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  • *We should like to thank the Editor and two anonymous referees whose comments and suggestions greatly improved the exposition of this paper. We also thank Christa Hainz, Monika Schnitzer, Jean Tirole, Thomas A. Weber and participants at the University of Toulouse, the 2nd CEPR School in Applied Industrial Organization, the Kiel-Munich Workshop, the SFB Transregio IO Summer School and the 3. Media Workshop for helpful comments and suggestions. Richard Schmidtke is grateful for financial support from the ‘Kurt Fordan Förderverein’. Parts of this paper were written while Richard Schmidtke visited the University of Toulouse which he thanks for its hospitality and support. Financial support from the Deutsche Forschungsgemeinschaft through SFB/TR 15 is also gratefully acknowledged.


The existing literature on two-sided markets addresses participation externalities, but it has neglected pecuniary externalities between platforms. In this paper we build a model that incorporates both externalities. In our set-up, differentiated platforms compete in advertising levels and offer consumers a service free of charge that is financed through advertising. We show that advertising can exhibit the properties of a strategic substitute or complement. Surprisingly, we find that platform profits can increase with market entry and that there are cases in which the level of advertising rises with entry. We also consider endogenous entry and provide a welfare analysis.