A THEORETICAL REVIEW OF NETWORK EFFECTSON PLATFORM PRODUCTS
Kazuhiko Kato/Tatsuyuki Negoro
1-6-1, Nishiwaseda, Shinjyuku-ku,
169-8050 TokyoWaseda UniversityABSTRACT
Network effects appear to increase the benefits that consumers derive from a product as theuser set expands. In platform products, they are known as one of key mechanisms of being
successful on that business. This is mainly because they generate the incentives for users inchoosing the platform. For examples, many business achievements, such as VHS video,Microsoft windows OS and NTT Docomo i-mode have exhibited network effects. The
purpose of this study is to present a new elaborated concept of network effects and eightperspectives in platform products with layered structure which constructed by threeplayers i.e. platform leaders, complementary products (complementors) and users.
Firstly, there have been many studies about network effects and almost all studies haveargued the influence to end-users, based on the network scale (the number of subscribers).
However, the study alludes the necessity of network effects with the significance oflinkages between members i.e. access frequency and weight, as well as the number oflinkages between members.
Secondary, the study classifies four categories and eight perspectives working between
couples of layers among platform products, complementary products and users. Four
categories are as follows,
1.Network effects between users, 2.Network effects between complementary products(complementors), 3.Network effects between a user and complementary products(complementors), 4.Network effects between a complementary product (complementor)
and users.
Consequently, the study offers two suggestions. The First one is a new elaborated concept
regarding network effects i.e. the significance of linkages between members. The other one
is four categories between couples of layers among platform products, complementary
products and users, compared with two conventionally categories between products andusers typically by Katz & Shapiro (1985). In addition, an actual case is presented to eachfour category, which exhibits the theoretical difference concerning network effects
between the study and that of Katz & Shapiro (1985).
Keywords: Network effects, Platform products, Complementary products, Complementors

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A theoretical review of network effects on platform products

INTRODUCTION
Discussion about the diffusion of platform products is often based upon the theory ofpositive network effects. There have been many cases upon the theory, such as QWERTYvs. Dvorak’s DSK, Microsoft Internet Explorer vs. Netscape Navigator, VHS vs. Beta. On
the other hand, we have already obtained a common finding regarding the existence ofnetwork effects which prove the increasing value for users as the number of its users
increases. This study is focusing on so-called indirect network effects arising from theamount and variety of complementary products.
The purpose of the study is mainly three points,•To review the concept of network effects in theory•

To classify network effects particularly on platform products with the layered structureon the study, which results in the quite different categories from those of Katz &Shapiro•

To prepare developing the strategic theory of platform product by adopting theclassification framework

Definition of network effects and platform products
Network effects are a characteristic that causes a product to have a value to a potential
customer which depends on the network who owns the products. In other words, thenetwork of prior adopters is a term in the value available to the next adopter.
The definition of network effects on this study is as follows,
Network effects are defined as the property of a network which influences the users’utility.
In general, the meaning of effects has positive and negative; however, as can be understoodfrom above, positive network effects are principally mentioned in the study. From atheoretical point of view, many researchers argue network effects. For instance, Rohlfs(2001)1 describes the meaning of network externalities. Network externalities: These apply
to products and services that use telecommunications networks. As the set of users expands,

1Rohlfs, J. H. (2001). “Bandwagon Effects in High-Technology Industries”, The MIT Press, pp8.

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A theoretical review of network effects on platform products

each user benefits from being able to communicate with more persons (who have becomeusers of the products or services).
On the other hand, the definition of platform products on the study is as follows, “Platformproducts are “core” products (hardware, software or services) which position insidecomplex products with layered structure.”2As a reference, the term of platform is explained by Cusumano, M.A3 as follows, “Theterm “Platform” can refer to a foundation product that has the most value when it works as
the core of a system of components made by one or more firms.”

The definition of network effects by Katz and Shapiro (1985)4
In the meantime, Katz and Shapiro (1985) classifies 2 categories on network effects asfollows,
Direct physical effects: The consumption externalities may be generated through a direct
physical effect of the number of purchasers on the quality of the product. The utility that aconsumer derives from purchasing a telephone，for example，dearly depends on thenumber of other households or businesses that have joined the telephone network. Thesenetwork externalities are present for other communications technologies as well, including
Telex，data networks, and over-the-phone facsimile equipment.
Indirect effects: There may be indirect effects that give rise to consumption externalities.
For example, an agent purchasing a personal computer will be concerned with the numberof other agents purchasing similar hardware because the amount and variety of softwarethat will be supplied for use with a given computer will be an increasing function of thenumber of hardware units that have been sold. This hardware-software paradigm also
applies to video games, video players and recorders, and phonograph equipment.

2Negoro, T & Kato, K.(2006) “A Critical Development of the Four Levers Framework on Platform
Leadership by M. A. Cusumano & A. Gawer :Through the Re-examination of Cases by M. A.
Cusumano & A.Gawer and an Additional Case Study of Java”, Research Institute of Information
Technology and Management, Waseda Univ. Working Papers,No.18.2006.pp14. Partly Revised
3Cusumano, M. A.(2004).”The business of software”, Free Press, pp74
4Katz, M. L & Shapiro, C.(1985）.“Network Externalities, Competition, and Compatibility”, American
Economic Review,Vol.75,No.3,pp.424-440.

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A theoretical review of network effects on platform products

A NEW ELABORATED CONCEPT OF NETWORK EFFECTS

As a first proposition, this study demonstrates a new elaborated concept regarding network
effects. One main historical point of view is that to what extent of network effects working
the incentives in choosing the platform for users has depended on the number of network
members. Nevertheless, as another essential concept, the significance of specific linkages
is insisted in this study. In other words, the number of linkages is not necessarily
automatically causing the incentives for platform users because the significance of specificlinkages is important as well.

