Network Effects on Chinese Mobile Telephony Market - Essay Example

Shurmer (1993) uses consumer survey results to analyze network externalities in software by questioning consumers directly about their attitudes towards software standards. Park (2003) studies the role of network effects in the standard war of video recording systems. However, most of this literature is concerned with indirect network effects, which are defined as "market mediated effects" including cases where complementary goods are more readily available or lower-priced as the number of users of good increases. In contrast, there are very few works on direct network effects, which are defined as those generated through a direct physical effect of the number of purchasers on the value of a product.

In the mobile telecommunication industry, the 2G (second generation) mobile networks are believed to exhibit the direct network effects: the value of a network increases when people can call a larger set of persons. In the presence of such effects, mobile users would prefer to subscribe to the operator with a larger installed base, which offers a more attractive product. In turn, more customers are induced to subscribe to its networks producing a yet bigger installed base advantage. Accordingly, the service providers tend to compete more aggressively to increase their market share than would otherwise be the case. However, along with the diffusion of the 3G networks, indirect network effects begin to play an increasing role, since their usage heavily relies on the available data services. This could be an interesting topic for future studies.

Compatibility is one critical factor conditioning the impact of network effects on market outcomes. It is defined as a measure of the extent to which utility derived by users of a given network product is influenced by the number of users of competing network products (Katz and Shapiro, 1985). The incentive for compatibility is subject to the relative sizes of the demands for each competing network goods. When companies have similar installed bases, they make their products compatible to expand the market. However,   random forces could result in one company having a bigger consumer base, in which case the larger one may have the incentive to make its product incompatible artificially.