Innovation and Policy Support for Two-Sided Market Platforms: Can Government Policy Makers and Executives Optimize Both Societal Value and Profits?

Information technology (IT) can transform societies, governments, and businesses alike. Technological innovation requires difficult but critically important strategic decisions. Making good decisions becomes even more challenging for platforms tightly linked to network externalities that are inherent in two-sided markets. Inspired by the driverless car industry, which is now receiving green signals from available technology and government policies, this study introduces a model of competing IT platforms that use a complementary physical medium. The aim is to understand the possible incentives for technological innovation to inform decision makers from both industry and government. Although the existing literature on two-sided markets focuses on platform pricing strategies for network expansion, it pays little attention to decisions that involve high levels of innovation. For this reason, the study investigates how platforms can strike a balance between these two decision alternatives, namely price and improved quality from innovation. This study examines the conditions under which platforms receive incentives to innovate in the presence of network externalities. We also examine how equilibrium is influenced by technological asymmetry between the competing platforms, and consumers’ and service providers’ multihoming (i.e., choosing between multiple options) behavior. We extend focus to a government policy perspective by studying how to subsidize innovations. Three different policies are considered: (1) subsidies for consumers, (2) subsidies for service providers, and (3) innovation-based subsidies for platforms. The scholarly and practical implications of our findings are discussed.