Durable Goods Monopoly with Network Externalities with Application to the PC Operating Systems Market

Abstract

We analyze a model of multi-period monopoly in durable goods. Taking into consideration the special conditions of software markets, we assume that there are no used software markets and that manufacturers stop selling older software when they introduce a replacement model. We show that nominal as well as discounted (real) prices decrease over time but are above cost, thereby violating the Coase conjecture. In contrast, when "new" durable goods are introduced by the monopolist which are only partially compatible with "old" durable goods, prices may increase over time. This occurs when the intensity of network externalities arising from weak partial forward compatibility (influencing the demand of the old good from sales of the new one) is low compared to the intensity of network externalities arising from partial backward compatibility (influencing the demand of the new good from sales of the old one). A new product introduced by an entrant is successful only when it has strong externalities arising from forward compatibility. In this case, the entrant and the incumbent have opposite incentives regarding the degree of forward compatibility of the new product (that defines the extent of network externalities of the old product on consumers of the new one).

Optimal Bundling of Technological Products with Network Externality

“…is the demand for the bundle. This additive formulation is consistent with studies such as Choi (1994, p. 169), Economides (2000, p. 4) and Farrell and Saloner (1986, p. 944 Economides (2000), Haruvy and Prasad (1998) and Katz and Shapiro (1986), that consumers have perfect foresight (i.e., rational expectations) about equilibrium demand.…”

“…We specify it as n i D i , i.e., as a linear function of the market demand D i for product i. Parameter n i (n i ≥ 0) captures the degree of network externality for product i. This linear form and product-specific network parameter assumptions are commonly used (e.g., Economides 2000;Padmanabhan, Rajiv, and Srinivasan 1997).…”

A model of the dynamics of the market of COTS software, in the absence of new entrants

“…There is a positive feed back between the OS and the applications, the more OSs are sold there is more incentive for the applications developers to develop new and different applications. As the number of available applications grows for a particular OS, the value of the OS increases, as more users are willing to buy that particular OS, this is called the "network externality" or "network effect" (Economides 2000). Therefore, the value of the software product is strongly influenced by its "network externalities."…”

A Cost Model of Open Source Software Adoption

“…than having a telephone in a network of 1 billion telephones already installed. In particular "network effects," often cause "lock-in" situations (Katz & Shapiro, 1994;Economides 2000). More generally, an organization is locked into using a product by a complex combination of technical connectivity issues and liability and contractual agreements that bind it to a specific supplier, brand, or vendor even for future investments.…”