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I studied industrial organization for my Econ. Ph.D. four decades ago. At that time industrial organization had no way to incorporate 'network effects' into monopoly theory. With the advent of social media (especially Facebook) since then accusations of monopoly power against social media are heard daily. Has someone articulated a theory of network effects as the source of monopoly?
Many thanks.
Here's a solid example of it in formal literature, with about 1k citations:
Competition with Switching Costs and Network Effects
by Joseph Farrell and Paul Klemperer
The general thought of the article is that customers who are "locked in" to a particular product can lead to competitors preferring to separate markets rather than competing with one another. To be pedantic, they are not full monopolies (but they're certainly not classically competing either).
Even four decades ago, there were some references around, see for instance:
Katz Michael L. and Carl Shapiro, 1985, "Network Externalities, Competition, and Compatibility," American Economic Review, 75, 424-440.
The literature is mainly considering oligopoly theory, however, because competition between different standards is often an important issue with networks. See also:
Amir, Rabah and Natalia Lazzati, 2011. "Network effects, market structure and industry performance," Journal of Economic Theory, 146, 2389-2419.
and the references cited there.
It was certainly a large part of the DOJ's case against Microsoft at the turn of the millennium. Get your favorite internet search tool and search for "doj v microsoft monopoly network effects" (no quotes) and you'll find the original complaint (https://www.justice.gov/atr/complaint-us-v-microsoft-corp):
- Microsoft has maintained a monopoly share (in excess of 80%) of the PC operating system market over an extended period of time. The durability of Microsoft's market power in part reflects the fact that the PC operating system market is characterized by certain economies of scale in production and by significant "network effects." In other words, the PC operating system for which there are the greatest number, variety, and quality of applications will be selected by the large majority of PC users, and in turn writers of applications will write their programs to work with the most commonly used operating system, in order to appeal to as many potential customers as possible. Economies of scale and network effects, which reinforce one another, result in high barriers to entry.
As well as testimony: https://www.justice.gov/atr/testimony-franklin-m-fisher-united-states-v-microsoft-corporation. There's a whole section in there dedicated to "What Is the Role of Network Effects?"
Network effects can also be thought of as economies of scale in consumption. The demand of the firm is increasing in the "expected" demand of the firm, as each consumer's decision depends on how many others have acquired the product. As such, a firm that is able to convince users that they will have many users in the future is able to establish a competitive advantage over potential rivals in the market. This can have a snowball effect. Consumers expect the firm to have high demand, so they acquire the good and in a fulfilled expectations type of way, the firm obtains a high demand. Potential rivals face the installed base of the firm as the main deterrent for their own demand. This confers monopoly power to the original firm. One thing to bear in mind is that, although the firm has market power, it is also providing a "superior" product, because, in addition to the product's intrinsic value, it also adds, the network effect to the utility of the consumers. This is why we do not have so many Antitrust cases against network monopolies such as Facebook, Amazon etc... as we could expect.
