Network structure effects on incumbency advantage

Abstract

Research summary: The literature on network effects has implicitly assumed that an increase in the size of the installed base magnifies network effects, which is a source of incumbency advantage. We argue that the overemphasis on this relationship has resulted in controversy and confusion in the literature, where the role of social networks remains largely unaddressed. By developing computational models of network effects with various network structures, we show that social distance in a customer network plays a moderating role that strengthens or weakens the relationship between the installed base and network effects, which in turn, affects the durability of incumbency advantage. When the average social distance between members in a customer network is large, the incumbency advantage will not be amplified, and an entrant with an incompatible product or service may find ways into the market. On the other hand, when the average social distance is small, early entry with a growing installed base will magnify incumbency advantage.Managerial summary: In evaluating the strength of incumbency advantage or determining the price of an early mover, the size of the installed base has been widely used. We find that it is not a sufficient statistic, and confusion and error appear to result from assuming that it is. Our study suggests that degrees of separation, a measure of social distance in a network, can provide managers with an additional yardstick to sharpen their evaluation. When customer networks are characterized by fewer degrees of separation, the conventional use of the installed base as a metric may be reasonable. On the other hand, when customer networks are characterized by larger degrees of separation, the conventional use may potentially mislead managers in their decision-making. Thinking about the roots of user benefits (e.g., access to a few significant others vs. hubs) may be a reasonable starting point for assessing degrees of separation in a customer network. Copyright (c) 2015 John Wiley Sons, Ltd.