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

Abstract

Strong network effects typically lead to 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 thus potential maximization, a refinement of Nash equilibrium justified by many theoretical and experimental studies, can always select a unique equilibrium. Under potential maximization, platforms often subsidize one side and charge the other, i.e., divide and conquer. The fundamental determinant of which side to subsidize or 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.