Consumer coordination in the small and in the large: Implications for antitrust in markets with networdk effects

Journal of Competition Law and Economics

Volumn 4, Issue 2, 2008, Pages 207-262

  Spulber, Daniel F ^a  

^a NONE

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[No Author keywords available]

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EID: 50549093002     PISSN: 17446414     EISSN: 17446422     Source Type: Journal    
DOI: 10.1093/joclec/nhm031     Document Type: Article

References (163)

1. On monopolization and other antitrust issues in network markets, see, e.g., H. Hovenkamp, The Antitrust Enterprise: Principle and Execution (Cambridge, MA: Harvard University Press, 2005), Chapter 12
2. and K. C. Baseman, F. R. Warren-Boulton and G. A. Woroch, "Microsoft Plays Hardball: The Use of Exclusionary Pricing and Technical Incompatibility to Maintain Monopoly Power in Markets for Operating System Software," Symposium: Microsoft and the United States Department of Justice, 40 Antitrust Bulletin 265-315 (1995). On concerns over exclusionary behavior
3. see, e.g., C. Shapiro, "Exclusivity in Network Industries," 7 George Mason Law Review 673-83 (1999)
4. D. A. Balto, "Networks and Exclusivity: Antitrust Analysis to Promote Network Competition," 7 George Mason Law Review, 523-76 (1999)
5. and R. D. Blair and A. K. Esquibel, "Some Remarks on Monopoly Leveraging, Symposium: Microsoft and the United States Department of Justice, 40 Antitrust Bulletin 371-96 (1995).
6. See P. David, "Clio and the Economics of QWERTY," 75 American Economic Review 332-7 (1985)
7. P. David, "Heros, Herds and Hysteresis in Technological History: The Battle of the Systems=Reconsidered," 1 Industrial and Corporate Change 129-80 (1992)
8. B. Arthur, "Competing Technologies, Increasing Returns, and Lock-In by Historical Events," 97 Economic Journal 642-65 (1989)
9. B. Arthur, "Positive Feedbacks in the Economy," 262 Scientific American 92-9 (1990)
10. B. Arthur, Increasing Returns and Path Dependence in the Economy (Ann Arbor, MI: University of Michigan Press, 1994)
11. M. L. Katz and C. Shapiro, "Network Externalities, Competition, and Compatibility," 75 American Economic Review, 424-40 (1985)
12. M. L. Katz and C. Shapiro, "Systems Competition and Network Effects," 8 The Journal of Economic Perspectives 93-115 (1994)
13. N. Economides, "The Economics of Networks," 14 International Journal of Industrial Organization 673-99 (1996)
14. N. Economides and C. Himmelberg, "Critical Mass and Network Evolution in Telecommunications," in Toward a Competitive Telecommunications Industry: Selected Papers from the 1994 Telecommunications Policy Research Conference, Gerard Brock, ed. (Manwah, NJ: Lawrence Erlbaum Associates, 1995)
15. J. Farrell and G. Saloner, "Standardization, Compatibility, and Innovation," 16 Rand Journal of Economics 70-83 (1985)
16. J. Farrell and G. Saloner, "Installed Base and Compatibility: Innovation, Product Preannouncements, and Predation," 76 American Economic Review 940-55 (1986). For additional references and an overview of the literature,
17. see J. Farrell and P. Klemperer, "Coordination and Lock-In: Competition with Switching Costs and Network Effects," Handbook of Industrial Organization (Berkeley, CA: University of California, 2006), forthcoming, CEPR Discussion Paper Number 5798, August 2006.
18. See Farrell and Klemperer, 2006, ibid.
19. Farrell and Klemperer, 2006, supra note 2, set out this argument and describe "several layers of pessimism" about markets with network effects: First, both splintering and coordination on the "wrong" standard are possible, so that adopters collectively may fail to take the best deal offered. Second, because offering better deals is thus unreliable as a way to win the market, sponsors focus more on attracting expectations in other ways and on arranging to extract more rent if they do win-so sponsors offer less good deals. Third, if expectations track history rather than surplus, collective switching costs come to include the value of network effects, cementing us into what can be badly outdated (or just bad) standards. Fourth, the strong competitive advantage conferred on a firm that attracts adopters' expectations opens up new avenues for mischief. Here, "splintering" refers to consumers failing to adopt a single technology, with different groups adopting different technologies due to a coordination failure.
