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Competing Across Technology-Differentiated Channels: The Impact of Network Externalities and Switching Costs

  • Siva Viswanathan

    ()

    (Decision and Information Technologies Department, The Robert H. Smith School of Business, University of Maryland, College Park, Maryland 20742)

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    Technology-driven commerce channels, such as the Web, possess several unique features that differentiate them from traditional channels. The interaction between firms operating across these differentiated channels involves interesting competitive dynamics that cannot be captured by isolated models of electronic markets. This paper develops a stylized spatial differentiation model to examine the impact of differences in channel flexibility, network externalities, and switching costs on competition between online, traditional, and hybrid firms. A basic model highlighting the moderating influence of the hybrid firm on both channels is extended to account for differential network externalities and switching costs across the two channels. Our analysis indicates that while network effects as well as switching costs lead to the tipping of markets, such tipping occurs primarily due to the moderating effects of the competing channel. More importantly, with network effects an increased market share does not translate into higher profits. Contradictory to conventional wisdom, our results indicate that in a static market, consumers rather than firms, benefit from increasing network externalities, with competitive effects outweighing the surplus-extraction abilities of firms. Our results also highlight the importance of alternative revenue streams and provide insights for firms grappling with issues of channel choice as well as integration and divestiture.

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    File URL: http://dx.doi.org/10.1287/mnsc.1040.0338
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    Article provided by INFORMS in its journal Management Science.

    Volume (Year): 51 (2005)
    Issue (Month): 3 (March)
    Pages: 483-496

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    Handle: RePEc:inm:ormnsc:v:51:y:2005:i:3:p:483-496
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    1. Michael Smith & Erik Brynjolfsson, 1999. "Frictionless Commerce? A Comparison of Internet and Conventional Retailers," Computing in Economics and Finance 1999 1022, Society for Computational 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.
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    5. Paul Klemperer, 1995. "Competition when Consumers have Switching Costs: An Overview with Applications to Industrial Organization, Macroeconomics, and International Trade," Review of Economic Studies, Oxford University Press, vol. 62(4), pages 515-539.
    6. Wernerfelt, Birger, 1985. "Brand loyalty and user skills," Journal of Economic Behavior & Organization, Elsevier, vol. 6(4), pages 381-385, December.
    7. Steven C. Salop, 1979. "Monopolistic Competition with Outside Goods," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 141-156, Spring.
    8. Katz, Michael L & Shapiro, Carl, 1986. "Technology Adoption in the Presence of Network Externalities," Journal of Political Economy, University of Chicago Press, vol. 94(4), pages 822-41, August.
    9. Sridhar Balasubramanian, 1998. "Mail versus Mall: A Strategic Analysis of Competition between Direct Marketers and Conventional Retailers," Marketing Science, INFORMS, vol. 17(3), pages 181-195.
    10. Cooper, Thomas E, 1989. "Indirect Competition with Spatial Product Differentiation," Journal of Industrial Economics, Wiley Blackwell, vol. 37(3), pages 241-57, March.
    11. Paul Klemperer, 1987. "The Competitiveness of Markets with Switching Costs," RAND Journal of Economics, The RAND Corporation, vol. 18(1), pages 138-150, Spring.
    12. Katz, Michael L & Shapiro, Carl, 1985. "Network Externalities, Competition, and Compatibility," American Economic Review, American Economic Association, vol. 75(3), pages 424-40, June.
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