This paper develops a new diffusion model that incorporates the indirect network externality. The market with indirect network externalities is characterized by two-way interactive effects between hardware and software products on their demands. Our model incorporates two-way interactions in forecasting the diffusion of hardware products based on a simple but realistic assumption. The new model is parsimonious, easy to estimate, and does not require more data points than the Bass diffusion model. The new diffusion model was applied to forecast sales of DVD players in the United States and in South Korea, and to the sales of Digital TV sets in Australia. When compared to the Bass and NSRL diffusion models, the new model showed better performance in forecasting long-term sales. Copyright (C) 2008 John Wiley & Sons, Ltd.