Understanding Network Effects in Software Markets: Evidence from Web Server Pricing1

John M. Gallaugher

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Digital Platforms and Economics Consumer Market Behavior and Pricing Open Source Software Innovations

Abstract

Prior theoretical research has established that many software products are subject to network effects and exhibit the characteristics of two-sided markets. However, despite the importance of the software industry to the world economy, few studies have attempted to empirically examine these characteristics, or several others which theory suggests impact software price. This study develops and tests a research-grounded model of two-sided software markets that accounts for several key factors influencing software pricing, including network externalities, cross-market complementarities, standards, mindshare, and trial-ability. Applying the model to the context of the market for Web server software, several key findings are offered. First, a positive market share to price relationship is identified, offering support for the network externalities hypothesis even though the market examined is based on open standards. Second, the results suggest that the market under study behaves as a two-sided market in that firms able to capture market share for one product enjoy benefits in terms of both market share and price for the complement. Third, the positive price benefits of securing consumer mindshare, of supporting dominant standards, and from offering a trial product are demonstrated. Last, a negative price shock is also identified in the period after a well-known, free-pricing rival has entered the market. Nonetheless, network effects continued to remain significant during the period. These findings enhance our understanding of software markets, offer new techniques for examining such markets, and suggest the wisdom of allocating resources to develop advantages in the factors studied.

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2019Diffusion of Innovations 1 1989User Acceptance of Computer Technology: A Comparison of Two Theoretical Models 1978Social Learning Theory.1991Development of an Instrument to Measure the Perceptions of Adopting an Information Technology Innovation 1985Network externalities, competition, and compatibility 1985Clio and the economics of QWERTY 2003Platform Competition in Two-Sided Markets 1982Contestable Markets and the Theory of Industry Structure

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