Composition Effects in Platforms with Population Heterogeneity

Abstract

I develop a duopoly model of competition between platforms, incorporating users with heterogeneous preferences over both the platforms' characteristics and the presence of other users. Hence platforms are concerned with both the number and composition of users. The model yields novel representations of heterogeneity, size effects, and composition effects. I use these representations to decompose the relationship between the price and the size and composition of a platform. Prices need not be monotonic in the size of the installed base and profitability can similarly vary inversely. I identify conditions under which prices are increasing, decreasing, or unchanging in platform size. Given that users care about composition, nonpricing strategies to cultivate platform composition emerge when platforms cannot sufficiently leverage price discrimination. Composition effects and cultivation reframe the dominant-firm fringe-firm paradigm and explain the presence of multiproduct firms in platform markets, such as online dating.