needs to satisfy:

[ K ( F * )]2 
*
*
 K ( F * )
C ( F )    nd ( F ) 
2


*
S. Sen
Direction of solution
C ( F * )
*
*

n
(
F
)
d
*
K ( F )
Pricing Stage
(platform chooses flat
fees pc and bd)
Decision Timeline
At the optima, the participation level of developers equals
the ratio of rate of change in the costs to the platform
and the developers.
(Platform provider
chooses F)
Adoption Stage
(nd developers and xc
consumers join the
platform)
Exploring the Trade-offs Between Functionality-rich Versus Minimalist Design: A Two-sided Market Analysis
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Analysis (1): Impact of cross-externalities on platform design
•
Using the conjugate pair theorem, we have:
 2U p
F *
sign
 sign
0

F
 2U p
F *
sign
 sign
0

F
•
Proposition 3: Increase in cross-externality benefits provides incentives for the platform to
invest in built-in functionalities
•
How does F* change with the cost functions C(F) and K(F), i.e. when should a platform create
a functionality-rich / minimalist design?
Impact of α and β on F*
S. Sen
Exploring the Trade-offs Between Functionality-rich Versus Minimalist Design: A Two-sided Market Analysis
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Analysis (2): Presence of Multiple Maxima
•
•
•
•
•
•
S. Sen
AWS example scenario
K(F) convex, C(F) concave
Basic functionalities help developers a lot (K’(F) is large -ve), marginal value to developers
from ‘niche’ functionalities is decreasing (K’(F) is small -ve →0 as F increases)
Cost of adding basic functionality is large, marginal cost of adding ‘niche’ functionality
decreases
Multiple maxima (Depending on K(F), the design should be minimalist or functionality rich)
Counterintuitive: For the K’(F) that initially decreases faster and slowly later on
(i.e. K(F)=0.25e-0. 43*F) the platform will invest in higher functionality level
Exploring the Trade-offs Between Functionality-rich Versus Minimalist Design: A Two-sided Market Analysis
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Analysis (3): Presence of Multiple Maxima
•
•
K(F) convex, C(F) convex
Basic functionalities help developers a lot (K’(F) is large -ve), marginal value to developers from
‘niche’ functionalities is decreasing (K’(F) is small -ve →0 as F increases)
•
•
Multiple maxima (Depending on K(F), the design should be minimalist or functionality rich)
Counterintuitive: For the K’(F) that initially decreases faster and slowly later on (i.e. K(F)=0.5e-0.194*F)
the platform will invest in higher functionality level
S. Sen
Exploring the Trade-offs Between Functionality-rich Versus Minimalist Design: A Two-sided Market Analysis
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Analysis (4): Complex design decisions
S. Sen
•
K(F) concave, C(F) convex
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Design depends upon boundary values as well as the rate of change of K(F)
•
Non-intuitive platform functionality design outcome
Exploring the Trade-offs Between Functionality-rich Versus Minimalist Design: A Two-sided Market Analysis
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Analysis (5): Boundary values
•
•
IMS scenario
K(F) concave, C(F) concave
•
F* is on the boundary, platform will be either minimalist or functionality-rich depending on the Fmax
S. Sen
Exploring the Trade-offs Between Functionality-rich Versus Minimalist Design: A Two-sided Market Analysis
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Alternative Utility Function: Robustness
Interior Solution:
U c  q  nd  pc
Proposition 1: The optimal price levels (p*c, b*d) and the optimal adoption levels of consumers and
developers (x*c, n*d) of the two-sided market, which maximizes the platform provider’s profit
are given by:
q ( 2q  (   ) K ( F )   (   ))
pc* 
4q  (   ) 2
q (   )  ( 2q   (   )) K ( F )
bd* 
4q  (   ) 2
2q  (   ) K ( F )
4q  (   ) 2
(    2 K ( F )) q
nd* 
4q  (   ) 2
xc* 
   
Boundary constraints need to be satisfied, second order conditions require q  

 2 
Design Solution:
S. Sen
2
C ( F * )
*
*

n
(
F
)
d
*
K ( F )
Exploring the Trade-offs Between Functionality-rich Versus Minimalist Design: A Two-sided Market Analysis
25
Alternative Utility Function: Robustness (1)
Using the conjugate pair theorem, we again have:
 2U p
F *
sign
 sign
0

F
 2U p
F *
sign
 sign
0

F
Proposition 3: Increase in cross-externality benefits provides incentives to the platform to invest in
built-in functionalities
Proposition 4: Increase in platform’s stand-alone benefits decreases platform’s need to invest in
higher levels of built-in functionalities
F *
sign
0
q
S. Sen
Exploring the Trade-offs Between Functionality-rich Versus Minimalist Design: A Two-sided Market Analysis
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Alternative Utility Function: Robustness (2)
S. Sen
•
K(F) convex, C(F) convex
•
•
Non-intuitive behaviors still present
For the K’(F) that initially decreases faster and slowly later on (i.e. K(F)=0.5e-0. 35*F) the
platform will invest in higher functionality level
Exploring the Trade-offs Between Functionality-rich Versus Minimalist Design: A Two-sided Market Analysis
27
Conclusions
•
We provide an analytical framework to investigate trade-offs in platform design
•
Multiple design optima may arise
•
The design decision can be complex and non-intuitive
•
Design decision is based not only on the rate of change in costs from adding functionalities,
but also the relative rate of change in platform’s and developer’s costs, as well as boundary
values
•
Robustness analysis:
–
–
Alternative demand function
Non-linear externality functions
•
The model can help in providing design guidelines for network platforms
•
Potential for future exploration
Thank you!
S. Sen
Exploring the Trade-offs Between Functionality-rich Versus Minimalist Design: A Two-sided Market Analysis
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