ESSAYS ON COMPLEMENTARY PRODUCT VARIETY IN SYSTEM MARKET

SUN LI

Publication

ESSAYS ON COMPLEMENTARY PRODUCT VARIETY IN SYSTEM MARKET

SUN LI

Abstract

This thesis investigates the effect of complementary product variety (or variety effect) in a system market. A system consists of a platform (hardware) and its complementary products (software), and consumers exhibit preference for complementary product variety. It is one of the main reasons for the existence of indirect network effect between hardware purchase and software availability. The existing literature abstracts away the differences between each type of software, and consequently the effect of software supply is simply ¿the more the merrier¿. We aim to provide a deeper understanding of the variety effect by recognizing that each type of complementary software is different from the others and by allowing the software to have type-specific effect on the hardware adoption process. This thesis consists of three essays. Essay I uses an extended Generalized Bass Model to incorporate the effect of software variety in the hardware adoption process by consumers, and explains the variety effect on hardware diffusion from the information spill-over perspective. Essay II proposes a structural model to examine the consumer choices of competing platforms when software variety is part of the attributes of a system. Essay III further extends the model in Essay I to a co-diffusion model which describes the two-way adoption externalities (i.e., indirect network effect) between consumers and software developers when both parties adopt a new-generation hardware technology. Using retail sales data from the 5th-generation video game market in the United Sates, we find empirical evidence that different types of software do show distinct effects in the adoption process. Even if the overall effect of software supply to the hardware adoption is positive, its underlying type-specific effect could vary dramatically across different software types. The finding suggests that ignoring the type of complementary software in the studies of indirect network effect might give uninformative or even misleading results when consumers exhibit preferences for complementary product variety. Consumer heterogeneity in terms of the preference for hardware technology and software variety also plays a major role in the dynamic change of variety effect over time. Therefore it is of strategic importance for the platform makers to target the right consumers and provide the right type (or types) of complementary products, in order to drive up the hardware adoption rate effectively.