Two-Sided Network Effects: A Theory of Information Product Design

Geoffrey G. Parker () and Marshall W. Van Alstyne ()
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Geoffrey G. Parker: Tulane University, New Orleans, Louisiana 70118
Marshall W. Van Alstyne: Boston University, and Massachusetts Institute of Technology, Boston, Massachusetts 02215

Management Science, 2005, vol. 51, issue 10, 1494-1504

Abstract: How can firms profitably give away free products? This paper provides a novel answer and articulates trade-offs in a space of information product design. We introduce a formal model of two-sided network externalities based in textbook economics---a mix of Katz and Shapiro network effects, price discrimination, and product differentiation. Externality-based complements, however, exploit a different mechanism than either tying or lock-in even as they help to explain many recent strategies such as those of firms selling operating systems, Internet browsers, games, music, and video. The model presented here argues for three simple but useful results. First, even in the absence of competition, a firm can rationally invest in a product it intends to give away into perpetuity. Second, we identify distinct markets for content providers and end consumers and show that either can be a candidate for a free good. Third, product coupling across markets can increase consumer welfare even as it increases firm profits. The model also generates testable hypotheses on the size and direction of network effects while offering insights to regulators seeking to apply antitrust law to network markets.

Keywords: network effects; network externalities; two-sided markets; free information; business models; strategic complements; product design (search for similar items in EconPapers)
Date: 2005
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Citations: View citations in EconPapers (395)

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Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:51:y:2005:i:10:p:1494-1504

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