Quantitative Analysis of Network Externalities

In this paper, we extend a standard nested logit model, developing an empirically applicable dynamic structural model of consumers’ choices and producers’ pricing in an oligopolistic market for newly introduced durable products with network externalities. The model is then applied to quantitatively analyze the extent to which network externalities contributed to the de facto standardization of the VHS format in the U.S. home VCR market during the years 1981-1988. The estimation results established in the paper show: (i) the network advantage of VHS explains at least 70.3 percent to 86.8 percent of (the logarithm of) relative sales of VHS to Betamax in each year; (ii) an increase in the network advantage of VHS was an engine of tipping toward the VHS format; and (iii) the network advantage of VHS was mainly due to its expected growth advantage in the early 1980’s, but as the household penetration rate of VCR jumped in mid 1980’s, the installed base advantage became more important. Our quantitative analyses also indicate that this tipping process was intact by a big average price/quality advantage of Betamax in 1987, implying the significance of an applications barrier to entry.