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Network Effects, Pricing Strategies, and Optimal Upgrade Time in Software Provision

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  • Yi-Nung Yang

    (Department of Economics at Utah State University)

Abstract

There are many products which have little or no value in isolation, but if combined with other products or services, they generate more value. The utility that a given user derives from these products depends upon the number of other users who consume the same products. This kind of positive consumption externality is defined as a network externality. Network externalities are pervasive in the computer in the computer software market. While software vendors consider pricing strategies, they must also take into account the impact of network externalities on their sales. Our main interest in this paper is to describe the firm's strategies and behavior in the presence of network externalities. Based on the two-stage model in this paper, we find that the software firm will charge a lower price to attract more users in the first stage, then charge a higher price as it does in monopoly as traditional economic theory indicates. And our dynamic model shows that the optimal upgrade time occurs when gross profit of the first edition equals the gross profit of the second edition of the software. This implies that either too earlier or late promotion of the new software version will causes profit loss.

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Bibliographic Info

Paper provided by EconWPA in its series Industrial Organization with number 9602001.

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Length: 15 pages
Date of creation: 10 Feb 1996
Date of revision:
Handle: RePEc:wpa:wuwpio:9602001

Note: Type of Document - MS Word 2.0; prepared on IBM PC; to print on HP; pages: 15 ; figures: included. Word for Windows 2.0 document submitted via ftp
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Related research

Keywords: network externalities; software; upgrade;

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References

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  1. Joseph Farrell & Garth Saloner, 1986. "Installed Base and Compatibility, With Implications for Product Preannouncements," Working papers 411, Massachusetts Institute of Technology (MIT), Department of Economics.
  2. Stanley M. Besen & Joseph Farrell, 1994. "Choosing How to Compete: Strategies and Tactics in Standardization," Journal of Economic Perspectives, American Economic Association, vol. 8(2), pages 117-131, Spring.
  3. Choi, J.P., 1991. "Network Externality, Compatibility Choice, and Planned Obsolescence," Discussion Papers 1991_67, Columbia University, Department of Economics.
  4. Katz, Michael L & Shapiro, Carl, 1985. "Network Externalities, Competition, and Compatibility," American Economic Review, American Economic Association, vol. 75(3), pages 424-40, June.
  5. Kathleen Reavis Conner & Richard P. Rumelt, 1991. "Software Piracy: An Analysis of Protection Strategies," Management Science, INFORMS, vol. 37(2), pages 125-139, February.
  6. Neil Gandal, 1994. "Hedonic Price Indexes for Spreadsheets and an Empirical Test for Network Externalities," RAND Journal of Economics, The RAND Corporation, vol. 25(1), pages 160-170, Spring.
  7. Birger Wernerfelt, 1986. "A Special Case of Dynamic Pricing Policy," Management Science, INFORMS, vol. 32(12), pages 1562-1566, December.
  8. S. J. Liebowitz & Stephen E. Margolis, 1994. "Network Externality: An Uncommon Tragedy," Journal of Economic Perspectives, American Economic Association, vol. 8(2), pages 133-150, Spring.
  9. Church, Jeffrey & Gandal, Neil, 1992. "Network Effects, Software Provision, and Standardization," Journal of Industrial Economics, Wiley Blackwell, vol. 40(1), pages 85-103, March.
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