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Barriers to network-specific innovation

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Author Info
Antoine Martin
Michael J. Orlando

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Abstract

We consider an environment in which participants make payments over a network and can invest in a technology that reduces the marginal cost of using the network. A network effect results in multiple equilibria; either all agents invest and usage of the network is high or no agents invest and usage of the network is low. The high-usage equilibrium can be implemented through introduction of a coordinator. Under monopoly network ownership, however, fixed costs associated with use of the network-specific technology result in a hold-up problem that implements the low-investment equilibrium. And even where subsidies can avoid such hold-up, optimal monopoly pricing of network usage may avoid investment in the network-specific technology if demand for on-network transactions is sufficiently inelastic.

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Paper provided by Federal Reserve Bank of Kansas City in its series Research Working Paper with number RWP 04-11.

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Date of creation: 2004
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Handle: RePEc:fip:fedkrw:rwp04-11

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Keywords: Payment systems;

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    • Jean-Charles Rochet Author-Email: rochet@cict.fr Author-Workplace-Name: IDEI, University of Toulouse & Jean Tirole Author-Email: tirole@cict.fr Author-Workplace-Name: IDEI, University of Toulouse, 2006. "Two-Sided Markets: A Progress Report," RAND Journal of Economics, The RAND Corporation, vol. 37(3), pages 645-667, Autumn.
  2. Joseph Farrell & Garth Saloner, 1985. "Standardization, Compatibility, and Innovation," RAND Journal of Economics, The RAND Corporation, vol. 16(1), pages 70-83, Spring. [Downloadable!] (restricted)
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  3. Schiff, Aaron, 2003. "Open and closed systems of two-sided networks," Information Economics and Policy, Elsevier, vol. 15(4), pages 425-442, December. [Downloadable!] (restricted)
  4. Rochet, Jean-Charles & Tirole, Jean, 2003. "Platform Competition in Two-Sided Markets," IDEI Working Papers 152, Institut d'Économie Industrielle (IDEI), Toulouse. [Downloadable!]
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  5. Julian Wright, 2004. "The Determinants of Optimal Interchange Fees in Payment Systems," Journal of Industrial Economics, Blackwell Publishing, vol. 52(1), pages 1-26, 03. [Downloadable!] (restricted)
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  6. Klepper, Steven, 1996. "Entry, Exit, Growth, and Innovation over the Product Life Cycle," American Economic Review, American Economic Association, vol. 86(3), pages 562-83, June. [Downloadable!] (restricted)
  7. Katz, Michael L & Shapiro, Carl, 1985. "Network Externalities, Competition, and Compatibility," American Economic Review, American Economic Association, vol. 75(3), pages 424-40, June. [Downloadable!] (restricted)
  8. Klein, Benjamin, 1988. "Vertical Integration as Organizational Ownership: The Fisher Body-General Motors Relationship Revisited," Journal of Law, Economics and Organization, Oxford University Press, vol. 4(1), pages 199-213, Spring.
  9. Bengt Holmstrom, 1982. "Moral Hazard in Teams," Bell Journal of Economics, The RAND Corporation, vol. 13(2), pages 324-340, Autumn. [Downloadable!] (restricted)
  10. Cardillo, Matthew & Martin, Antoine & Orland0, Michael, 2004. "Innovation on networks: Coordination, governance, and the case of VISA," Journal of Financial Transformation, Capco Institute, vol. 12, pages 104-106.
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