20. See R. H. Coase, "The Problem of Social Cost," 3 Journal of Law and Economics 1-44 (1960).
21. See F. A. Hayek, "Spontaneous (Grown) Order and Organized ('Made') Order," in Market, Hierarchies & Networks: The Coordination of Social Life, G. Thompson, J. Francis, R. Levacic, and J. Mitchell, J., eds (London: Sage, 1991), pp. 293-301
22. F. A. Hayek, Law, Legislation and Liberty, Volume 2: The Mirage of Social Justice (Chicago, IL: The University of Chicago Press, 1976)
23. and F. A. Hayek, The Constitution of Liberty (Chicago: Chicago University Press, 1960), pp. 159-160.
24. United States v. Microsoft Corp., 253 F.3d 34, 49 (D.C. Cir.), cert. denied, 534 U.S. 952 (2001).
25. Hovenkamp, 2005, supra note 1, at p. 285.
26. Microsoft Corporation against Commission of the European Communities Case T-201/04, Ruling on September 17, 2007 by the European Court of First Instance.
27. D. F. Spulber, "Firms and Networks in Two-Sided Markets," in T. Hendershott, ed., Handbook in Information Systems, Vol. 1 (Amsterdam: Elsevier, 2006), pp. 137-200.
28. See D. F. Spulber, Market Microstructure: Intermediaries and the Theory of the Firm, (New York: Cambridge University Press, 1999)
29. D. F. Spulber, "Market Microstructure and Incentives to Invest," 110 Journal of Political Economy 352-81 (2002)
30. D. F. Spulber, "Market Making by Price-Setting Firms," 63 Review of Economic Studies 559-80 (1996)
31. D. F. Spulber, "Market Microstructure and Intermediation," 10 Journal of Economic Perspectives 135-52 (1996).
32. D. F. Spulber, "Deregulating Telecommunications," 12 Yale Journal on Regulation 25-67 (1995).
33. D. F. Spulber and C. S. Yoo, "Access to Networks: Economic and Constitution Connections", 88 Cornell Law Review 885-1024 (2003)
34. D. F. Spulber and C. S. Yoo, "Network Regulation: The Many Faces of Access," 1 Journal of Competition Law and Economics 635-78 (2005a)
35. D. F. Spulber and C. S. Yoo, "On the Regulation of Networks as Complex Systems: A Graph Theory Approach," 99 Northwestern University Law Review 1687-722 (2005b)
36. D. F. Spulber and C. S. Yoo, "Mandating Access to Telecom and the Internet: The Hidden Side of Trinko," 107 Columbia Law Review (2007a)
37. D. F. Spulber and C. S. Yoo, Networks in Telecommunications: Economics and Law (Cambridge: Cambridge University Press, 2007b).
38. J. G. Sidak and D. F. Spulber, "The Tragedy of the Telecommons: Government Pricing of Unbundled Network Elements Under the Telecommunications Act of 1996," 97 Columbia University Law Review 1201-81 (1997)
39. J. G. Sidak and D. F. Spulber, "Network Access Pricing and Deregulation," 6 Industrial and Corporate Change 757-82 (1997)
40. J. G. Sidak and D. F. Spulber, Deregulatory Takings and the Regulatory Contract: The Competitive Transformation of Network Industries in the United States (Cambridge: Cambridge University Press, 1997)
41. J. G. Sidak and D. F. Spulber, "Deregulation and Managed Competition in Network Industries," 15 Yale Journal on Regulation 117-48 (1998)
42. J. G. Sidak and D. F. Spulber, "Cyberjam: Internet Congestion of the Telephone Network," 21 Harvard Journal on Law and Public Policy 327-94 (1998).
