Network Effects, Nonlinear Pricing and Entry Deterrence
A number of products that display positive network effects are used in variable quantities by heterogeneous customers. Examples include corporate operating systems, infrastructure software, web services and networking equipment. In many of these contexts, the magnitude of network effects are influenced by gross consumption, rather than simply by user base. Moreover, the value an individual customer derives on account of these network effects may be related to the extent of their individual consumption, and therefore, the network effects may be heterogeneous across customers. This paper presents a model of nonlinear pricing in the presence of such network effects, under incomplete information, and with the threat of competitive entry. Both homogeneous and heterogeneous network effects are modeled. Conditions under which a fulfilled-expectations contract exists and is unique are established. While network effects generally raise prices, it is shown that accompanying changes in consumption depend on the nature of the network effects -- in some cases, it is optimal for the monopolist to induce no changes in usage across customers, while in others cases, network effects raise the usage of all market participants. Optimal pricing is shown to include quantity discounts that increase with usage, and may also involve a nonlinear two-part tariff. These results highlight the impact of network effects on the standard trade-off between price discrimination and value creation, and have important implications for pricing policy. The threat of entry generally lowers profits for the monopolist, and increases customer surplus. When network effects are homogeneous across customers, the resulting entry-deterring monopoly contract is a fixed fee and results in the socially optimal outcome. However, when the magnitude of heterogeneous network effects is relatively high, there are no changes in total surplus induced by the entry threat, and the price changes merely cause a transfer of value from the seller to its customers. The presence of network effects, and of a credible entry threat, are also shown to increase distributional efficiency by reducing the disparity in relative value captured by different customer types. Regulatory and policy implications of these results are discussed.
|Date of creation:||22 Jul 2003|
|Note:||Type of Document - PDF; prepared on Windows NT; pages: 40 ; figures: included|
|Contact details of provider:|| Web page: http://econwpa.repec.org|
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Jullien, Bruno, 2000. "Competing in Network Industries: Divide and Conquer," IDEI Working Papers 112, Institut d'Économie Industrielle (IDEI), Toulouse, revised Jul 2001.
- Stole, Lars A, 1995. "Nonlinear Pricing and Oligopoly," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 4(4), pages 529-562, Winter.
- Nicholas Economides, 1997.
"The Economics of Networks,"
Brazilian Electronic Journal of Economics,
Department of Economics, Universidade Federal de Pernambuco, vol. 1(0), December.
- Economides, Nicholas, 1996. "The economics of networks," International Journal of Industrial Organization, Elsevier, vol. 14(6), pages 673-699, October.
- Nicholas Economides, 1995. "The Economics of Networks," Working Papers 94-24, New York University, Leonard N. Stern School of Business, Department of Economics, revised Sep 1995.
- Nicholas Economides, 1997. "The Economics of Networks," Industrial Organization 9701002, EconWPA.
- Arun Sundararajan, 2003. "Nonlinear pricing of information goods," Industrial Organization 0307003, EconWPA.
- Erik Brynjolfsson & Chris F. Kemerer, 1996. "Network Externalities in Microcomputer Software: An Econometric Analysis of the Spreadsheet Market," Management Science, INFORMS, vol. 42(12), pages 1627-1647, December.
- Erik Brynjolfsson & Chris F. Kemerer, 1993. "Network Externalities in Microcomputer Software: An Econometric Analysis of the Spreadsheet Market," Working Paper Series 158, MIT Center for Coordination Science.
- Jean-Charles Rochet & Lars A. Stole, 2002. "Nonlinear Pricing with Random Participation," Review of Economic Studies, Oxford University Press, vol. 69(1), pages 277-311.
- Economides, Nicholas, 1996. "Network externalities, complementarities, and invitations to enter," European Journal of Political Economy, Elsevier, vol. 12(2), pages 211-233, September.
- Nicholas Economides, 1997. "Network Externalities, Complementarities, and Invitations to Enter," Industrial Organization 9701004, EconWPA.
- Cabral, Luis M. B. & Salant, David J. & Woroch, Glenn A., 1999. "Monopoly pricing with network externalities," International Journal of Industrial Organization, Elsevier, vol. 17(2), pages 199-214, February.
- Luis Cabral & David Salant & Glenn Woroch, 1994. "Monopoly Pricing With Network Externalities," Industrial Organization 9411003, EconWPA.
- A. Michael Spence, 1977. "Entry, Capacity, Investment and Oligopolistic Pricing," Bell Journal of Economics, The RAND Corporation, vol. 8(2), pages 534-544, Autumn.
- Jean-Charles Rochet & Philippe Chone, 1998. "Ironing, Sweeping, and Multidimensional Screening," Econometrica, Econometric Society, vol. 66(4), pages 783-826, July.
- Katz, Michael L & Shapiro, Carl, 1985. "Network Externalities, Competition, and Compatibility," American Economic Review, American Economic Association, vol. 75(3), pages 424-440, June.
- Sanjeev Dewan & Haim Mendelson, 1990. "User Delay Costs and Internal Pricing for a Service Facility," Management Science, INFORMS, vol. 36(12), pages 1502-1517, December.
- Gandal, Neil, 1995. "Competing Compatibility Standards and Network Externalities in the PC Software Market," The Review of Economics and Statistics, MIT Press, vol. 77(4), pages 599-608, November.
- Mandy, David M, 1992. "Nonuniform Bertrand Competition," Econometrica, Econometric Society, vol. 60(6), pages 1293-1330, November.
- Shmuel S. Oren & Stephen A. Smith & Robert B. Wilson, 1982. "Nonlinear Pricing in Markets with Interdependent Demand," Marketing Science, INFORMS, vol. 1(3), pages 287-313. Full references (including those not matched with items on IDEAS)
When requesting a correction, please mention this item's handle: RePEc:wpa:wuwpio:0307002. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (EconWPA)
If references are entirely missing, you can add them using this form.