FOUR CATEGORIES OF NETWORK EFFECTS

This study classifies four categories working between couples of layers among platformproducts, complementary products and users. Four categories are as follows,
1.Network effects between users：The increase of platform products’ users causes network
effects between users
2.Network effects between complementary products (complementors) ：The increase of
platform products’ users causes network effects between complementary products(complementors).
3.Network effects between a user and complementary products (complementors)：The
increase of complementary products and complementors caused by the increase of
platform products’ users generates network effects to a user.
4.Network effects between a complementary product (complementor) and users ：Theextension of users caused by the increase of platform products generates network effects toa complementor.

Comparison with the theory by Katz and Shapiro (1985)
Upon four categories, this study examines conformity with the network effects theory byKats and Shapiro (1985). They differentiated between direct network effects in terms of
direct “physical” effects of being able to access and indirect network effects arising fromthe amount and variety of the complementary products. The comparison with Kats andShapiro (1985) is as follows,4A theoretical review of network effects on platform products

1. Network effects between users >>> Direct physical effects by Katz and Shapiro
2. Network effects between complementary products (complementors) >>> NotApplicable
3. Network effects between a user and complementary products (complementors) >>>Indirect effects by Katz and Shapiro
4. Network effects between a complementary product (complementor) and users >>> Not
Applicable

Classification of eight categories
By combining two indications i.e. the proposed concept and four categories, total eightperspectives are made as an analytical framework. To distinguish each perspective, codes5
are assigned below respectively in the study.
The number and diversity of linkages：1.UU-N 2.CC-N 3.UC-N 4.CU-N
The significance of linkages ：1.UU-S 2. CC-S 3.UC-S 4.CU-S

UU-N, CC-N, UC-N and CU-N
UU-N explains that from platform users’ point of view, the incentives in choosing platform
depend on the number and diversity of other accessible users.
CC-N explains that from platform complementors’ point of view, the incentives inchoosing platform depend on the number and diversity of other accessible complementors.
UC-N explains that from platform users’ point of view, the incentives in choosing platform
depend on the number and diversity of other accessible complementary products(complementors).
CU-N explains that from platform complementors’ point of view, the incentives inchoosing platform depend on the number and diversity of other accessible users.
5For example, UU-N stands for User to User in terms of Number. CU-S stands for a Complementor to Usersin terms of Significance.

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A theoretical review of network effects on platform products

UU-S, CC-S, UC-S and CU-S
UU-S explains that from platform users’ point of view, the incentives in choosing platform
depend on the significance of other particular accessible users.
CC-S explains that from platform complementors’ point of view, the incentives inchoosing platform depend on the significance of other particular accessible
complementors.
UC-S explains that from platform users’ point of view, the incentives in choosing platform
depend on the significance of other particular accessible complementary products(complementors).
CU-S explains that from platform complementors’ point of view, the incentives inchoosing platform depend on the significance of other particular accessible users.

ACTUAL CASESIn the following, actual cases are illustrated in turn from eight perspectives.
1. Network effects between users
Actual case in the number of linkages (case UU-N): OS users choose OS type to share theinformation easily e.g. regarding trouble shooting with the large number of other same OSusers.
Actual case in the significance of linkages (case UU-S): OS users choose OS type toexchange files consistently with the significant other same OS users. e.g. Linux users.
2. Network effects between complementary products (complementors)
Actual case in the number of linkages (case CC-N): Complementors developing statistics
software choose to adopt the spreadsheet software on the OS that is already diffused
widely.
Actual case in the significance of linkages (case CC-S): Complementors providing atraining for particular application software choose OS for the significant segment users’demand. e.g. Unix training outsourcers

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A theoretical review of network effects on platform products

3. Network effects between a user and complementary products (complementors)
Actual case in the number of linkages (case UC-N): Game users choose the platform i.e.
game hardware brand, because of the diversity of application software.
Actual case in the significance of linkages (case UC-S): A user chooses the platform forgetting killer game application software. e.g. Sony Play station user/ Final Fantasy X
4. Network effects between a complementary product (complementor) and users
Actual case in the number of linkages (case CU-N): A complementor developing gamecontents application chooses the platform game maker due to the large number of gameusers.
Actual case in the significance of linkages (case CU-S): A complementor manufacturing acable connecting PC to the portable game chooses the platform game maker with targetingthe segment of heavy music listeners over the portable game. e.g. Manufacturer of USB
cable for Play Station Portable by Sony/GAMETECH CO.,LTDCONCLUSION
To sum up, there have been many studies about network effects and almost all studies
argue the influence to end-users, based on the network scale (the number of subscribers).
However, this study alludes the necessity of network effects with the significance oflinkages between members i.e. access frequency and weight, as well as the number oflinkages between members.
Platform product is defined as the product with collateral complementary products. The
study develops the concept of network effects on platform products.
Consequently, the study classified four categories between couples of layers among
platform products, complementary products and users, compared with two categories
between products and users mainly by Katz & Shapiro (1985). In addition, an actual case ispresented to each four category, which exhibits the theoretical difference concerning
network effects between the study and that of Katz & Shapiro (1985).
As a future assignment, the study is still open to question about main levers i.e. strategic
schemes for the growth of ecosystem made up of platform leaders and complementors, byleveraging network effects on the platform strategy on a theoretical basis. Further
investigations shall be provided.

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A theoretical review of network effects on platform products

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