43. S. J. Liebowitz and S. E. Margolis, "The Fable of the Keys," 33 Journal of Law and Economics 1-26 (1990)
44. S. J. Liebowitz and S. E. Margolis, "Network Externality: An Uncommon Tragedy," 8 The Journal of Economic Perspectives 133-50 (1994)
45. S. J. Liebowitz and S. E. Margolis, "Path Dependence, Lock-in and History," 11 Journal of Law, Economics and Organization 205-26 (1995)
46. S. J. Liebowitz and S. E. Margolis, "Are Network Externalities a New Source of Market Failure?," 17 Research in Law and Economics 1-22 (1995)
47. S. J. Liebowitz and S. E. Margolis, "Market Processes and the Selection of Standards," 9 Harvard Journal of Law and Technology 283-318 (1996)
48. S. J. Liebowitz and S. E. Margolis, Winners, Losers, and Microsoft: Competition and Antitrust in High Technology (Oakland, CA: Independent Institute, 1999)
49. S. J. Liebowitz, and S. E. Margolis, "Network Effects," Handbook of Telecommunications Economics, Vol. 1, M. E. Cave et al., eds (Amsterdam: Elsevier Science, 2002).
50. M. L. Katz and C. Shapiro, "Systems Competition and Network Effects," 8 The Journal of Economic Perspectives 93-115 (1994).
51. Liebowitz and Margolis (1994, 2002) point out that the argument that indirect network effects represents an "externality" repeats conceptual errors in Pigou's "pecuniary externality" concept.
52. See J. Rohlfs, "ATheory of Interdependent Demand for a Communications Service," 5 The Bell Journal of Economics and Management Science 16-37 (1974)
53. R. Artle and C. Averous, "The Telephone System as a Public Good: Static and Dynamic Aspects," 4 Bell Journal of Economics and Management Science 89-100 (1973) examine interdependent demand in communications based on the number of subscribers.
54. i di
55. It is important to emphasize that the model based on the number of subscribers is a simplification for purposes of illustration. It is more accurate to allow each individual's consumption level to vary and to allow each individual's consumption to have differential effects on the benefits of others. Economic analysis using the simplified model should be checked by careful consideration of the more general model.
56. Spulber and Yoo, 2005, supra note 13.
57. See the discussion of Spulber and Yoo, 2005b, supra note 13.
58. See, e.g., Farrell and Saloner, 1986, supra note 2.
59. Ibid.
60. M. Granovetter, "Economic Action and Social Structure: The Problem of Embeddedness," 91 The American Journal of Sociology 481-510 (1985).
61. Ibid.
62. On the subject of "mass collaboration," see D. Tapscott and A. D. Williams, Wikinomics: How Mass Collaboration Changes Everything (New York: Portfolio, Penguin, 2006). On the related subject of "peer production,"
63. see Y. Benkler, "Coase's Penguin, or, Linux and The Nature of the Firm," 112 Yale Law Journal 369-446 (2002).
64. See Benkler, 2002, ibid.
65. Janet Kornblum, "Teens Hang Out At MySpace," USA Today, www.USATODAY.com, January 9, 2006, "Murdoch Marvels at MySpace Acquisition," October 18, 2007 http://www.ctv.ca/servlet/ ArticleNews/story/CTVNews/20071018/myspace_071018/20071018?hub=SciTech
66. Benkler (2002, supra note 27, p. 436) suggests that "Contributions may vary widely in their hedonic taste for creation, their social-psychological attitude toward participation, or in opportunities for indirect monetary appropriation."
67. Economists have studied two-sided markets for well over a century. Eugen von Böhm-Bawerk's (1891) famous market for horses originates the important idea of a two-sided market. Böhm-Bawerk introduces the term "two-sided competition," stating that "The case of two-sided competition is the most common in economic life, as it is the most important in the development of the Law of Price. It demands, therefore, our most careful attention." Rather than characterizing supply and demand as aggregates, he begins with individual buyers and sellers and their subjective valuations. E. von Böhm-Bawerk, Positive Theory of Capital, translated from the German by W. E. Smart (London: Macmillan, 1891).
68. The term "two-sided market" has a long history. Shapley and Shubik employ the term "two-sided market" and observe that "Two-sided market models are important, as Cournot, Edgeworth, Böhm-Bawerk, and others have observed, not only for the insights they may give into more general economic situations with many types of traders, consumers, and producers, but also for the simple reason that in real life many markets and most actual transactions are in fact bilateral - i.e., bring together a buyer and a seller of a single commodity."
69. See L. S. Shapley and M. Shubik, "The Assignment Game I: The Core," 1 International Journal of Game Theory 111-30 (1972), at 111.
