What is a Two-Sided Market

A two-sided market occurs when two user groups or agents interact through an intermediary or platform to the benefit of both parties. Also known as a "two-way market" or a "two-sided network," examples of two-sided markets are seen in a variety of industries and companies. One example is in the relationship between market-makers (specialists), who are required to give both a firm bid and firm ask for each security in which they make a market (acting as intermediaries), and buyers and sellers of securities.

Breaking Down Two-Sided Market

A two-sided market can create value by simplifying and accelerating transactions, as well as lower their cost for the parties it connects. As a two-sided network grows, successful platforms are able to scale. Users, seeing a larger potential marketplace, will then pay a higher price to access the platform. Two-sided marketplaces have an advantage over traditional one-sided markets (often found in service or manufacturing-oriented businesses), which at some point experience diminishing returns on market growth (customer acquisition).

A two-sided market is often defined by the relationship the intermediary has with the external groups or agents on its platform. This relationship is seen in pricing in particular. Those that oversee platforms must maintain equilibrium between both sides of the network, sometimes subsiding the more price-sensitive side and charging higher prices to the side that stands to gain the most from the platform's success. It should be noted that any change to one side of the market will change the pricing on the other side, known the "waterbed effect."

Two-Sided Market Examples

Two-sided markets exist in various industries, serving the interest of manufacturers, retailer, service providers and consumers. A classic example is the yellow pages telephone directory, which serves consumers and advertisers. Credit card companies, which act as an intermediary between card-holding consumers and merchants, and video-game platforms, such as Microsoft's Xbox or Sony's PlayStation, which offer a platform that video-game developers and gamers benefit from, are examples of two-sided markets. Some modern companies that illustrate this relationship include Match.com, Facebook, LinkedIn and eBay. Some, such as Amazon.com, employ both a two-sided market and a one-sided market.

Two-Sided Markets and Trading

In the financial world, "two-sided market' is mainly used in the context of the Financial Industry Regulatory Authority (FINRA) requirement that market makers give both a firm bid and firm ask for each security in which they make a market. This term can also be applied in the bond market. For example, some broker-dealers make two-sided markets on larger, actively traded bonds and rarely make a two-sided market in inactively traded bonds. The theory is that this helps to enhance liquidity and market efficiency.