Karan Bokil
Prof Q.
67-250
January 28, 2016
HW #3 Network Effects
1. Are network effects good or bad for innovation? Explain:
Network effects can be good and bad for innovation, although it depends on what market or
area one is looking at. An example of this could be Microsoft Windows operating system, which
has a market share that is almost impossible to compete with. A former Microsoft general
manager once said “"It is this switching cost that has given our customers the patience to stick
with Windows through all our mistakes, our buggy drivers, our high TCO [Total Cost of
Ownership], our lack of a sexy vision at times, and many other difficulties” (Gallaugher 8.2).
Accordingly, Microsoft’s huge market share and staying power hinders innovation in the scope
of operating systems in general, because it has no incentive to innovate. Furthermore, other
more innovative operating systems are unable to compete and innovate operating systems in
general because customers and developers would be unwilling to try it out considering
Microsoft’s network effects. On the other hand, network effects can inspire innovation within
the ancillary market provided by a stable technology supported by network effects. For instance,
mobile app developers have very little room to innovate if they must spend more time formatting
their code and ideas to work on multiple phones with varying standards in between. The
network effects of Apple’s iPhone enabled a standard format of hardware for developers to
create for and spend more time innovating instead of accommodating.
2. Identify and describe three strategies that Amazon uses to compete in markets where
network effects are present. Hint: you should evaluate the strategies presented in
section 5 of chapter 8 and apply them to the case of Amazon:
One of the key strategies Amazon practices in the various markets it competes in is
moving in early in order to develop its network effects fast. For example, Amazon quickly
moved in to the space of e-readers with its Kindle product line before any competition such as
the Nook arrived. In effect, it was able to create a two-sided network where its early, large
number of users attracted more publishers and authors, and vice versa. Consequently, Amazon
was also able to exert its staying power network effect for more effects like complementary
benefits through starting subscription models and providing exclusive Kindle books.
Amazon also seeds various markets when asserting its business strategy. The company
has developed its own advertisement system for “Kindles, on other Amazon-owned sites like
IMDb, within mobile apps, and via Amazon-targeted ads on third-party websites” (Gallaugher
7.2). Thus, by selling cheap e-readers or providing free movie ratings via its subsidiary
company, it is able to reinforce use of Amazon as a retailer and circumvent the network effects
of other competing online retailers.
Another technique Amazon employs is subsidizing adoption. This tactic was evident
when the company released its Fire phone at a $199 starting price with an additional incentive of
a year subscription of Amazon Prime worth $100. The strategy was intended to get past the
staying power network effects of other well-established smartphones. However, while its $100
free value was enticing for some, an overwhelming number of people preferred to utilize other
phones because of the network effects they had already established. Sometimes, network effects
are too strong for giants like Amazon to overcome, causing $170 million of losses.