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Two-Sided Network Effects: A Theory of Information Product Design

Management Science, Vol, 51, No. 10, pp. 1494–1504, 2005

11 Pages Posted: 27 Jul 2008 Last revised: 27 Mar 2012

Geoffrey Parker

Dartmouth College

Marshall W. Van Alstyne

Boston University – Questrom School of Business; Massachusetts Institute of Technology (MIT) - Sloan School

Date Written: September 29, 2010

Abstract

How can firms profitably give away free products? This paper provides a novel answer and articulates tradeoffs in a space of information product design. We introduce a formal model of two-sided network externalities based in textbook economics - a mix of Katz & Shapiro network effects, price discrimination, and product differentiation. Externality-based complements, however, exploit a different mechanism than either tying or lock-in even as they help to explain many recent strategies such as those of firms selling operating systems, Internet browsers, games, music, and video.

The model presented here argues for three simple but useful results. First, even in the absence of competition, a firm can rationally invest in a product it intends to give away into perpetuity. Second, we identify distinct markets for content providers and end consumers and show that either can be a candidate for a free good. Third, product coupling across markets can increase consumer welfare even as it increases firm profits.

The model also generates testable hypotheses on the size and direction of network effects while offering insights to regulators seeking to apply antitrust law to network markets.

Keywords: Two Sided Markets, Network Externalities, Network Effects, Antitrust, Information Pricing, Cross-Subsidy, Freemium

JEL Classification: D4, D8, L0, L1, L2, M2

Suggested Citation

Parker, Geoffrey and Van Alstyne, Marshall W., Two-Sided Network Effects: A Theory of Information Product Design (September 29, 2010). Management Science, Vol, 51, No. 10, pp. 1494–1504, 2005. Available at SSRN: https://ssrn.com/abstract=1177443

Geoffrey Parker

Dartmouth College ( email )

Hanover, NH 03755
United States
603-646-9075 (Phone)

HOME PAGE: http://engineering.dartmouth.edu/people/faculty/geoffrey-parker

Marshall W. Van Alstyne (Contact Author)

Boston University – Questrom School of Business ( email )

595 Commonwealth Avenue
Boston, MA 02215
United States
617-358-3571 (Phone)

HOME PAGE: http://questromapps.bu.edu/mgmt_new/Profiles/VanAlstyneMarshall.html

Massachusetts Institute of Technology (MIT) - Sloan School ( email )

Center for Digital Business
5 Cambridge Center - NE25, 7th Floor
Cambridge, MA 02142
United States
617-253-0768 (Phone)

HOME PAGE: http://web.mit.edu/marshall/www/home.html

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