Intraconnectivity and Interconnectivity: When Value Creation May Reduce Profits
Posted: 24 Oct 2012
Date Written: 2012
This paper analyses firms' decisions to provide connectivity to their customers. We distinguish between intraconnectivity — the ability of one firm's customers to connect to each other— and interconnectivity — the ability of one firm's customers to connect with another firm's customers. The profitability implications of allowing connectivity are not a straightforward consequence of the consumer value of connectivity, because connectivity affects not only the customer value but also the intensity of competition by creating or changing network externality. We find that if sales are driven by brand switching rather than by category expansion, a firm may find it optimal not to provide intraconnectivity even if providing it is not costly and may find it optimal to provide interconnectivity even at a cost exceeding the consumer value of connectivity. On the other hand, if category expansion is possible, providing intraconnectivity may be profitable. In this case, either the equilibrium intraconnectivity provision may be asymmetric or both firms may find it (individually) optimal to provide intraconnectivity. Under certain conditions in the latter case, the firms' choice of intraconnectivity is a prisoner's dilemma game.
Keywords: network externality, product design, pricing, competitive strategy, game theory
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