Fragility of two-sided markets

Two-sided markets are inherently fragile for participation of each side depends on a certain degree of confidence in participation on the other side. Thus, small negative shocks can lead to quick downward spirals.

Following the ill-advised ban on Uber and other taxi aggregators in four Indian states (Delhi, Karnataka, Andhra Pradesh, Telangana), business for drivers who ply their services via such apps has dropped significantly. While on first inspection you might expect it to go to zero (given their services have been banned), the fact that enforcement is tough (there is nothing to identify a cab as “belonging to Uber”) means that apart from Delhi (where Uber has pulled its services) these cabs continue to ply.

In the days after the ban, various news reports have interviewed drivers who ply for Uber who complain about drastically reduced services. While numbers vary from report to report, the general sense is that so far the number of trips per driver per day has fallen by half. And I expect this to fall further unless drastic steps are taken – such as issuance of new regulations or removal of the ban.

In a “normal” market (where the owner of the market is also a participant), when demand for a particular good drops, price is expected to fall and availability is expected to increase. If demand for a particular item that you have in stock drops, you need to take steps to get rid of the excess inventory that you have. You are most likely to indulge in discounting or other such promotional activities, in order to make it more attractive for the buyers to buy, and thus take the inventory off your shelves.

In a “two-sided market” (one where the owner of the market is not a participant), however, things work differently. It is a popular saying that in such markets “demand creates its own supply”. A corollary to that is that “lack of demand creates lack of supply”. Let us take the case of Uber itself. Over the last few days, irrespective of whether the ban on the service is official or not, legal or not, the number of people who have been requesting for the service has dropped.

Now, if you are a driver using the app, you realise that your potential revenues and profits from continuing to use the app are not as high as they used to be. Thus, if there are other avenues for you to make money, you are now more likely to take those avenues rather than logging on to Uber (since the “hurdle rate” for such a switch is now lower thanks to lower Uber revenues). As many of you take the same route, the availability of cabs on Uber also drops – something that I’ve seen anecdotally over the last few days. And when availability of Uber cabs drops beyond a point, I start questioning my trust in the service – a week ago I would be confident that I would be able to hail an Uber from anywhere in Bangalore with very high confidence; that confidence has now dropped. And when my trust in the service drops, I start using it less, and when many of us do that, drivers see less demand and more of them pull away from the market. And this results in a vicious cycle.

Notice that things would work very differently had Uber been a “traditional” taxi service which owned its cabs and employed its drivers. In that case, falling demand would have been met with a response that would have made it easier for customers to buy – price cuts, perks, etc.

The point is that platforms or two-sided markets are inherently fragile, and highly dependent on confident in the system. I leave my car at home only if I have enough trust in the taxi platforms that I’ll be able to get a cab when I need one. A driver will forsake other trips and switch on his Uber app only if he is confident that he can get enough rides through the app.

The same network effects that can lead to a rapid ramp-up in two-sided markets can also lead to its downfall. All it takes is a small trigger that leads to loss of confidence in the service from one side. Unless that loss of confidence is quickly addressed, the “positive feedback” from it can quickly escalate and the market grinds to a halt!

Another good example of lack of confidence killing two-sided markets is in the market for CDOs and associated derivatives in 2007-08. There were standardised pricing models for such products and a vibrant market existed (between sophisticated financial institutions) in 2007. When house prices started coming down, some people started expressing doubts in such models. Soon, this led to massive loss of trust in the pricing models that underpinned such markets and people stopped trading. This meant companies were unable to mark their securities to market or rationalise their portfolios, and this led to the full-blown 2008 financial crisis!

So when you build a platform, you need to make sure that both sides of the market retain confidence in your platform. For in the platforms business loss of confidence can lead to a much quicker fall than in “traditional” markets. This dependence on confidence thus makes such markets fragile.

The Personality Cult

So all business newspapers report that LK Advani had issued a “warning” to Yeddyurappa a while back that he was getting too corrupt. Nevertheless, several BJP “party workers” in Karnataka have been coming out in defence of Yeddy, saying he’s innocent and that he’s still their leader. Some of them have refused to accept the leadership of DV Sadananda Gowda. And some of the leaders themselves are quite silent on the issue, preferring to say that the “law will take its own course”.

This points to a larger problem that is afflicting Indian politics nowadays which is the “personality cult”. First of all, we have several parties (too many to name here) where the only ideology is “absolute loyalty to a certain party leader”. Even in parties that don’t fall under this definition (the BJP for instance), we seem to have several “local leaders” who carry significant weight, and local units of parties that are more loyal to their leaders than to the parties. In fact, if you were to objectively look at it, as a voter there seems to be no escape at all from this cult.

This has several disturbing consequences. One stems from the belief that “loyalty should be rewarded”. Given the loyalty that so many of our “leaders” get from “party workers” it is not surprising that the “leaders”, upon assuming power, accord to these workers plum rent-seeking posts, which will keep them happy. This can result in positive feedback – once a leader has shown that he ¬†will “reward” loyalists, more people clamour to get close to him, and they too must get rewarded. And so it goes.

Another fallout of this personality cult is a dramatic increase in security, with not inconsiderable cost to the public. Given t he power that some of our “leaders” wield, the payoffs of bumping off an opposing leader are quite strong, both in terms of electoral politics and otherwise. Parties which have been built on “personal loyalty” as an “ideology”, upon losing their leaders, will suddenly have no “natural centre” and will tend to fragment. Hence, it is in the interest of all politicians to provide themselves “security”, which comes at the cost of the general public (cue traffic jams whenever there is “VIP movement” in some city, or the fact that our generally under-staffed police force has to spend so much of its effort in “VIP security” rather than other more important policing duties).

Then, we seem to be moving to a situation where parties are bereft of ideologies, and are simply collections of random leaders (who have lots of “followers”) thrown together. I’ll probably address this in detail in another post, but if you come to think of it there is very little to choose between different political parties now in terms of ideology. Yes, the BJP might have the nominal ideology of building a Ram Temple, but take that out and there is little to separate it from the Congress. The regional parties are even worse. The only difference you could probably see there is in terms of the dominant caste or lobby backing each party.

Again, it needs to be pointed out that multipolar politics in India is very young – it’s existed for little more than twenty years. Still, the future of Indian politics is worrisome, and I don’t know how we’ll get out of the rut we’re in.