The chilling effects of network externalities

Abstract

Conventional wisdom suggests that network effects should drive faster market growth due to the bandwagon effect. However, as we show, network externalities may also create an initial slowdown effect on growth because potential customers wait for early adopters, who provide them with more utility, before they adopt. In this study, we explore the financial implications of network externalities by taking the entire network process into account. Using an agent-based as well as an aggregate-level model, and separating network effects from word of mouth, we find that network externalities have a substantial chilling effect on the net present value associated with new products. This effect may occur not only in a competitive framework, such as a competing standards scenario, but also in the absence of competition. Drawing on the collective action literature in order to relate network effects to individual consumer threshold levels, we find that the chilling effect is stronger with a small variability in the threshold distribution, and is especially affected by the process early on in the product life cycle. We also find a "hockey stick" growth pattern by empirically examining the growth of fax machines, CB radios, CD players, DVD players, and cellular services.

Linking Consumer Opinions with Reservation Prices in an Agent-Based Model of Innovation Diffusion

“…We have demonstrated that when the discontinuation of adoption is allowed then two different faces of WOM, positive and negative, are revealed. This outcome expands the findings of [2], who discussed only the negative impact of WOM.…”

“…The diffusion process of innovative products has been studied in the literature from various perspectives, including the impact of consumer heterogeneity, the role of social influence and the effectiveness of promotion and advertisement [1][2][3]. In this paper we extend a relatively simple, yet sufficiently rich agent-based model of opinion formation [4,5] by linking the opinions of potential consumers with their market behavior via the concept of the reservation price, i.e.…”

“…We focus on word-of-mouth (WOM) as the core social interaction, because it has been found to have a powerful influence on consumer behavior [2]. Empirical results indicate that there are two types of WOM: positive that enhances the diffusion by providing positive information about the product in the social network and negative that spreads the negative information about the product and limits diffusion [7,8].…”

Cellular Automata with network incubation in information technology diffusion

“…In economics, we mention, among others, Katz and Shapiro (1985), Cabral (1990), Katz and Shapiro (1986), Economides and Himmelberg (1995),and Grajek (2002). In marketing science there are interesting integrated contributions by Goldenberg et al (2005), Srinivasan et al (2004), Rahmandad and Sterman (2004), and Shuster (1998), and general review agendas by Hauser et al (2006) and Muller et al (2007). In sociological and statistical sciences there are interesting advances that emphasise some social and multiphase aspects of diffusion under network effects.…”

“…In order to consider the incubation or chilling effect of network externalities (see, for instance, Goldenberg et al (2005)) we propose a general model based on a Cellular Automata representation which describes an adoption process depending on a dynamic market potential generated by heterogeneous individual thresholds. For successful network goods we may argue, at the aggregate level, that the market potential is characterised by a local depression which describes a change-point time, t, separating two different regimes: a long preliminary incubation period followed by a sudden take-off associated with the attainment of a positive critical mass.…”