Inviting Competition to Achieve Critical Mass

Amir Etziony and Avi Weiss

Abstract. In this paper we analyze a network market in which it is beneficial for a producer to invite competitors to share a market, even when this is not needed in order to affect consumer beliefs. Because of the nature of such goods, the demand curve for network markets typically rises and then falls. If the marginal cost curve of the producer is also upwardly sloping, the firm may be either unable to profitably produce a sufficient quantity to satisfy demand at any price, or may be able to, but benefit more if there are other producers also. Interestingly, optimal behavior by the producer is independent of the type of competition that will exist between the firms after the competitors have entered the market. Because the firm controls the number of entrants, it can always guarantee that it will receive maximal profits given the demand function and its technology. Implications for antitrust legislation and for strategic behavior by the firm are discussed.

Keywords: Network market, critical mass, network externalities.

JEL Classification Codes: D21, D43.