nep-net New Economics Papers
on Network Economics
Issue of 2006‒10‒28
seven papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Coordination and Lock-In: Competition with Switching Costs and Network Effects By Farrell, Joseph; Klemperer, Paul
  2. Legal vs Ownership Unbundling in Network Industries By Cremer, Helmuth; Crémer, Jacques; De Donder, Philippe
  3. Alliances and industry analysis By Garcia-Pont, Carlos
  4. Text and Voice: Complements, Substitutes or Both? By Andersson, Kjetil; Foros, Øystein; Steen, Frode
  5. The sustainability of free/open source software By Giorgio Padrin; Christian Genthon; Fabio Arcangeli
  6. Love thy Neighbour, Love thy Kin: Strategy and Bias in the Eurovision Song Contest By Clerides, Sofronis; Stengos, Thanasis
  7. Procuring Innovation By Cabral, Luís M B; Cozzi, Guido; Denicolo, Vincenzo; Spagnolo, Giancarlo; Zanza, Matteo

  1. By: Farrell, Joseph; Klemperer, Paul
    Abstract: Switching costs and network effects bind customers to vendors if products are incompatible, locking customers or even markets in to early choices. Lock-in hinders customers from changing suppliers in response to (predictable or unpredictable) changes in efficiency, and gives vendors lucrative ex post market power - over the same buyer in the case of switching costs (or brand loyalty), or over others with network effects. Firms compete ex ante for this ex post power, using penetration pricing, introductory offers, and price wars. Such 'competition for the market' or 'life-cycle competition' can adequately replace ordinary compatible competition, and can even be fiercer than compatible competition by weakening differentiation. More often, however, incompatible competition not only involves direct efficiency losses but also softens competition and magnifies incumbency advantages. With network effects, established firms have little incentive to offer better deals when buyers’ and complementors’ expectations hinge on non-efficiency factors (especially history such as past market shares), and although competition between incompatible networks is initially unstable and sensitive to competitive offers and random events, it later 'tips' to monopoly, after which entry is hard, often even too hard given incompatibility. And while switching costs can encourage small-scale entry, they discourage sellers from raiding one another’s existing customers, and so also discourage more aggressive entry. Because of these competitive effects, even inefficient incompatible competition is often more profitable than compatible competition, especially for dominant firms with installed-base or expectational advantages. Thus firms probably seek incompatibility too often. We therefore favour thoughtfully pro-compatibility public policy.
    Keywords: coordination; indirect network effects; lock-in; network effects; network externalities; switching costs
    JEL: D42 D43 L12 L13 L14 L15
    Date: 2006–08
  2. By: Cremer, Helmuth; Crémer, Jacques; De Donder, Philippe
    Abstract: This paper studies the impact of legal unbundling vs ownership unbundling on the incentives of a network operator to invest and maintain its assets. We consider an industry where the upstream firm first chooses the size of a network, while several downstream firms then compete in selling goods and services that use this network as a necessary input. We contrast the (socially) optimal allocation with several equilibrium situations, depending on whether the upstream firm owns zero, one or two downstream firms. The first situation corresponds to ownership unbundling between upstream and downstream parts of the market. As for the other two cases, we equate legal unbundling with the following two assumptions. First, each downstream firm maximizes its own profit, without taking into account any impact on the upstream firm's profit. Second, the upstream firm is not allowed to discriminate between downstream firms by charging different access charges for the use of its network. On the other hand, we assume that the upstream firm chooses its network size in order to maximize its total profit, including the profit of its downstream subsidiaries. Our main results are as follows. Because the investment in the network is not protected, at the time at which it is made, by a contract, the upstream firm will not take into account the interests of its clients when choosing its size. This effect can be mitigated by allowing it to own part of the downstream industry. In other words, ownership separation is more detrimental to welfare than legal unbundling. We also obtain that these results are robust to the introduction of asymmetry in network needs across downstream firms, imperfect downstream competition and downstream investments.
    Keywords: China walls; vertical separation
    JEL: L22 L51 L95
    Date: 2006–07
  3. By: Garcia-Pont, Carlos (IESE Business School)
    Abstract: Traditionally alliances have been left at of industry analysis. We have been focusing basically on the economic characteristics determining bargaining power on the relationships between the actors in a value system. The paper proposes a methodology to analyze industries from a very different perspective that incorporates alliances as one of the main drivers of industry structure.
