Rethinking Market Power in the Digital Platform Era

Market share isn't everything.

Platform Papers is a blog about platform competition and Big Tech. The blog is linked to platformpapers.com, an online repository that collects and organizes academic research on platform competition.

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By Paul Belleflamme, Eric Toulemonde, and Martin Peitz.¹

Major digital platform antitrust cases are currently challenging the market dominance of tech giants like Google, Amazon, Meta, and Apple. The U.S. Department of Justice has successfully argued that Google is a monopoly in the digital advertising market, with potential remedies including breaking up its business. Amazon faces accusations of marketplace manipulation. The Federal Trade Commission is challenging Meta over its acquisitions of Instagram and WhatsApp. Apple is under European Union scrutiny for restrictive app store practices.

Underlying these legal actions is a growing belief that the market power amassed by these digital platforms over the years has reached excessive levels and must be curtailed to foster fair competition in digital markets. A crucial step in substantiating this belief is defining and measuring market power as clearly as possible. However, as our paper published in the International Journal of Industrial Organization demonstrates, this task proves challenging in markets with digital platforms.

Image source: The Authors, via Gen AI.

Usual Definition and Indicators of Market Power

Market power is typically defined as a firm's ability to sustain prices above competitive levels. While market power is not inherently problematic from a competition policy perspective, the concern lies in how firms gain and utilise it. A high degree of market power can allow firms to act almost independently of competitors, potentially harming consumers and market efficiency. By assessing market power, competition authorities can determine if interventions are necessary to maintain healthy competition. As such, market power is scrutinised when assessing mergers and potentially anti-competitive business practices.

Focusing on price effects, market power can be defined as the ability to raise prices above marginal costs and measured by the Lerner index, which measures price-cost margins. Calculating price-cost margins can be challenging due to the need for reliable marginal cost estimates, often hindered by a lack of adequate cost data.

Competition authorities often consider two more easily quantifiable indicators: market shares and profits. Market shares reveal a firm’s relative size compared to competitors, with high market shares indicating potential market power. Certain thresholds (e.g., 40% to 50% in the EU) can suggest dominance, streamlining merger and antitrust assessments. Economic profits also help assess market power as sustained high profits indicate the ability to set prices above competitive levels. While economic profits are not directly observable, a firm’s financial statements can help infer economic profit under specific conditions.

In most industries, the choice of indicator is one of convenience because market shares and profits tend to correlate with price-cost margins. Thus, a firm with a larger market share tends to enjoy higher profits and higher price-cost margins. For instance, a well-known brand of sneakers can demand premium prices due to its popularity and brand equity.

Challenges Raised By Digital Platforms

The rise of digital platforms has complicated the picture in several dimensions. By connecting different groups of users, these "two-sided platforms" challenge our traditional understanding of market power. There are at least three reasons for that:

1. Unlike traditional businesses, platforms often set multiple prices, typically charging distinct prices to different user groups. For example, Airbnb charges different fees to travellers (‘guests’) and property owners (‘hosts’).

2. Below-cost pricing is commonplace in markets with platforms. Platforms might lose money on one side to attract users, making profits on the other. For instance, a social media platform might offer its services to users for free and charge advertisers.

3. The omnipresence of network effects—whereby the platform’s value depends on how intensively people use it—creates a complex interplay between user groups and pricing strategies. For instance, if Airbnb lowers its fees for hosts, more hosts will join, attracting more guests (a manifestation of positive cross-side network effects). This increased activity could then lead Airbnb to adjust its fees for guests.

These factors make it tricky to measure market power in markets with digital platforms. In particular, the two easily quantifiable indicators of market power—market shares and profit—may point in opposite directions. Our economic model shows that a platform might have a larger market share on both sides of its business but still be less profitable than its competitor. This challenges the traditional view that bigger always means more powerful or successful.

For example, consider two ride-hailing platforms competing in the same city, assuming drivers and riders tend to be active on one platform at any time. Suppose that historically, Platform A has attracted more drivers and riders than Platform B, making it appear more powerful based on market share. However, this does not necessarily imply that Platform A is more profitable. If competition is more intense among drivers than riders, drivers may be subsidised (that is, they pay a price below the cost of serving them) while riders contribute revenue. In this scenario, being the larger platform can be a mixed blessing: while it may lead to higher profits from riders, it can also result in greater losses from subsidising drivers. Consequently, the negative impact of the latter may outweigh the benefits, leading Platform A to generate lower overall profits than Platform B.

In sum, a large market share for subsidised users is costly, which does not play out well for the overall platform profit, even if the platform has a larger market share for users who generate revenues.

About the research: We characterise the equilibrium of the linear specification of duopoly platform competition with singlehoming on both sides when platforms are asymmetric. On both sides, we allow for differences in marginal costs, stand-alone benefits, and per-user cross-group network effects across firms. We identify market environments where one platform obtains a larger market share on both sides but has a lower overall profit than the other platform. This outcome is compatible with each firm charging a positive markup on both sides.

In our paper, we present additional numerical examples, extending one of the workhorse models of platform competition, the linear two-sided singlehoming model proposed by Armstrong (2006). Thereby, we demonstrate how the three traditional measures of market power—price-cost margins, market shares, and profits—can yield conflicting results. In some cases, Platform A has a larger price-cost margin than Platform B on one side but a smaller margin on the other. This discrepancy indicates that price-cost margins alone do not clearly show which platform has greater market power. In another example, Platform A holds larger market shares and higher price-cost margins on both sides, suggesting stronger market power. However, despite these advantages, Platform A generates lower overall profits. Finally, we illustrate that the tension between market share and profit can occur even when users are not subsidised in equilibrium.

Takeaways

Our analysis allows us to draw three significant insights:

1. For regulators. Market share alone might not tell the whole story when assessing market power in digital industries, even in the long run: a smaller platform may achieve a higher profit than its larger rivals.

2. For investors. A platform's profitability might better indicate its long-term success than its size or user numbers.

3. For platform operators. Success in this space requires a delicate balancing act between attracting users and generating profit.

As our digital economy evolves, grasping these complexities becomes essential. Two-sided platforms challenge our traditional views on market power and success, emphasising the need to assess competition issues carefully in the digital age.

This blog is based on the authors’ research, which is published in the International Journal of Industrial Organization and is included in the Platform Papers references dashboard:

Belleflamme, P., Peitz, M., & Toulemonde, E. (2022). The tension between market shares and profit under platform competition. International Journal of Industrial Organization, 81, 102807.

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1. During the preparation of this post, the authors used GenAI tools to collect ideas and improve the exposition. After using these services, the authors reviewed and edited the content as needed; they take full responsibility for the publication’s content.