Overview of Network Overview of Network IndustriesIndustriesNien-Pen Liu

Main CharacteristicsMain CharacteristicsConsumption externalitiesComplements, compatibility and

standardsSwitching costs and lock-in Supply-side economies of scaleDifferentiation of products and

prices

Consumption externalitiesConsumption externalitiesDirect network effects

- The demand depends on how many other people purchase it- In general: fax, email

Indirect network effects- The more people that have DVDs, the more DVD-readable content will be provided

Direct network effectsDirect network effectsPositive feedbackMultiple equilibria

- Importance of expectations- The critical mass

Complements, compatibility Complements, compatibility and standardsand standardsComplements

- Definition: Commodity A complements commodity B if more of commodity A increases the value of an extra unit of commodity B- Examples: More software increases the value of a computer; More roads increase the value of a car

Information technologies have increased greatly the complementarities between commodities◦ Computers and operating systems (OS)◦ DVD players and DVD disks◦ Wi-Fi sites and laptop computers

How should a firm behave when it produces a commodity that complements another commodity?

The problem is: When you make more of your product (commodity A) you increase the value of firm B’s product (commodity B). Can you get for yourself some of gain you create for firm B?

The noncooperative firms ignore the external benefit (complementarity) each creates for the other. So each undersupplies the market, causing a higher market price.

These externalities are fully internalized in the merged firm, inducing it to supply more computers and OS and thereby cause a lower market price.

Alternatives include:- Collaborate- Negotiate- Nurture- Commoditize

Compatibility and standards- The problem of coordination- Mix and match

Switching costs and lock-Switching costs and lock-in in Cost of switching

- Compare Ford v. Toyota and Windows v. Linux- When very large, we have lock-in

Classification of the various lock-ins- Contracts- Training and learning- Data conversion- Search cost- Loyalty cost

Affecting price competition in two opposing ways

Supply-side economies of Supply-side economies of scalescaleHigh fixed sunk cost together

with almost negligible marginal cost- Declining average cost- Example: information goods

More concentrated industries- This may not be so bad for consumers as is often thought, why?- Competition to acquire monopoly- Reduction in fixed costs- Pressure from complementors

More advanced topicsMore advanced topicsPlatform pricing and competition

- Two-sided markets

- Focusing on this issue

Position Auctions - Internet advertising and the generalized second-

price auction

Conditioning on purchase history

Two-sided marketsTwo-sided marketsMany markets involve two groups

of who interact via “platforms”, where one group’s benefit from joining a platform depends on the size of the other group that joins the platform.

Examples of two-sided networks - Video games

- Web search

- Smart phone operating systems

- 7-11

Pricing the platform - Platform providers have to choose a price for each side,

factoring in the impact on the other side’s growth and willingness to pay.

- a “subsidy side,” a group of users who, when attracted in volume, are highly valued by the “money side,” the other user group

Some important factors - Ability to capture cross-side network effects

- User sensitivity to price

- User sensitivity to quality

- Output costs

- Same-side network effects

- Users’ brand value

Similar networks, different pricing

- PC vs. video games

The threat of envelopment - The real damage comes when your new rival offers

your platform’s functionality as part of a multiplatform bundle.

Thanks for listening.