Early-Mover Advantages • 381

Network Effects

Consumers often place higher value on a product if other consumers also use it. When this occurs, the product is said to display network effects or network externalities. In some networks, such as telephone and social media networks, consumers are physically linked. The network effect arises because consumers can communicate with other users in the network. These are known as actual networks. The more users in the actual network, the greater the opportunities for communication, and the greater the value of the network.

In virtual networks, consumers are not physically linked. The network effect arises from the use of complementary goods. Computer operating systems, video gaming (e.g., Sony Playstation), and smart phones are all examples of virtual networks. As the number of consumers in a virtual network increases, the demand for complementary goods increases. This increases the supply of the complementary goods, which in turn enhances the value of the network. This is evidenced by the vast selection of programs to run on IBM-based personal computers, games to play on the Playstation, and applications to download to Apple’s iPhone and iPad. Remarkably, consumers in virtual networks never need to communicate with each other to enjoy the network effects. As long as their collective purchasing power encourages the supply of complementary products, each individual consumer benefits from the network.

In markets with network effects, the first firm that establishes a large installed base of customers has a decided advantage. New customers will observe the size of the network and gravitate toward the same firm. In this way, network effects offer a prime opportunity for first-mover advantage, provided the first mover can develop an installed base.

Networks and Standards

Many networks evolve around standards. Microsoft’s Windows 7 operating system is a direct descendant of its original MS-DOS standard introduced in 1982 for use with IBM personal computers and quickly adopted by makers of PC “clones.” Sony’s Blu-ray technology for high-definition home theater emerged after a brief format war waged against Toshiba’s HD-DVD format. The persistence of standards makes standard-setting a potentially powerful source of sustainable competitive advantage and raises two key issues. First, should firms in fledgling markets attempt to establish a standard, thereby competing “for the market,” or should they share in a common standard, thereby competing “in the market”? Second, what does it take to topple a standard?

Competing “For the Market” versus “In the Market”

A firm must consider several factors when deciding whether to compete “for the market” or “in the market.”

•The oligopoly theory presented in Chapter 5 shows that, on average, it is better to be a monopolist half the time than a duopolist all the time. This means that if all other factors are equal, a firm will earn higher expected profits by trying to achieve monopoly status for its own standard (competing for the market) than by settling for a share of the market with a common standard (competing in the market).

•When two or more firms compete for the market, the winner is often the firm that establishes the largest installed base of customers, thereby enhancing the value of