Systems Competition and Network Effects

Many products have little or no value in isolation, but generate value when combined with others. Examples include: nuts and bolts, which together provide fastening services; home audio or video components and programming, which together provide entertainment services; automobiles, repair parts and service, which together provide transportation services; facsimile machines and their associated communications protocols, which together provide fax services; automatic teller machines and ATM cards, which together provide transaction services; camera bodies and lenses, which together provide photographic services. These are all examples of products that are strongly complementary, although they need not be consumed in fixed proportions. We describe them as forming systems, which refers to collections of two or more components together with an interface that allows the components to work together. This paper and the others in this symposium explore the economics of such systems. Market competition between systems, as opposed to market competition between individual products, highlights at least three important issues: expectations, coordination, and compatibility. A recent wave of research has focused on the behavior and performance of the variety of private and public institutions that arise in systems markets to influence expectations, facilitate coordination, and achieve compatibility. In many cases, the components purchased for a single system are spread over time, which means that rational buyers must form expectations about