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Working Paper

The Impacts of the Supporting-Firm Base in Markets with Network Effects

Qi Wang and Jinhong Xie, 2010 [10-108]

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Many markets are subject to network effects: in those markets, the more people who jump on the bandwagon and adopt the product or service, the more value the users get out of it. When there are battles in those markets over what format for a given technology or product will become the standard, customers’ reluctance to purchase goes up because purchasing a product or service that uses the losing standard can be very damaging financially. (Consider, for example, the battle during the 1980s between Beta and VHS to become the standard video format, or the more recent battle between Blu-ray and HD-DVD to become the standard for high-definition DVD players.)

Many studies have examined how the size of the customer base affects which standard wins out in the end but none have looked at how the size of supporting-firm base (i.e., the number of firms supporting a given technology) affects the outcome of a standards war. Qi Wang of the State University of New York at Binghamton and Jinhong Xie of the University of Florida propose that the support of firms on the supply side is also a potentially important market force. The authors argue that consumers understand that companies are better able to judge a winning technology than they themselves are, so consumers are likely to take firms’ support as a sign that the technology is a good one. Furthermore, sheer numbers of supporting firms increase the chances that the technology will survive. Finally, customers may perceive that if a large number of firms support a certain technology, there is more likely to be price competition, which may in turn increase the number of users of the technology, thereby strengthening the network effects and the chance that the technology will become the industry standard.

The authors test their proposed theory on the impact of the supporting-firm base with an analysis of the history of 3.5-inch floppy disk drives’ success in the market from 1983, when they were introduced, until 1998, during which time they vied with disk drives of other sizes and eventually became the standard.

The authors find that customers do indeed value a product more highly when a large number of firms support it. Furthermore, a large base of supporting firms reinforces, rather than substitutes for, a large base of consumer adopters. This suggests that firms can’t merely substitute building up firm support for building up customer support (or vice versa), but must work on both at once. This means extra work for companies, but the good news is that improvements on one front will have beneficial effects on the other.

The authors also examine the importance of several characteristics of the supporting firms. They find that customers value the support of incumbent firms more than the support of newcomers, which the authors attribute to customers’ recognition that incumbents have certain advantages over newcomers in terms of specialized assets. They also find that customers value the support of firms that commit to a single technology more than the support of firms that embrace multiple competing technologies. The authors suggest that customers interpret commitment to a single technology as a demonstration of confidence, whereas support of multiple technologies is seen as waffling.

The primary takeaway for marketing managers in fields with network effects and strong standards competition is that an innovating firm can improve customers’ assessment of its product and speed up acceptance of the product by encouraging other firms to support its product’s technology. Because customers do not value all firms equally, managers should concentrate on those firms that support only a single standard and that have produced the previous generation technology. For companies that are trying to choose which technology to support among competing standards, the research indicates that it is better to join the side with the most members, as that is the side that customers will turn to.

Finally, because a strong customer base and a strong supporting-firm base reinforce each other and are both necessary to win the standards war, the authors suggest that rather than competing on price (which will draw customers, but at the expense of other supporting firms), companies should choose ways of competing that do not alienate either the customer or the supporting-firm side of the equation. Lowering licensing fees, for example, could draw in more supporting firms without adversely affecting customers.

Qi Wang is Assistant Professor of Marketing at the State University of New York at Binghamton. Jinhong Xie is the Etheridge Professor of International Business and Professor of Marketing at the Warrington College of Business Administration, University of Florida.

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