Network Externalities
Description
J. Hofmoki:
"The network effects concept was introduced to the economic literature in 1985 by M.L. Katz and C.Shapiro, who used the term ‘Network Externalities’. They noted that, in the case of many products, “the utility that a user derives from consumption of the good increases with the number of other agents consuming the good” (Katz, Shapiro, 1985:424). This concept was later refined by S. Liebowitz and S. Margolis, who argued that network effects, in their pure form, do not need to coincide with externalities; i.e. positive or negative effects on parties not involved in a given transaction (Liebowitz, Margolis, 1994). The added value of existing and new customers results from direct interactions between the users of a given good, as well as from the increased availability of complementary products and services.
Back in the 1980s and 1990s, when the network effects concept was introduced and refined, traditional telephone systems were viewed as the primary exemplification of these effects. Nowadays, with the rapid development of information technologies, the ICT sector is believed to demonstrate the most significant network effects, just to mention the development of the World Wide Web, where new essential functionalities were added once the number of Internet users increased. The same goes for websites facilitating exchanges via the Internet (eBay) or dedicated portals used for social networking. The developments taking place within the Internet spectrum clearly contrast with the classic CPR scenario. Specifically, the network effects increase radically once the number of users of a given Internet good reaches a certain threshold. For CPR goods, the increased number of users results in the excessive exploitation of a given resource.
While emphasizing the incidence and magnitude of positive network effects, particularly in the case of Internet Commons, I shall point out negative implications, as well. These are reflected in the so called ‘locked-in situations’, profoundly exemplified in the market for professional software applications, presently dominated by Microsoft. The providers of alternative applications, often of superior quality, have faced major obstacles convincing potential clients to shift from Microsoft Office. The clients were reluctant to lose obvious benefits derived from the network effects: compatibility with the applications used by their business partners, standard installations on purchased hardware, access to auxiliary services, additional combatable applications, etc. " (http://dlc.dlib.indiana.edu/archive/00003831/00/Hofmokl_213801.pdf)