Policy Challenges in Two-Sided Network Industries

FOREWORD Europe Economics is an independent economics consultancy, specialising in economic regulation, competition policy and the application of economics to public policy and business issues. Most output is either private to clients, or published (a list of current published reports is available at: www.europe-economics.com). Europe Economics Staff Working Papers are intended to provide a complementary channel for making available economic analysis undertaken by individuals within the firm. The present paper has been prepared by Dr Ricardo Gonçalves, a consultant at Europe Economics. This paper reviews recent economic research into two-sided network industries, and provides a critical analysis of some regulatory decisions in that context. It is hoped that this work will provide a relevant technical contribution to an important area of current debate. No part of this publication may be reproduced except for permitted fair dealing under copyright law. Full acknowledgment of author and source must be given. Please apply to Europe Economics at the address above for permission for other use of copyright material. 1 INTRODUCTION Some industries possess two peculiar characteristics which make them particularly interesting. First, they provide a good or service which increases in value with the number of persons who consume it (a so-called " network externality "). Think about telecommunications, or credit cards, and you will immediately understand that the value to any given consumer of using a telephone or credit card network increases with the number of people already connected to the telephone or credit card network, as more transactions become possible. In both cases, your phone or credit card gains wider acceptance and increases the number of opportunities you can make use of them by the fact that more people connect to the telephone or credit card network. These industries are often referred to as network industries. Railways is another example of a network industry. At a given time of day, as more people use trains, train companies will usually increase the number of services per hour to accommodate demand, and therefore benefit all existing users by giving them more flexibility when choosing a train time for their trip. 1 Second, these network industries often face a two-sided demand, in so far as the transactions which they enable are demanded by two separate (and uncoordinated) types of consumer, whose participation is essential. Again, think of credit cards and you will realise that in order to enable a transaction a cardholder must present …