70. See Spulber, 2006, supra note 4.
71. Ibid.
72. Spulber examines the effects of network structures when firms act as market makers. See Spulber (2006) supra note 4.
73. See D. Lucking-Reiley and D. F. Spulber, "Business-to-Business Electronic Commerce," 15 Journal of Economic Perspectives 55-68 (2001).
74. These exchanges are subject to regulation by such agencies as the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC).
75. Coordination in electric power transmission networks to manage loads is achieved through industry associations and regulations
76. See A. C. Pigou, The Economics of Welfare (London: Macmillan, 1920)
77. E. J. Mishan, "Reflections on Recent Developments in the Concept of External Effects," 31 Canadian Journal of Political Economy 3-34 (1965)
78. and E. J. Mishan "The Postwar Literature on Externalities: An Interpretive Essay, 9 Journal of Economic Literature 1-28 (1971).
79. 1) = c.
80. 2, q1) = c.
81. R. H. Coase, "The Problem of Social Cost," 3 Journal of Law & Economics 1-44 (1960).
82. See Daniel F. Spulber, 1989, Regulation and Markets, Cambridge, MA, Cambridge University Press, Chapters 12 and 13, for further discussion.
83. See S. N. S. Cheung, "The Fable of the Bees: An Economic Investigation," 16 Journal of Law & Economics 11-33 (1973). On pollination in agriculture
84. see Roger A. Morse and Nicholas W. Calderone, The Value of Honey Bees As Pollinators of U.S. Crops in 2000, Research Report (Ithaca, NY: Cornell University, 2000).
85. See J. E. Meade, "External Economies and Diseconomies in a Competitive Situation," 62 Economic Journal 54-67 (1952).
86. The fable was used to illustrate market failure by F. M. Bator, "The Anatomy of Market Failure," 72 Quarterly Journal of Economics 351-79 (1958)
87. see also E. J. Mishan, "Reflections on Recent Developments in the Concept of External Effects," 31 Canadian Journal of Political Economy 3-34 (1965).
88. 1) = p.
89. 1*) = p.
90. On the optimal outcome and Nash equilibria with network effects, see P. H. Dybvig and C. S. Spatt, "Adoption Externalities as Public Goods," 20 Journal of Public Economics 231-47 (1983).
91. Ibid.
92. See, e.g., E. Kalai and E. Lehrer, "Rational Learning Leads to Nash Equilibrium," 61 Econometrica, 1019-45 (1993) and the references therein.
93. See, e.g., R. Lagunoff, "On the Evolution of Pareto-Optimal Behavior in Repeated Coordination Problems" 41 International Economic Review 273-93 (2000).
94. J. B. Van Huyck, R. C. Battalio, and F. W. Rankin, "On the Origin of Convention: Evidence from Coordination Games," 107 Economic Journal 576-96 (1997).
95. F. A. Hayek, The Constitution of Liberty (Chicago, IL: University of Chicago Press, 1960), p. 160.
96. See Spulber, 1999, supra note 5.
97. See F. A. Hayek, "The Use of Knowledge in Society," 35 The American Economic Review 519-30 (1945)
98. at pp. 521-522. See also Friedrich Hayek, Law, Legislation and Liberty, v. 1 Rules and Order (Chicago, IL: University of Chicago Press, 1973), Chapter 2.
99. Hayek, 1945, p. 521.
100. Ibid, pp. 521-2.
101. Ibid, p. 524.
102. Ibid, p. 527.
103. Ibid, p. 528
104. A. D. Chandler, The Visible Hand: The Managerial Revolution in American Business (Cambridge, MA: Harvard University Press/Belknap Press, 1977), at p. 238.
105. On the "marketing mix" and the four Ps of marketing (product, price, place, and promotion), see P. Kotler, Marketing Management, 9th edn (New York: The Free Press, 1999).
