The last three decades have witnessed unprecedented growth in network industries such as video games, computers, credit cards, media, social networking and telecommunications. (Ramon and Francisco, 2009, p.1) The aim of this essay is to provide an understanding of the dynamics of platform completion by analyzing the role of installed base, consumer expectations and platform quality. These factors then help explain a platform’s position, the barriers to entry and the formation of a monopoly in the network market. This essay also focuses on the social media market for Facebook and Google+ and their rise to platform leadership, which is interesting as this is a recent and fascinating new area of research in economics.

The remaining of this essay is organized into 3 sections. Section 2 explains the concept of network externalities, differentiates between direct and indirect network externalities, and explains the role of installed base and consumer expectations for products in the network market. The section then goes on to apply these concepts to platform markets to understand platform competition and how using the concept of critical mass a platform rises to dominance. Section 3 discusses some key business strategies applicable to platform markets. Section 4 concludes the analysis by extending a few strategy proposals as to how Google+ may possibly dominate in the social media market, where Facebook is currently dominant.

Section 2:

Products such as eBay are substantially different from ordinary products since they enjoy network externalities. Industry platforms are not under the full control of the innovator unlike ordinary products. An industry platform is the basic technology for a broader ecosystem of businesses, determining which complimentary innovations are required to make it useful. (Gawer and Cusumano, 2008, p.28) Network externality is the increased benefit that a consumer derives from owning a product as the number of consumers of the product increases and vice-versa. There are two forms of network externalities: direct and indirect. Direct network externalities are those generated through a direct effect of consumers on the value of a product. (Liebowitz andMargolis, n.d, p.1-2) For example, the value of a fax machine increases when the number of users for it increases since the users will have greater use for it. While, indirect network externalities is where complimentary goods (toner cartridges) are more readily available as the number of consumers of a product (printer) increases enhancing the value of the product.

The value of products having network externalities is divided into two parts. The first is the intrinsic value which is the value of the product even if there are no users using it; it is the value of the technology itself. The second component is the external value which is the ability of users to interact with each other derived from the installed base which is a consumer base that consists of the number of users of a product. (Liebowitz andMargolis, n.d, p.3) The external value is more essential than the intrinsic value as the value of a product can be increased significantly by increasing the number of users, for example a fax machine’s value will be insignificant if there are no other users using it but as the installed base increases its usefulness to interact with others increases, increasing its value. Other than the installed base, consumer expectations which are an aggregate of the expectations of the population play a vital role in the success or failure of a new product. It is based on the beliefs of everyone. Network externalities can be positive or negative. A consumer’s willingness to pay for a product with positive network externalities increases if he expects other consumers to purchase that product while, a consumer’s willingness to pay for a product with negative network externalities decreases if he expects other consumers to purchase it. Furthermore, there is a possibility of multiple equilibria when the network externality is positive. If consumers expect a product will fail, it usually will as few will acquire the product. On the contrary, if they expect a product to succeed, it usually will. In a network market there are a number of barriers to entry which prevents success of a new firm. The concept of multiple equiliria in network industries is used to explain the start up problem of generating expectations to achieve critical mass. (Amir and Lazzati, 2011, p.4) Consumers in the market will purchase a product if the price of the product is lesser than or equal to its value. Therefore, when a new firm starts its business in a network market it needs to gain control of the initial installed base to adopt the new product before others do so that the value of the product exceeds its price which is called the concept of critical mass. A product that has been in the market for some time will have a large installed base established which will make it relatively more valuable to new rival products. Even if the new product has better technological features its value will pertain only to its intrinsic value as its external value is dependent on the installed base. In network industries history matters giving the first firm to enter an advantage to lock in a large installed base which acts as an entry barrier to the market and bigger the installed base is the larger will be the entry barrier. Another entry barrier is the formation of coalitions between two or more dominating firms in an oligopoly. When a coalition is formed the price wars are absent and competition between the dominant firms decreases ensuring that the consumers remains intact to their product, making it difficult for new firms to attract consumers.

