Divide and Conquer in Two-Sided Markets: A Potential-Game Approach

Abstract

Network effects typically generate multiple equilibria in two-sided markets. To overcome the methodological challenge of selecting an appropriate equilibrium, this paper shows that many two-sided market models are weighted potential games, and therefore a refinement of Nash equilibrium justified by many theoretical and experimental studies, potential maximization, pins down an equilibrium. Under potential maximization, platforms often subsidize one side and charge the other, i.e., divide and conquer. The primary determinant of which side to subsidize/monetize is cross-side network effects. This divide-and-conquer strategy implies that platforms are often designed to favor the money side much more than the subsidy side.