August 8, 2017    4 minute read

The Economics of Online Platforms

Freemium Services    August 8, 2017    4 minute read

The Economics of Online Platforms

Online platforms made possible the incredible recent development of Web 2.0, from social networks to photography communities, and so on. But what is a platform? How does it work? Why is the traditional way of doing business giving space to this new type of economic interaction?

What Is a Platform?

An online platform is a nexus of rules and architecture that generates a useful product or service for third parties. In short, a platform is a place where people interact according to certain rules while pursuing a useful goal. For instance, Google Play is a platform where a group of people download apps, while others create them. However, there are many other platforms, like Twitter, Linkedin, Lyft, EyeEm and so on.

The concepts behind a platform are multiple, starting from that of a network. The rationale is straightforward: more users, more value. In fact, a platform has a competitive advantage if it is popular. This point merits further explanation. Generally, the idea is that a platform is better than another if the former has more features or has more quality in some ways.

However, this may not be true because of the network effect. In fact, a platform that has a wider network may beat its competitors even if the latter have more interesting features. For instance, two interesting competitors are WhatsApp and Telegram. The latter in particular offers some features, like privacy or phone calls, that are superior to WhatsApp.

However, due to its popularity, WhatsApp is the leader in this market. Hence the value is not added, like in traditional economics, by focusing especially on the supply side, but on the demand side. Behind the whole process, there is a quite simple rule: the first to get more than half of the market is going to be the winner. This suggests that for users it is more favourable to enter the wider network even if it is not the best one.

Moreover, a platform with a wide network has a very strong locking costs which consolidate its position. WhatsApp has approx. 1 billion users. If a user wants to change app and use Telegram, with 100 million users, he/she has to take into account that many of his/her friends are not on that platform. All this tends towards a market structure in which “one gets all”. In some ways, this is a new kind of competition where it is easier to get the whole market and transform it in a monopoly.

Strategy to Widen a Network

Behind the high potential of a platform is the network, but how to strengthen it? There are different strategies, but here follows the most interesting one. Imagine that a company has two products/services. The following step is to choose which product to subsidise facing losses. The decision must be driven by considering the potential increase in demand for that product: in the end, the goal is to get new users.

However, the company has to recover from losses caused by the chosen product. The strategy increases the price of the other product to reach the breakeven point. For instance, the App Store offers free apps to users and this brings to losses for Apple. However, offering apps for free increases the attractiveness towards the Apple “Ecosystem” and as a consequence iPhones are more attractive, even if they are more expensive.

Another example relates to Adobe Acrobat Reader DC, which is a free PDF reader. Also in this case, the company is facing losses in order to widen the amount of people using their reader. However, on the other side, they offer Adobe Acrobat Reader Pro DC for those users who need to modify their PDF files by charging them a lump sum monthly. Hence, it is possible to raise the price of a product to increase the company’s profits and the following graph is the demonstration. All that counts is that the increase in profits in the second market is bigger than the decrease in the first one. Platforms that are profitable even with free products or services were not attainable before. Another strategy to strengthen the network of a platform is to encourage the growth of complementary markets. The strong demand for smartphones, tablets and so on brought to platforms’ success. But also, utilising viral marketing brings to success; in fact nowadays many companies are supporting their sales with social networks.


Day after day, millions of people are using platforms of different genres. The business behind is growing incredibly thanks to the technological improvements of recent years. The whole process is relatively new and there are many undiscovered opportunities to exploit.

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