Recommended reading: Matchmakers

It was reported in yesterday’s Sunday-Mail (24 July, p. 21) that “Baby boomers are increasingly turning to Uber, Airbnb and eBay to boost their retirement income because of stockmarket falls and minuscule bank interest rates.” That is, they are participating in the so-called sharing or collaborative economy, or more technically they have become participants in multisided platforms, the subject of a brilliant new book I read over the weekend: Matchmakers: The New Economics of Multisided platforms, written by leading US micro-economist David S. Evans and MIT Emeritus Professor Richard Schmalensee.

matchmakers

You can pick up a copy of Matchmakers at Dymocks, Albert St, Brisbane

The platforms are multisided, involving different groups of users, and value is created by connecting different types of users with each other, such as passengers and drivers who are connected by Uber, which is the matchmaker. Evans and Schmalensee demonstrate how highly successful multisided platform often have more than two sides, and connect a variety of types of users. For example, the authors identify that Facebook has a multisided platform bringing together friends, businesses, and app developers.

The book lucidly explains the fundamental economic concepts underpinning multisided platforms such as Uber and Airbnb, particularly the direct and indirect network effects. Positive network effects of both varieties mean that multisided platforms can end up with a huge scale, facilitated by the internet and smart phones, and end up dominating a market (at least temporarily).

A direct network effect is the type that has been taught in economics courses for decades: the impact on a user of a network of an additional user joining the network. Examples of positive network effects that were typically given related to telephones and fax machines. There was no point owning a fax machine if there was no one else to send a fax to, for example, so the value of owning a fax machine increased as more people owned one.

Two-sided and multisided platforms also involve an indirect network effect, which is the impact on a participant in a platform from a participant of a different type joining the platform. For example, a positive indirect network effect is the benefit to a rider of an additional Uber driver joining the Uber platform. Riders benefit when new drivers join Uber because the greater supply of drivers means lower waiting times and less likelihood of surge pricing.

Because of network effects, the demands of users, of the same type and of different types, are interdependent. For example, Facebook is more valuable to you when more of your friends are on it, and riders will not use Uber if there are no drivers (and drivers will not join Uber if there are no riders). Due to this interdependence, there is a massive chicken-and-egg problem, as there is a risk in the early days of a platform that not enough users of different types register and the platform never attains the critical mass it needs to generate rapid self-sustaining growth. As a result, it is very difficult for any particular platform to take off, and intense effort is needed in the early months and years to sign up enough users of different types. The authors give the terrific example of how difficult it was for Youtube to gain critical mass, and the massive efforts that the site founders took to attract uploaded videos and promote those videos to potential users. The authors’ analysis of what they call the ignition problem leads them to one of their great insights (on p. 199):

“Things will be both slower, and faster, than you might think.”

It is difficult for multisided platforms to reach the scale that is necessary for them to suddenly become attractive to a much larger number of users and to experience rapid growth. So successful platforms will come along infrequently, but the successful ones will grow rapidly in a very short time.

This book is a very important contribution to the economics of multisided platforms, which are profoundly transforming our economy and way of life. As such, it is obviously highly recommended reading.

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