Entry into Platform-Based Markets

Abstract

This paper seeks to understand when an entrant with superior quality can successfully enter a platform-based market. We analyze a model where an entrant platform with superior quality competes with an incumbent platform. We find that the entrant's success depends critically on the strength of indirect network effects and the consumers' discount factor of future applications. Contrary to the popular belief that an entrant's quality advantage needs to be sufficiently high to overcome the incumbent's installed-base advantage in such markets, we find that under certain conditions, an entrant with a small quality advantage can gain market share over time when competing with an incumbent with a huge installed-base advantage. To demonstrate the model's applicability, we examine the entry of the Xbox console into the video game industry. We find that Xbox has a small quality advantage over the incumbent, PlayStation 2, and the strength of indirect network effects and the consumers' discount factor in this market are such that PlayStation 2's huge installed-base advantage is unsustainable.

Keywords: platform-based markets, winner-take-all, platform competition, indirect network effects, video game industry

JEL Classification: L13, M21, O33