Finally, there are two ways in which the passing of time impacts the intensity of competition and the incentives to cooperate through compatibility. First, cooperation in making systems compatible relaxes competition early in the product life-cycle because the threat of all users choosing one network (tipping) is reduced, but it intensifies competition later in the product life-cycle because it prevents a firm from gaining control over the market (Katz & Shapiro, 1994). Second, a later-period competitor may gain performance and cost advantages from improved technologies. Although the later entrant would benefit from the size effects of compatibility with the established networks, the new entrant may favor incompatibility in order to exploit the advantage of the new technology and therefore leave users of the old technology stranded (Katz & Shapiro, 1992).
Although telephone operators belong to a class of firms for which network externalities clearly impact the value of the services provided by firms (Rohlfs, 1974; Economides, 1996), regulatorily imposed interconnect agreements make it possible for any customer of any operator to connect to any other customer, including those who are customers of other operators, while roaming allows customers to use their phone and subscription to access the network of any operator. Initially, the mandated and regulatorily imposed interconnection required by the 1996/1997 regulatory regimes that exist in most EU countries, and the subsequent 1998 telecommunication liberalization directive (Larouche, 2000) should eliminate the impact of network externalities on the value of the services of an individual firm. Correspondingly, network externalities should not affect customer value or competition when services are fully compatible and the prices charged to consumers do not depend on where calls are terminated. However, if networks choose to charge different prices for calls terminating in the subscriber’s network and those terminating in a rival’s network, this creates a price differential between services that are identical for the consumer and generates network externalities despite interconnection (Laffonte et al., 1998). Value-added Short Message Services allow for both price and functionality differentiations that can generate similar network externalities, and although it is difficult to differentiate on and off-net phone calls functionally operators may be tempted to ensure greater on-net capacity and reliability than interconnect capacity. We assume that in building their networks the operators take into account the possibility of network externality-generating actions by competitors, given that a number of opportunities exist despite regulatorily mandated interconnect.
In conclusion, despite overall compatibility within the European mobile phone network there are significant opportunities for operators to introduce price and functional incompatibilities whereby network externalities can affect competition.
The mobile phone industry is a clear example of an industry built around a mediating technology (Thompson, 1967), but a similar value-creating and competitive logic can also be applied to other network industries, such as banks, railroad companies, and airlines. We will focus on three factors that we expect will affect the nature of strategic action within the mobile phone industry: market concentration, time evolution, and market penetration. These factors actually represent different but complementary views of the origins of firm conduct. Network externalities moderate the theorized relationships. First, according to the structureconduct-performance (SCP) paradigm, industry structure, particularly market concentration, is a critical determinant of competitive behavior that reduces industry rivalry (Porter, 1980). Network externalities create additional dependencies among rival firms. Second, from a product-life-cycle (PLC) perspective, the evolution of time shapes firm-level strategy and should affect industry competition when there are strong first-mover advantages, particularly in industries with strong network externalities. Finally, market penetration, as an indicator of network-externality effects, is a key driver of subscription and service usage value in value network industries. We have chosen to use market penetration rather than actual network size because it better reflects the degree of connectivity within the respective countries. The connectivity relevant to users is higher for a given number of subscribers in a small Nordic country than in a large country.
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