4.4 Why do firms offer online platforms?
4.4.1 The world without online platforms
As profits only depend on the intensityk of style preferences, any effects induced by a change in type preferences or ad effectiveness only lead to redistribution between the online and offline profits, or between the profits from advertising or from consumers, respectively. This, however, is profit-neutral for media outlets. An increase in the distance cost parameter in the style dimension,k, induces the same effect as in standard models: An increase in k leads to higher prices of both firms, as well as to higher profits.30 Hence, a key result of this section is that adding an additional dimension to a spatial competition framework does not lead to higher profits, which contradicts the intuition gained from one-dimensional models.
The profit function now simplifies to:33
Π˜i = ˜pci,OF Fn˜ci,OF F + ˜pai,OF F. (13)
Deriving the equilibrium is as in Section 4.3 and yields the following results:
˜
pci,OF F =k−βOF F, n˜ci,OF F = 1 2,
˜
pai,OF F = βOF F
2 , Π˜i = 1
2k−COF F. (14)
The equilibrium of the game without online entry reflects the standard result of spatial competition in a two-sided market. The incentive to set prices above marginal costs is reduced by the negative externality of consumer prices on advertising revenues. The higher the ad-effectiveness, the lower are consumer prices. As prices and the disutility from deviating from the preferred style of coverage are equal for both platforms, both firms serve half of the market. Again, media profits are increasing in consumers’
disutility k from obtaining the wrong style of coverage. Comparing Eq. (11) to Eq.
(14) shows immediately that profits are at least as high as in a situation in which both firms enter the online market. Hence, there is no obvious reason why media outlets would choose to enter the online market in the first place.
Proposition 4 If and only if ∆β < 0, i.e. online advertisements are more effective than offline advertisements, and the condition|∆3β|< `≤1for an interior equilibrium on the market with online and offline platforms is fulfilled, all consumer prices decrease compared to the situation without online platforms. As there are positive fixed costs of entering the online market (CON > 0), coordinately committing to not entering the online market yields higher profits than entering on the whole parameter range of the interior equilibrium.
Proof. See Section A4 of the Appendix.
Comparing the equilibrium without online platforms to the equilibrium where both firms enter the online market, the evolution of prices is more complex than the initial suggestion of prices increasing if consumers’ preferences can be met more accurately
33Note that the demand for advertising space is again normalized to 1.
through offering more specialized goods (online platforms). As discussed in the pre-vious section, media outlet i sets prices such that more consumers are allocated on the platform with the higher ad effectiveness. The size of this effect is subject to the weighted average of the ad effectiveness parameters βt (see second term of Eq. 9).34 I now analyze whether average consumer prices are higher or lower in a two-dimensional market of online and offline platforms compared to a one-dimensional market in which there are only offline platforms. The result critically depends on the size of the adver-tising externality, which, in turn, is subject to the sign of ∆β. There are two cases:
First, online platforms have a higher ad effectiveness than offline platforms (average ad effectiveness increases), and second, online platform have a lower ad effectiveness than offline platforms (average ad effectiveness decreases).
In the first case where βON > βOF F (which implies ∆β < 0), the advertising effect is stronger on the online platforms (follows from comparing the second terms of the consumer prices in Eq. 9). Hence, if the advertising effect on the offline platform is stronger in a two-dimensional than in a one-dimensional market, offline as well as online consumer prices are lower in a two-dimensional market. This implies that av-erage consumer prices decrease due to the introduction of online platforms. This is illustrated by the following example: If βON =βOF F +, with 0 < <1−βOF F, the advertising externality on offline prices in the two-dimensional case yields:
βOF F ++ 2βOF F 3
| {z }
ad effect if ∆β<0
=βOF F +
3 > βOF F
| {z }
ad effect, no online
, ⇐⇒ pci,OF F <peci,OF F. (15)
This equation shows that the negative effect of the advertising externality on consumer prices is larger in the two-dimensional than in the one-dimensional case.
As pci,ON < pci,OF F, if ∆β <0, average prices decrease when online platforms are intro-duced.35 In other words, competition for consumers has increased as advertisements can on average be sold at a higher price. In the second case of ∆β >0, however, the average ad effectiveness has decreased which leads to an increase in consumer prices.36 Comparing equilibrium consumer prices with and without online platforms, there is an upward shift in offline consumer prices, as the negative effect of the advertising
34Note that consumer prices in the case of both firms entering the online market are pci,ON =k−2βON+β3 OF F −∆9`2β andpci,OF F =k−βON+2β3 OF F −∆9`2β.
35Note that the ad asymmetry effect (third term of Eq. 9) always reduces prices in the two-dimensional case.
36Note that online prices are higher than offline prices if offline advertisements are more effective than online advertisements.
externality is weaker than in the one-dimensional case without online platforms. The (negative) effect of the advertising externality is dominated by the (positive) effect of the advertising market taking less influence on the firms’ profits, and average consumer prices increase. This illustrates two key findings of the model: (i) The average level of the ad effectiveness is decisive for the pricing decision of media outlets, and (ii) consumers may benefit from the introduction of online platforms as prices decrease.
The media outlets, however, cannot benefit if both firms enter the online market. When comparing media profits in the regime without an online market to the profits where both firms enter, it becomes obvious that they are again only a function of the distance cost parameter k, and the fixed costs. This confirms the intuition of the benchmark model that any gain in the advertising market is compensated for by a loss in the consumer market, and vice versa. This shows unequivocally that the type dimension is irrelevant for media profits. AsCON >0, profits are lower in the case of both media outlets entering the online market.