106. AT&T e-mail commercial advertisement, March 29, 2007.
107. AT&T website: Attreferrals.com.
108. Dybvig and Spatt, 1983, discuss government provision of insurance contracts to induce consumers to adopt a network good. The insurance is never paid in equilibrium because consumers adopt the good. They do not consider provision of network goods by private firms. Private firms are better able to create such mechanisms than the public sector. Private firms have far better market information than the government. Governments have cumbersome bureaucracies and are subject to corruption; an agency for the subsidization of consumer adoptions of goods in network industry seems far afield from the standard functions of government. Moreover, the government would need to select technology winners to provide the subsidy. Governments do promote universal service in network industries through common carrier regulations and regulated rates with cross subsidies. Such promotion of universal service is a subject of considerable controversy, however.
109. "Apple Sells More Than 100 Million iPods," Reuters, April, 10, 2007, washingtonpost.com, Apple Press release, http://www.apple.com/pr/library/2007/04/09ipod.html
110. Ibid.
111. Ibid.
112. Ibid.
113. Ibid
114. CIA Factbook, https://www.cia.gov/cia/publications/factbook/geos/xx.html
115. Nokia Expects 3 Billion Mobile Phone Users by 2008, Telecommunications Industry News, December 15, 2005.
116. Websites are measured in terms of web servers, although "one host may have multiple sites by using different domains or port numbers," see Hobbes' Internet Timeline Copyright 1993-2006 by Robert H Zakon, Version: 8.2, ArcHive-location: http://www.zakon.org/robert/internet/timeline/
117. Ibid.
118. On measuring the diameter of the Web, see Albert László, Linked: The New Science of Networks (Cambridge, MA: Perseus Publishing, 2002).
119. J. Battelle, The Search: How Google and its Rivals Rewrote the Rules of Business and Transformed Our Culture (New York: Portfolio, Penguin, 2005).
120. Ibid, p. 240.
121. For an overview of the literature, see A. Devenow and I. Welch, "Rational Herding in Financial Economics," 40 European Economic Review 603-15 (1996)
122. L. R. Anderson and C. A. Holt, "Information Cascades and Rational Conformity," Encyclopedia of Cognitive Science (New York: Macmillan, 2001)
123. S. Bikhchandani, D. Hirshleifer, and I. Welch, "Learning from the Behavior of Others: Conformity, Fads, and Informational Cascades," 12 Journal of Economic Perspectives 151-70 (1998). With herding, inefficiencies can occur if individuals rely on the behavior of other agents rather than on their own private information.
124. See I. Welch, "Sequential Sales, Learning, and Cascades," 47 The Journal of Finance 695-732 (1992)
125. S. Bikhchandani, D. Hirshleifer, and I. Welch, "A Theory of Fads, Fashion, Custom, and Cultural Change as Informational Cascades," 100 Journal of Political Economy 992-1026 (1992)
126. A. V. Banerjee, "A Simple Model of Herd Behavior," 107 Quarterly Journal of Economics 797-817 (1992). Choi connects herd behavior with network effects in the adoption of new technologies
127. see J. P. Choi, "Herd Behavior, the 'Penguin Effect,' and the Suppression of Informational Diffusion: An Analysis of Informational Externalities and Payoff Interdependency," 28 Rand Journal of Economics 407-25 (1997).
128. See L. Bru and X. Vives, "Information Externalities, Herding and Incentives," Centre for Economic Policy Research, Discussion Paper No. 3080, November 2001.
129. J. H. Rohlfs, Bandwagon Effects in High-Technology Industries (Cambridge, MA: MIT Press, 2001).
130. Ibid., at p. 190.
131. D. F. Spulber, "The Interplay Between Social Networks and Market Networks," Northwestern University Working Paper, 2007, examines a strengthening of the Nash equilibrium requirements to allow blocking by incremental groups. The incremental Nash equilibrium selects the Pareto-dominant Nash equilibrium. This shows that the formation of incremental groups is sufficient for equilibrium adoption decisions to achieve an efficient outcome.
132. Liebowitz and Margolis, 1994, supra note 15.
133. See M. S. Granovetter, "The Strength of Weak Ties," 78 The American Journal of Sociology 1360-80 (1973)
134. and M. S. Granovetter, "The Strength of Weak Ties: A Network Theory Revisited," 1 Sociological Theory 201-33 (1983).
135. See F. Harary, R. Norman, and D. Cartwright, Structural Models (New York: Wiley, 1965).
136. For additional discussion, see B. G. Malkiel, "The Efficient Market Hypothesis and Its Critics," 17 Journal of Economic Perspectives 59-82 (2003).
