Network Externalities and App Store Fees in Mobile Platforms

Abstract

The benefits consumers get from a mobile phone depend on the software apps available to use on that phone. This creates an interdependence between the demand for handsets and the demand for software apps. To quantify the importance of these indirect network externalities, we develop a model of consumer demand for handsets and apps, as well as a model of developer entry decisions. We estimate the model using a unique dataset of mobile phone sales and app downloads. We find that a 1% increase in the number of apps results in a 1.5% increase in smartphone sales, with significant heterogeneity in this network externality between apps on platforms. To illustrate the applicability of the model, we compute the equilibrium platform fees for Apple and Android. We find that the complementarity between the handset sales and app demand implies lower platform fees with Apple's tight vertical integration. We estimate that increasing the strength of indirect network externalities by 10% results in a decrease in optimal fees by 2.5% for Apple and 0.5% for Android indicating a tight coupling of the two sides of the market for Apple, compared to Android.

Keywords: Platform Competition, Indirect Network Effects, Online Marketplace, Two-sided Markets

JEL Classification: L1