Network Effect Theory


There are several definitions for network effects in the economic literature which are more or less detailed or specific. Katz and Shapiro (Katz et al. 1985, p. 424) describe the source of positive consumption externalities as the “utility that a user derives from consumption of goods” which “increases with the number of other agents consuming the (same) good”. Another definition also provided by Katz and Shapiro defines network effects as “the value of (a) membership to one user (which) is positively affected when another user joins and enlarges the network” (Katz et al. 1994, p. 94). Church, Gandal and Krause (Church et al. 2002, p. 1) emphasize that “network effect exists if consumption benefits depend positively on the total number of consumers who purchase compatible products”. Economides introduces the term “network industries” where external effects in vertical industries play a crucial role (Economides 1996a). According to these definitions, it is easy to come up with many examples such as computer or telecommunication networks, but also automated teller machines (ATM), credit cards, VHS video systems, QWERTY keyboards and more. Such wide definitions would also include newspaper subscriptions, golf club memberships, or customer loyalty programs. Literally all kinds of consumption with positive feedbacks on the supply side, as well as on the consumer side could be subsumed under the terms of network effects and network externalities. Obviously, such a broad definition is not helpful to describe the unique constellation in communication networks, where each adopter is a “consumer” and (willingly or not) a “supplier” of an adopted standard at the same time.


Switching Cost Network Effect Network Externality Communication Standard Adoption Decision 
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© Deutscher Universitäts-Verlag | GWV Fachverlage GmbH, Wiesbaden 2006

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