An industry can be defined as the set of firms that co-create value, e.g. suppliers and customers and those who compete for the creation of value, i.e., rivals, potential entrants, and makers of substitutes (Porter, 1980). Industry is thus partially defined by a division of primary activities between multiple firms (Ferrier et al., 1999; Andersen & Fjeldstad, 2003). In long-linked industries, the product in various stages of completion carries cost and value from one chain to another, giving rise to an extended value chain or business system of value chains (Porter, 1985). In contrast, mediators interconnect with their competitors to create larger networks. Mobile phone companies interconnect with their competitors to provide cross-network services, e.g., to allow customers of one mobile phone company to call customers of a competitor, and they make roaming agreements allowing customers of one mobile phone company access to the services of another. Furthermore, new service layers can be introduced internally by extending the range of services provided by the mobile phone company over its own network, e.g., introducing Short Messaging Service (SMS) text messaging. New service layers can also be introduced by way of layered multi-firm co-production, e.g., the introduction of mobile phone Internet services by separate Internet Service Providers (ISPs) that provide their services over the mobile phone network. In summary, horizontal network scope and vertical service-range expansion can occur through two basic means: internal growth or external cooperative arrangements.
The value of a product is determined by a network externality when it increases with the number of product users. Thus network externalities lead to demand-side economies of scale. Recent work in economics has advanced the understanding of network externalities and their implications for competition and cooperation (Farrell & Klemperer, 2003). Telephone service is frequently used to exemplify network externalities. The value of having a phone is clearly dependent on who else has one. The value is tied to those whom the customer can call and be called by. Size is used to model the connectivity that a network offers its users. Expectations about network size are assumed to determine the value of membership and thus the actual size that networks attain.
The literature on network externalities examines how firms compete and when they choose to cooperate by making their products compatible. Three factors are of particular interest to the present study: (1) the role of the actual and expected size of the relevant network; (b) the impact of industry structure; and (c) the impact of technological evolution. Firms compete fiercely to increase network size because this influences the value of their offering. Competing firms may also cooperate by making their products compatible in order to increase the size of the relevant network. Firms with large existing networks or good reputation will be against compatibility, or cooperation, while smaller firms will favor compatibility (Katz & Shapiro, 1985). However, customers may have low a priori expectations of the size of a new network service regardless of provider, e.g. they may worry about whether a new mobile network will take off. If so, providers benefit by cooperating to make their networks fully interlinked, to maximize the expectations of connectivity and customer value.
There are also network-economic impacts of industry structure on competitive intensity. If a network is expected to have few users, the value to those users will be less, and the network will be small. On the contrary, if a network is expected to be large, the expected value of the service is higher, and more users will find it attractive to buy the service and the network will be large. Investments in forming expectations of network size thus make the service more valuable to prospective customers. A fully competitive market may not provide the participants with the ability to recapture such investments (Katz & Shapiro, 1985, p. 439). Competition in markets with low concentration may therefore be motivated by market-share building (driving others out of the market), to secure rents from investments in network expectations. Firms with a small initial advantage in a network market may be able to parlay its advantage into a larger, lasting one. Competition in network industries can thus be especially intense—at least until a clear winner emerges (Katz & Shapiro, 1994, p. 107).
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