Adoption of Information Technology Under Network Effects

Abstract

Because information technologies are often characterized by network effects, compatibility is an important issue. Although total network value is maximized when everyone operates in one compatible network, we find that the technology benefits for the users depend on vendor incentives, which are driven by the existence of “de facto” or “de jure” standards. In head-to-head competition, customers are better off “letting a thousand flowers bloom,” fostering fierce competition that results in a de facto standard if users prefer compatibility over individual fit, or a split market if fit is more important. In contrast, firms that sponsor these products are better off establishing an up-front, de jure standard to lessen the competitive effects of a network market. However, if a firm is able to enter the market first by choosing a proprietary/incompatible technology, it can use a “divide-and-conquer” strategy to increase its profit compared with head-to-head competition, even when there are no switching costs. When there is a first mover, the early adopters, who are “locked in” because of switching costs, never regret their decision to adopt, whereas the late adopters, who are not subject to switching costs, are exploited by the incumbent firm. In head-to-head competition, customers are unified in their preference for incompatibility when there is a first mover; late adopters prefer de jure compatibility because they bear the brunt of the first-mover advantage. This again underscores the interdependence of user net benefits and vendor strategies.

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