Trick or Treat? The Effects of Online App Platforms’ Tiered Commission Schemes on Innovation, Entry, and Profits

Online app platforms often charge developer firms commissions based on revenue tiers, moving beyond the traditional flat-rate schemes. Platforms like Steam have implemented an "upward" scheme, lowering rates for higher-earning firms to reward high performers and encourage innovation, while others like Apple have adopted a "downward" scheme, charging lower rates to lower-earning firms to support small businesses. These contrasting approaches raise key questions: How should a platform design its commission scheme? How does it impact the platform’s profits compared to the flat-rate scheme, and what are the implications for market entry, innovation, and profitability among firms with different levels of capabilities? Using a game-theoretic model involving a platform and two firms with differing innovation capabilities (i.e., high- and low-types), we find that the downward scheme is optimal only under specific conditions: When the entry cost is moderately high (requiring additional support for the low-type firm) and the innovation capability gap between firms is relatively narrow (making it feasible to provide the support). In most other cases, the upward scheme is more beneficial for the platform.  While the tiered scheme may seem to encourage entry by offering lower commission rates, we find tiered schemes may actually discourage the entry of the low-type firm. Additionally, the upward scheme's effect on firms' incentives to innovate may vary, potentially leading to a decline in quality. Interestingly, even with a better commission rate and increased effort in innovation, firms’ profits may suffer under tiered schemes. By contrast, tiered schemes offer the platform additional strategic levers compared to the flat-rate scheme, enabling it to extract more surplus from firms, which consistently leaves the platform better off with tiered schemes. We explain the mechanisms behind these findings, offering both theoretical insights and practical implications. Our in-depth analysis of different tiered schemes uncovers the dynamics at play, offering a new perspective to evaluate industry claims and market forecasts.