Tipping and Concentration in Markets with Indirect Network Effects

This paper develops a framework to measure ‘tipping’ – the increase in a firm’s market share dominance caused by indirect network effects. Our measure compares the expected concentration in a market to the hypothetical expected concentration that would arise in the absence of indirect network effects. In practice, this measure requires a model that can predict the counter-factual market concentration under different parameter values capturing the strength of indirect network effects. We build such a model for the case of dynamic standards competition in a market characterized by the classic hardware/software paradigm. To demonstrate its applicability, we calibrate its using demand estimates and other data from the 32/64-bit generation of video game consoles, a canonical example of standards competition with indirect network effects. In our example, we find that indirect network effects can lead to a strong, economically significant increase in market concentration. We also find important roles for beliefs on both the demand side, as consumer’s tend to pick the product they expect to win the standards war, and on the supply side, as firms engage in penetration pricing to invest in growing their networks.