Transcript Overview of Network Industries

Overview of Network
Industries
Nien-Pen Liu
Main Characteristics
Consumption externalities
 Complements, compatibility and
standards
 Switching costs and lock-in
 Supply-side economies of scale
 Differentiation of products and prices

Consumption externalities

Direct network effects
- The demand depends on how many other people purchase it
- In general: fax, email

Indirect network effects
- The more people that have DVDs, the more DVD-readable
content will be provided
Direct network effects
Positive feedback
 Multiple equilibria

- Importance of expectations
- The critical mass
Complements, compatibility and
standards

Complements
- Definition: Commodity A complements commodity B if more of
commodity A increases the value of an extra unit of commodity B
- Examples: More software increases the value of a computer; More
roads increase the value of a car

Information technologies have increased
greatly the complementarities between
commodities
◦ Computers and operating systems (OS)
◦ DVD players and DVD disks
◦ Wi-Fi sites and laptop computers
How should a firm behave when it
produces a commodity that complements
another commodity?
 The problem is: When you make more of
your product (commodity A) you increase
the value of firm B’s product (commodity
B). Can you get for yourself some of gain
you create for firm B?

The noncooperative firms ignore the
external benefit (complementarity) each
creates for the other. So each
undersupplies the market, causing a higher
market price.
 These externalities are fully internalized
in the merged firm, inducing it to supply
more computers and OS and thereby
cause a lower market price.


Alternatives include:
- Collaborate
- Negotiate
- Nurture
- Commoditize

Compatibility and standards
- The problem of coordination
- Mix and match
Switching costs and lock-in

Cost of switching
- Compare Ford v. Toyota and Windows v. Linux
- When very large, we have lock-in

Classification of the various lock-ins
- Contracts
- Training and learning
- Data conversion
- Search cost
- Loyalty cost

Affecting price competition in two
opposing ways
Supply-side economies of scale

High fixed sunk cost together with almost
negligible marginal cost
- Declining average cost
- Example: information goods

More concentrated industries
- This may not be so bad for consumers as is often thought, why?
- Competition to acquire monopoly
- Reduction in fixed costs
- Pressure from complementors
More advanced topics

Platform pricing and competition
- Two-sided markets
- Focusing on this issue

Position Auctions
- Internet advertising and the generalized second-price auction

Conditioning on purchase history
Two-sided markets
Many markets involve two groups of who
interact via “platforms”, where one group’s
benefit from joining a platform depends
on the size of the other group that joins
the platform.
 Examples of two-sided networks

- Video games
- Web search
- Smart phone operating systems
- 7-11

Pricing the platform
- Platform providers have to choose a price for each side, factoring
in the impact on the other side’s growth and willingness to pay.
- a “subsidy side,” a group of users who, when attracted in volume,
are highly valued by the “money side,” the other user group

Some important factors
- Ability to capture cross-side network effects
- User sensitivity to price
- User sensitivity to quality
- Output costs
- Same-side network effects
- Users’ brand value

Similar networks, different pricing
- PC vs. video games

The threat of envelopment
- The real damage comes when your new rival offers your
platform’s functionality as part of a multiplatform bundle.
Thanks for listening.