Digital business models and quality investment

In this paper, we study the competition between two horizontally differentiated digital platforms. Each platform can adopt either a user-funded or an ad-funded business model. The platforms also invest in service quality to attract users. We find that which business model is more conducive to quality investment depends on the relative value of the platforms' services to the marginal multi-homing user compared to the value of the marginal user to advertisers. From a consumer welfare perspective, in equilibrium, platforms tend to adopt the user-funded business model too often and insufficiently differentiate their business models. Our results also show that regulatory interventions in digital markets aiming at mitigating market power of ad-tech firms or improving privacy protection can induce shifts in business models, with potentially ambiguous effects on consumer welfare.