Multi-Sided Markets with Heterogeneous Users and Negative Externalities

Mass media such as newspapers, radio and television play an important role in our daily lives. With vast improvements in technology over the past two decades, new (social) mass media industries such as Social Network Sites (SNS), Weblogs and Podcasts have emerged as strong contenders. These industries act as a platform and serve more than one group of customers; this is known as a multi-sided market. Each customer group exert externalities on each other. With social media, the inter-group and intra-group externalities are stronger and more relevant. Advertisers are usually one of these groups of customers and they may exert negative externalities on other users. This feature is not often studied in the multi-sided market literature. We aim to model such industries by constructing a micro-founded two-sided market model with heterogeneous consumers where one side exerts negative externalities on the other. Examining how the platform can maximize profits within these constraints, we find that where negative externalities exist, not all potential advertisers will participate in the market. This amount of advertisers may also be less than socially optimal. Next, we extend the model to a three-sided market to mimic the SNS industry which includes application developers as a third group of consumers. We find similar results hold on the number of advertisers. We also find that the equilibrium number of application developers is not socially optimal. These results may be due to the interplay of externalities between and within each group. They present interesting insight on the efficiency of such type of markets.