Competition Between Two-Sided Platforms With Quality-Based Subsidization

Abstract

ABSTRACT We study platform competition in two-sided markets, where consumers value not only the number of providers on the other side of platforms but also their quality. In this context, enhancing provider quality is critical in the competition, and platforms may incentivize high-quality providers to join the platforms with a subsidy. The article examines a two-stage competition game between two platforms who decide their quality-based subsidization strategy and access fees charged to both sides of the platforms. We derive the equilibrium outcomes of the two competing platforms under different subsidization strategy scenarios, and provide insights on the impact of subsidization on platforms’ pricing, network sizes, quality, profits, and social welfare in a competitive setting. Our study shows that in competitive environment, subsidization is a double-edged sword that can lead to a prisoner’s dilemma for platforms, despite quality improvement. We also find that while subsidization has a positive quality effect that always increases consumer surplus, it may hurt provider surplus if the same-side competition effect among providers is too strong, which negatively affects provider surplus and may drive out low-quality providers under subsidization. As a consequence, the total social welfare also hinges on the provider side competition intensity.