Industry-accumulated and firm-specific market penetrations are key determinants of competitive behavior in network industries. Several authors have highlighted the importance of early competitive action aimed at influencing standards (Arthur, 1989; Farrell & Saloner, 1992) and managing expectations (Katz & Shapiro, 1994) to benefit from network externalities and the associated lock-in effects to appropriate the value created. Certainly, the value of the service increases with network size. As a result, companies can be expected to compete most fiercely to achieve ‘‘critical mass’’ when market penetration is still low (Economides, 1996).
From the above review of network externalities we know that expectations play a significant part in the determination of market shares. The network that customers expect to be large will indeed become large, because the customers’ willingness to pay for membership is higher. Once the network attains critical mass, the relative positions are more or less fixed and the network industry is on its equilibrium growth path (Economides, 1996). Networks therefore become more stable once the market reaches a high degree of penetration. This inertia means that there is less likelihood of purely competitive moves occurring. Correspondingly, strategic actions are more likely to be collaborative in their nature in markets with greater penetration.
Telecommunication operators sell two principal products: access and traffic, each one connected in its own way with market penetration. When the market reaches a high degree of penetration, there is less incentive to engage in access-related competitive strategic action to expand the network. Rather, a relatively greater number of collaborative moves or alliances between the networks already established in the market could be expected, in order to increase traffic in the respective networks. In fact, as penetration increases customers are committed and the main goal should be to increase the number of transactions with and within the respective customer sets, rather than increasing network size. This can be achieved mainly by way of alliances and other cooperative moves. Firms can be expected to look for new ways of increasing capacity utilization and transaction intensity mainly through collaboration with other firms, e.g., horizontal interconnection between networks and the vertical layering of new services.
Hypothesis 1. The probability of a strategic action being cooperative rather than competitive increases with market penetration.
Firms are less likely to engage in competitive moves if they feel that their competitors will retaliate (Porter, 1980; Dutton & Jackson, 1987; Chen et al., 1991).
Furthermore, the probability that the firm will engage in a competitive move decreases as the negative consequences of the competitors’ responses increase (Weigelt & MacMillan, 1988; Chen & MacMillan, 1992). The likelihood of retaliation is likely to be related to interdependence and market concentration. In fact, research in competitive dynamics confirms the basic notion from SCP that concentration reduces overall rivalry (i.e., the total number of strategic actions), while facilitating coordination and even collusion among the firms in the industry (i.e., there is a greater likelihood that a given strategic action involves collaboration rather than competition with other firms) (Smith et al., 1992).
The effect of concentration on the probability of collaborative actions (versus competitive moves) should be even stronger in the case of network industries. Network externalities increase the benefits to large firms in an industry because by providing large firms with the opportunity for monopoly rents from incompatible products. When services are not fully compatible, including as a result of on-net/offnet price differentiation, a smaller firm is at a disadvantage vis-a-vis a larger one" (Katz & Shapiro, 1985; Laffonte et al., 1998) and the payoff from enjoying a significant position in a concentrated industry can be considerable. When concentration is low, firms can be expected to compete for a position in a future concentrated market. Conversely, mobile phone operators need to have good interconnections with those networks that already have a strong presence in the market. When industry concentration is high, competitors cannot disregard the terms of access to the customer base of their fewer and stronger full-coverage competitors (Laffonte et al., 1998), which means that operators should be expected to refrain from discriminatory interconnect agreements that would increase competition and reduce the profits of firms in the industry.
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