    Keywords: Alliances; industry structure; networks;
    Date: 2006–09–11
  4. By: Andersson, Kjetil; Foros, Øystein; Steen, Frode
    Abstract: Text messaging has become an important revenue component for European and Asian mobile operators. We develop a simple model of demand for mobile services incorporating the existence of call externalities and network effects. We show that when incoming messages and calls stimulate outgoing communications, services that are perceived as substitutes, such as mobile text and voice, may evolve into complements in terms of the price effect when the network size becomes large. We estimate the demand for text messaging in the Norwegian market and find that the cross-price effect of voice depends on the network size. Voice is a substitute for text messages for small network sizes, and a complement for large network sizes.
    Keywords: call externalities; demand structure; network effects; positive feedback effects; text messaging
    JEL: C2 D12 L1
    Date: 2006–08
  5. By: Giorgio Padrin; Christian Genthon (LEPII - Laboratoire d'Economie de la Production et de l'Intégration Internationale - [CNRS : FRE2664] - [Université Pierre Mendès-France - Grenoble II]); Fabio Arcangeli
    Abstract: The paper applies three analytical frames to a better understanding of the itch to invent and innovate cooperatively, a still inadequately treated stylised fact, while drawing some lessons from an ongoing Free/Open Source software project on communication standards, software and services: Jabber , taken as an eloquent case and test bed for the proposed three - layered frame. The first frame derives form the territorial innovation systems literature: some features of the Internet economy, and particularly such standard - setting institutions as IETF working groups, provide a favourable climate to the governance of cooperative software projects. The second one is drawn from the economic theory of networks: the actual inducement s to cooperate can be explained by a class of models about the incentives and costs faced by an agent, rationally deciding whether to join a network and betting upon choosing a fitter one. The third one improves the latter, by introducing a simple evolutionary frame: the software project lifecycle. On the analytical level, a major finding is that economic models overestimate "cooperation failures": if developers were strictly "rational", they should cooperate at a much lower scale compared to observed patterns. This puzzle leads to the suggestion of re- introducing Smithian Moral Sentiment s into economic analysis. As another major point unveiled from the evidence of the case is the sensitive insuppressible key role of intrinsic motivations in this kind of innovative enterprises, linked strictly with the core nature of free /open source style of organizing. It stems that, in terms of institutional arrangement s, there's a wide spectrum of possibilities to experiment with, taking absolutely care not to destroy the vitality of the free ecology mining the critical drives of the innovator s. As far as policies are concerned, the paper aims to switch our attention to the long term sustainability of the novel software - services business models, and a "just" distribution of collective innovations net benefits.
    Keywords: economics of internet ; economics of software ; free/open source software<br />Product Life Cycle
    Date: 2006–10–10
  6. By: Clerides, Sofronis; Stengos, Thanasis
    Abstract: The annual Eurovision Song Contest provides a setting where Europeans can express their sentiments about other countries without regard to political sensitivities. Analyzing voting data from the 25 contests between 1981-2005, we find strong evidence for the existence of clusters of countries that systematically exchange votes regardless of the quality of their entries. Cultural, geographic, economic and political factors are important determinants of point exchanges. Factors such as order of appearance, language and gender are also important. There is also a substantial host country effect. We find some evidence of reciprocity but no evidence of strategic voting.
    Keywords: Eurovision; reciprocity; social networks
    JEL: Z13
    Date: 2006–06
  7. By: Cabral, Luís M B; Cozzi, Guido; Denicolo, Vincenzo; Spagnolo, Giancarlo; Zanza, Matteo
    Abstract: To stay on top of global competition, firms and governments often need to acquire innovative goods and services, including ideas and research, from their strategic suppliers. A careful design of procurement policy is crucial to make potential suppliers generate and sell the most suitable innovation. Moreover, procurement by public agencies and large firms often set the incentives for the development of innovations economy-wide. In this paper, guided by recent micro- and macro-economic research, we discuss vices and virtues of the many ways to induce potential suppliers to create and sell innovations. We consider a menu of procurement methods and policies for best procuring new knowledge and innovative products, discussing their costs and benefits in different possible scenarios and suggesting criteria to choose among them. We explain how to optimize the degree of competition between suppliers, as well as other more practical indirect ways to stimulate innovation. We discuss the effects of standard setting activities by large, often public, procurers on innovation races. We evaluate how public and large private firm’s procurement may induce innovation and growth at the national, industry or supply network level by affecting input market prices and the returns to human capital formation. Finally, we point out how risk management methods used in procurement should be modified when innovation is a central concern for a buyer.
    Keywords: (procurement) risk management; auctions; competitiveness; contests; ideas; innovation; innovation policy; innovative supply; knowledge; prizes; procurement; R&D; sourcing; standards; supplier investment; technology
    JEL: D44 H57 L15 O31 O38
    Date: 2006–07

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