The strategic value of platform encroachment: Seller entry and network effects

Jorge Padilla recently co-authored an article examining competition and welfare in platform markets where user participation is shaped by direct network effects. He compares pure intermediation with “encroachment,” a hybrid business model in which the platform competes with third-party sellers through its own private-label products. He shows that positive network effects limit the platform’s incentive to foreclose downstream rivals. Hence, while encroachment can restrict entry, it may increase consumer surplus, total welfare, and incumbent sellers’ profits when the marketplace has a sufficiently large number of incumbents.

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Abstract

In a platform market where user participation is endogenous and shaped by direct network effects, we compare the competitive and welfare effects of two alternative business models: pure intermediation and ‘encroachment’ — a hybrid model where the platform competes with third-party sellers by selling its own private-label products. There are two groups of sellers: entrants, who must pay a specialization cost to access the marketplace, and incumbents, who have already paid it. With encroachment, the platform has no incentive to entirely foreclose their downstream rivals if there are positive network effects. Surprisingly, although encroachment restricts entry, it increases consumer surplus, total welfare, and the incumbents’ profit when there is a sufficiently large number of incumbents in the marketplace.