Market Segmentation for Information Goods with Network Externality: a Note

Positive externalities characterize the consumption of a majority of information goods such as software and online content services including virtual communities. We show that network externality is critical for the market segmentation and product line structure of such information goods. A monopoly of multiple existing products offers exactly two distinct qualities. Essential for such a limited segmentation result is the complementary effect between the two products due to externality. In particular, the low quality should be offered for free under very general conditions. When development costs are taken into account, the low quality is developed only if the gain in revenue due to an enlarged network exceeds the extra development costs. Facing high-end competition, a low-end seller never segments his market. The high-end seller may choose to offer two products if he possesses a clear-cut quality advantage. (Information Goods; Network Externality; Market Segmentation; Product Line Pricing) Acknowledgement: This paper has significantly benefited from the comments and suggestions by the Associate Editor and three anonymous referees. Help from Marshall Freimer, Roy Jones, John Long, and Abraham Seidmann is also valuable. All remaining errors are the sole responsibility of the author.