Winners Take Some: The Impact of Conversion Technologies on Network Effects in Digital Goods Markets

Abstract

Both theoretical and empirical evidence suggest that, in markets with standards competition, strong network effects can make the strong grow stronger and even "tip" the market towards a single, winner-take-all standard. We theorize that the presence of conversion technologies will reduce the tendency towards market dominance in markets for digital goods. We develop three essays to explore this phenomenon within both an analytic and empirical framework.In essay 1 the results from a duopoly model confirm that the existence of a converter can mediate the network effects of a pre-existing installed base. A "winners-take-some" outcome that sustains competition after the entrant enters the market is more likely to arise with lower conversion costs. Surprisingly, higher quality conversion technology does not necessarily enhance the likelihood of the "winners-take-some" outcome.In essay 2 we endogenize the decision to provide a converter and incorporate explicit negotiations between firms concerning the extent of conversion. We find that the Subgame Perfect Nash Equilibrium involves firms' agreeing on providing converters at a sufficiently low price to all consumers. At this equilibrium, not only the entrant, but also the incumbent are better off since the provision of converters alleviates price competition and leads to both higher product v revenues and higher proceeds from the sale of converters. Moreover, under some circumstances the provision of converters is welfare enhancing.In essay 3 we empirically test our hypotheses in the context of the flash memory market where both network effects and high quality digital converters are present. Our results show that the availability of digital converters reduces the price premium of the leading flash card formats more than that of the minority formats. In addition, market concentration decreases as converters become more widely available. Our findings imply that producers of non-dominant standards are better off with the provision of conversion technology, as this technology tends to neutralize the impact of network effects.These findings have important implications for research and practice in IT standards competition and technology adoption as the introduction of conversion technologies provides an alternative mechanism to reduce the social costs of standardization without compromising the benefits of network effects.

Standards Competition in the Presence of Digital Conversion Technology: An Empirical Analysis of the Flash Memory Card Market

“…At the same time, new entrants are more likely to enter the market and to survive the standards war (Liu et al, 2007).…”