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Compatibility and Market Structure for Network Goods

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  • Nicholas Economides
  • Fredrick Flyer

Abstract

This paper analyzes the economics of industries where network externalities are significant. In such industries, firms have strong incentives to adhere to common technical compatibility standards, so that they reap the network externalities of the whole group. However, a firm also benefits from producing an incompatible product thereby increasing its horizontal product differentiation. We show how competition balances these opposing incentives. We find that market equilibria often exhibit extreme disparities in sales, output prices, and profits across firms, despite no inherent differences in the firms' production technologies. This may explain the frequent domination of network industries by one or two firms. We also find that the presence of network externalities dramatically affects conventional welfare analysis, as total surplus in markets where these externalities are strong is highest under monopoly and declines with entry of additional firms.

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File URL: http://raven.stern.nyu.edu/networks/98-02.pdf
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Bibliographic Info

Paper provided by New York University, Leonard N. Stern School of Business, Department of Economics in its series Working Papers with number 98-02.

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Date of creation: Nov 1997
Date of revision:
Handle: RePEc:ste:nystbu:98-02

Contact details of provider:
Postal: New York University, Leonard N. Stern School of Business, Department of Economics, 44 West 4th Street, New York, NY 10012-1126
Phone: (212) 998-0860
Fax: (212) 995-4218
Web page: http://w4.stern.nyu.edu/economics/
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Related research

Keywords: networks; network externalities; coalition structures; technical standards; compatibility;

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Cited by:
  1. Jiawei Chen & Ulrich Doraszelski & Joseph E. Harrington, Jr., 2009. "Avoiding market dominance: product compatibility in markets with network effects," RAND Journal of Economics, RAND Corporation, vol. 40(3), pages 455-485.
  2. Clements, Matthew T., 2004. "Direct and indirect network effects: are they equivalent?," International Journal of Industrial Organization, Elsevier, vol. 22(5), pages 633-645, May.
  3. Christian Wey, 1999. "Compatibility Investments in Duopoly with Demand Side Spillovers under Different Degrees of Cooperation," CIG Working Papers FS IV 99-02, Wissenschaftszentrum Berlin (WZB), Research Unit: Competition and Innovation (CIG), revised Aug 1999.
  4. Fabio Maria Manenti & Ernesto Somma, 2002. "One-Way Compatibility, Two-Way Compatibility and Entry in Network Industries," series 0004, Dipartimento di Scienze Economiche e Metodi Matematici - Università di Bari, revised Jan 2002.
  5. Sam Chandan & Christiaan Hogendorn, 2001. "The Bucket Brigade Pricing And Network Externalities In Peer-To-Peer Communications Networks," Wesleyan Economics Working Papers 2001-001, Wesleyan University, Department of Economics.
  6. Matthew Mitchell & Andrzej Skrzypacz, 2006. "Network externalities and long-run market shares," Economic Theory, Springer, vol. 29(3), pages 621-648, November.
  7. Baake, Pio & Boom, Anette, 2001. "Vertical product differentiation, network externalities, and compatibility decisions," International Journal of Industrial Organization, Elsevier, vol. 19(1-2), pages 267-284, January.
  8. Guibourg, Gabriela, 2001. "Interoperability and Network Externalities in Electronic Payments," Working Paper Series 126, Sveriges Riksbank (Central Bank of Sweden).

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