137. This is sometimes referred to as a fulfilled-expectations demand curve. Rohlfs (1974, supra note 18), Economides (1996), and Economides and Himmelberg (1995, supra note 2) conclude that the fulfilled expectations demand is nonmonotonic, that is, it is an inverted u-shaped curve because the willingness-to-pay curve has that slope. However, only the downward-sloping portion of the willingness-to-pay curve is the demand function because the other portion of the curve does not correspond to a stable equilibrium.
138. For corrections of the fable, see John E. Davies, "Giffen Goods, the Survival Imperative, and the Irish Potato Culture," 102.3 Journal of Political Economy 547-65 (1994)
139. Terrence McDonough and Joseph Eisenhauer, "Sir Robert Giffen and the Great Potato Famine: A Discussion of the Role of a Legend in Neoclassical Economics," XXIX Journal of Economic Issues 747-59 (1995)
140. and Sherwin Rosen, "Potato Paradoxes," 107.6 (pt 2) Journal of Political Economy S294-313 (1999). McDonough and Eisenhauer state that "the Giffen legend concerning the great potato famine appears at best to be a misinterpretation of some observed but misunderstood phenomenon, and at worst a kind of hoax." For a model with storage
141. see Yoram Barzel and Wing Suen, "The Demand Curves for Giffen Goods are Downward Sloping," 102 The Economic Journal 896-905 (1992). Claims that demands for luxury or superior goods are upward sloping typically are justified by assumption or by anecdotal speculation
142. see, e.g., Gary S. Becker, "A Note on Restaurant Pricing and Other Examples of Social Influences on Price," 99 The Journal of Political Economy 1109-16 (1991)
143. and S. Yao and Ke Li, "Pricing Superior Goods: Utility Generated By Scarcity," 10 Pacific Economic Review 529-38 (2005). The claims that network effects lead to upward-sloping demands for network goods similarly have no empirical foundation, although some anecdotes are offered
144. see, e.g., Rohlfs (1974, supra note 18, and 2001 supra note 80).
145. 2(n, i) < 0 for all n in [0, N].
146. The marginal consumer equals the ttal number of consumers N if u(N, N) ≥ p. The marginal consumer also can equal 0 if no one joins the network.
147. Hovenkamp, 2005, p. 281.
148. Ibid., p. 282.
149. R. A. Posner, Economic Analysis of Law (New York: Aspen, 2003), p. 324.
150. Hovenkamp, 2005, p. 278.
151. If output Q is the sum of Q′ and Q″, the natural monopoly property is defined formally as C(Q) ≤ C(Q′) + C(Q″).
152. See W. J. Baumol, J. Panzer, and R. D. Willig, Contestable Markets and the Theory of Industry Structure (New York: Harcourt, Brace, Jovanovich, 1982)
153. and D. F. Spulber, Regulation and Markets (Cambridge, MA: MIT Press, 1998).
154. n u(n/2, i)di - C(n/2)
155. n u(n/2, i)di - 2C(n/2)
156. n u(n/2, i)di. This condition is simply a restatement of the assumption that consumers prefer more members in a network.
157. See M. L. Katz and C. Shapiro, "Technology Adoption in the Presence of Network Externalities," 94 The Journal of Political Economy 822-41 (1986).
158. On the costs of interconnection, see Katz and Shapiro, 1985, supra note 2.
159. See Spulber and Yoo, 2003, supra note 13, for additional discussion related to this point.
160. Firms compete for a franchise in a regulated market, see H. Demsetz, "Why Regulate Utilities?," 11 Journal of Law and Economics 55-65 (1968).
161. See also Spulber, 1989 supra note 42 on competition for regulatory franchises. With low entry costs, market is "contestable" and firms compete to serve the market as in Baumol, Panzer, and Willig, 1982, supra note 96.
162. The presence of switching costs potentially creates an advantage for an incumbent because the price difference between the incumbent and the entrant must compensate for switching costs. The presence of network effects may interact with switching costs and presumably increase their input, see Farrell and Klemperer (2006, supra note 2). However, an incumbent advantage due to switching costs is not unique to an industry with network effects; any industry in which customers have switching costs can encounter this advantage.
163. Katz and Shapiro, 1985, supra note 2.