Network Effects and Conversion Technologies

From Information Systems at Pitt Business

As we enter a “digital era”, a new and different pattern of competition seems to be emerging in several digital goods markets. Despite strong demand for compatibility, these markets have not tipped towards a single standard, nor do we see a significant advantage for the incumbent over the new entrants. Witness, for example, the lack of standardization seen in markets for digital media files (e.g., Real Media, Windows Media, QuickTime, AVI, and MPEG), digital still files (e.g., JPEG, GIF, TIFF, and PNG), and digital flash memory cards (e.g., Compact Flash, SmartMedia, Secure Digital, Memory Stick, XD Picture, and Multimedia). An intriguing and important conundrum is why the competitive dynamics in these digital goods markets appear to be different, i.e., why are these markets not converging to a single standard as in other IT markets with network effects.This study investigates this issue in the context of the flash memory market.

[edit] Abstract

Both theoretical and empirical evidence suggests that, in markets with standards competition, strong network effects can make the strong grow stronger and, in some circumstances “tip” the market towards a single, winner-take-all standard. We theorize that the presence of low cost conversion technologies will reduce the tendency towards market dominance in markets for digital goods. We empirically test our hypotheses in the context of the flash memory card market where both network effects and high quality digital conversion technologies are present.

After first testing for and discovering the presence of significant network effects in the flash memory market, further analysis shows that the availability of digital converters provides a measurable reduction in the price premium of the leading flash card formats relative to that of formats with lower market shares. These market dynamics imply that producers of these non-dominant digital goods standards are better off with the provision of conversion technology, as this technology tends to neutralize the impact of network effects. In addition, further analysis shows that market concentration in the flash memory market decreases as converters become more widely available.

[edit] Paper Information

Authors:  Charles Liu, Chris Kemerer, Sandra Slaughter, Michael Smith

[edit] Keywords

Network Effects, Network Externalities, Conversion Technologies, Compatibility, Proprietary Technology Standards, Digital Goods, Flash Memory.