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6.5: Competing When Network Effects Matter

  • Page ID
    4532
  • Learning Objectives

    After studying this section you should be able to do the following:

    1. Plot strategies for competing in markets where network effects are present, both from the perspective of the incumbent firm and the new market entrant.
    2. Give examples of how firms have leveraged these strategies to compete effectively.

    Why do you care whether networks are one-sided, two-sided, or some sort of hybrid? Well, when crafting your plan for market dominance, it’s critical to know if network effects exist, how strong they might be, where they come from, and how they might be harnessed to your benefit. Here’s a quick rundown of the tools at your disposal when competing in the presence of network effects.

    Strategies for Competing in Markets with Network Effects (Examples in Parentheses)

    • Move early (Yahoo! Auctions in Japan)
    • Subsidize product adoption (PayPal)
    • Leverage viral promotion (Skype; Facebook feeds)
    • Expand by redefining the market to bring in new categories of users (Nintendo Wii) or through convergence (iPhone).
    • Form alliances and partnerships (NYCE vs. Citibank)
    • Establish distribution channels (Java with Netscape; Microsoft bundling Media Player with Windows)
    • Seed the market with complements (Blu-ray; Nintendo)
    • Encourage the development of complementary goods—this can include offering resources, subsidies, reduced fees, market research, development kits, venture capital (Facebook fbFund).
    • Maintain backward compatibility (Apple’s Mac OS X Rosetta translation software for PowerPC to Intel)
    • For rivals, be compatible with larger networks (Apple’s move to Intel; Live Search Maps)
    • For incumbents, constantly innovate to create a moving target and block rival efforts to access your network (Apple’s efforts to block access to its own systems)
    • For large firms with well-known followers, make preannouncements (Microsoft)

    Move Early

    In the world of network effects, this is a biggie. Being first allows your firm to start the network effects snowball rolling in your direction. In Japan, worldwide auction leader eBay showed up just five months after Yahoo! launched its Japanese auction service. But eBay was never able to mount a credible threat and ended up pulling out of the market. Being just five months late cost eBay billions in lost sales, and the firm eventually retreated, acknowledging it could never unseat Yahoo!’s network effects lead.

    Another key lesson from the loss of eBay Japan? Exchange depends on the ability to communicate! EBay’s huge network effects in the United States and elsewhere didn’t translate to Japan because most Japanese aren’t comfortable with English, and most English speakers don’t know Japanese. The language barrier made Japan a “greenfield” market with no dominant player, and Yahoo!’s early move provided the catalyst for victory.

    Timing is often critical in the video game console wars, too. Sony’s PlayStation 2 enjoyed an eighteen-month lead over the technically superior Xbox (as well as Nintendo’s GameCube). That time lead helped to create what for years was the single most profitable division at Sony. By contrast, the technically superior PS3 showed up months after Xbox 360 and at roughly the same time as the Nintendo Wii, and has struggled in its early years, racking up multibillion-dollar losses for Sony (Null, 2008).

    What If Microsoft Threw a Party and No One Showed Up?

    Microsoft launched the Zune media player with features that should be subject to network effects—the ability to share photos and music by wirelessly “squirting” content to other Zune users. The firm even promoted Zune with the tagline “Welcome to the Social.” Problem was the Zune Social was a party no one wanted to attend. The late-arriving Zune garnered a market share of just 3 percent, and users remained hard pressed to find buddies to leverage these neat social features (Walker, 2008). A cool idea does not make a network effect happen.