Smaller Slices of a Growing Pie: The Effects of Entry in Platform Markets

Abstract

The entry of firms into a platform has an ambiguous effect on the profitability of incumbent firms' operating on the platform: While entry increases competitive pressure on incumbents, supply-side expansion may attract new consumers---effectively increasing total platform size and presumably benefiting all firms. Guided by a simple model, this paper explores how firm entry affects incumbents’ outcomes in a two-sided market. Specifically, I focus on Yelp Transactions Platform, an online platform that connects consumers with local services. I study a quasi-exogenous increase in firms on the platform and exploit geographic variation to employ a difference-in-differences research design. I find that, on average, market expansion favors incumbents, though the average effect masks substantial heterogeneities: High-quality incumbent firms experience a positive effect, whereas low-quality firms perform unambiguously worse. Moreover, the relative magnitudes of these forces relate non-monotonically to platform maturity and size. These findings suggest that incumbent firms operating in platform settings will experience benefits and detriments from firm entry that vary dependent on the incumbents’ and platform’s characteristics.