Abstract
Both theoretical and empirical evidence suggest that, in many markets with standards competition, network effects make the strong grow stronger and can tip the market toward a single, winner-take-all standard. We hypothesize, however, that low cost digital conversion technologies, which facilitate easy compatibility across competing standards, may reduce the strength of these network effects. We empirically test our hypotheses in the context of the digital flash memory card market. We first test for the presence of network effects in this market and find that network effects, as measured here, are associated with a significant positive price premium for leading flash memory card formats. We then find that the availability of digital converters reduces the price premium of the leading flash card formats and reduces the overall concentration in the flash memory market. Thus, our results suggest that, in the presence of low cost conversion technologies and digital content, the probability of market dominance can be lessened to the point where multiple, otherwise incompatible, standards are viable. Our conclusion that the presence of converters weakens network effects implies that producers of nondominant digital goods standards benefit from the provision of conversion technology. Our analysis thus aids managers seeking to understand the impact of converters on market outcomes, and contributes to the existing literature on network effects by providing new insights into how conversion technologies can affect pricing strategies in these increasingly important digital settings.
Highlights
Network effects arise in many information technology (IT) markets where the value of a product or service demands interoperability
The second row shows that, even though the main effect of digital converter adoption is negative when evaluated at the average size of a flash memory card installed base (Mean column), it is positive for secondary flash card formats (-1 and -2 standard deviations columns) and the price premium is stronger for platforms with smaller market share
We illustrate some of these issues in the context of the flash memory market, where in spite of apparent network effects, there are multiple competing standards and little evidence of market consolidation
Summary
Network effects arise in many information technology (IT) markets where the value of a product or service demands interoperability. In the flash memory market the increasing adoption of digital converters reduces the impact of the installed base on the product price premium, despite evidence of network effects. 3. Research Model and Hypotheses Since the role of conversion technologies is of primary interest when network effects exist, identifying the presence and the magnitude of network effects is an important first step in evaluating the nature of standards competition in the flash memory card market. The literature would suggest a positive association between the size of the installed base and the flash memory card price, but it is possible that the magnitude of the positive network effects is too small to warrant a dominant firm market outcome. The distribution of observations, broken down by formats and year, is shown in Table 1 below
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