Quality Regulation on Two-Sided Platforms: Exclusion, Subsidization, and First-Party Application

Abstract

Managing the quality of complementary applications is vital to the success of a two-sided platform. While prior research has focused solely on restricting platform access based on a quality threshold, we compare three quality regulation strategies: 1) the platform excludes access to low-quality complementors, 2) it provides a fixed amount of subsidy to high-quality complementors, and 3) it develops its own high-quality applications in addition to those from third-party complementors. Our analyses reveal that the widely adopted exclusion strategy is a special case of the subsidization strategy, and it does not always benefit the platform. In contrast, both subsidization and first-party application strategies make the platform owner better off, with greater profits, higher average quality, and a larger consumer network size, but only subsidization always improves social welfare. In addition, the tradeoff between subsidization and first-party application strategies depends on the development cost of first-party applications, as well as the fraction of high-quality complementors, but the relationship is not monotonic. Interestingly, our results demonstrate that the platform does not have to sacrifice application quantity for higher application quality. With the right choice, it can profitably improve both measures simultaneously. This research provides concrete guidelines to help platform managers make decisions about regulating the quality of complementary applications.