A situation where Netscape’s Navigator dominated the internet browser market after which Microsoft introduced its Internet Explorer, which one continued to dominate? When Internet Explorer entered it needed to reach its tipping point which refers to acquiring a critical mass. Unless the critical mass is not attained its value remains low and so to increase its consumers Microsoft bundled it for free with its Windows Operating System which was already dominating in its market, giving its web browser a huge installed base. Navigator’s dominance thus reduced over the next few years from an 80% market share (Graph) as Internet Explorer’s dominance increased. (Gawer and Cusumano, 2008,p.34)

Market Share

Year

Graph: The market share of Netscape’s Navigator over the years

Section 3:

There can be two situations in a network market when a new firm enters, either there is no dominant firm yet and when there is a dominant firm. A new firm’s core strategy in either of the situations is to create and expand their installed base to a level where the value is greater or equal to the price of the product. For a new firm to enter into the market with no dominant firm it has to use the concept of coring. A firm should improve on it technical features to make its product fundamental to a technological system and make their product available to third parties which in turn opens the system for new usage possibilities. For a firm entering the market with a dominating firm should price its product at a low price as the value of its product is low and increase it as the value increases. In this situation the customers are already using the rival product, to get them to use the new product it should have greater technical capabilities and should be compatible with the old product to have low network effects. Also the new firm should provide incentives to consumers to start using the product such as free internet security from an operating system to gain popularity.

Section 4:
Facebook in today’s social media market is the dominating firm while Google+ is a new firm which has recently entered the market. It is still early to predict whether Google+ will succeed in taking over Facebook’s dominance but with the right strategies it is not impossible to do so. Google+ needs to increase its installed base to increase its value and attract more users. To achieve this Google+ should have better technical solutions than Facebook to attract potential users like its “Hangout” option which allows users to video chat much easily than Facebook. Google should bundle Google+ with its other websites like Gmail and also with its toolbar so that users can easily be updated. Google+ has a consumer base but the value is increased if they continue to use it to socialize for which incentives like free vouchers and prizes can be provided for inviting more users. Google+ should reduce the price of advertising to attract more users to advertise on it. Google+ could start its own social gaming for cheaper as Facebook is the only one and takes 30% of the revenues from developer. Google+ can also pay developers to create complimentary software to increase its value. (Brightman, 2011)
An analysis of the network market done in this essay provides an understanding of network externalities and its different types. It underlines the role of consumer expectations and installed base in creating entry barriers and the concept of critical mass in determining the position of a firm. The essay moves on to explain critical business strategies and how they apply to the competition between Google+ and Facebook. In my opinion Google+ is still a baby and will take months if not years to dethrone Facebook which already has a head start but only time will show us how the strategies they adopt will help them to dominate the social media market.

Bibliography

Brightman, J. (2011). Google to Overtake Facebook? 'Certainly a Possibility,' says Analyst.
Available from: http://www.industrygamers.com/news/google-to-overtake-facebook-certainly-a-possibility-says-analyst/

Gawer, A. and Cusumano, M.A. (2008). How Companies Become Platform Leaders.
Available from: http://sloanreview.mit.edu/the-magazine/2008-winter/49201/how-companies-become-platform-leaders/

Amir, R. and Lazzati, N. (2011). Network Effects, Market Structure and Industry Performance.
Available from: http://www.u.arizona.edu/~nlazzati/Papers/Job%20Market%20Paper%20II.pdf

Liebowitz, S.J. and Margolis, S.E. (n.d.). Network Externalities (Effects).
Available from: http://www.utdallas.edu/~liebowit/palgrave/network.html
Casadesus-Masanell, R. and Ruiz-Alised, F. (2009). Platform Competition, Compatibility, and Social Efficiency.
Available from: http://www.hbs.edu/research/pdf/09-058.pdf