What determines competition dynamics in markets with
indirect network effects? We analyze this question in a
hardware-software framework, where software producers
strategically compete in quality upgrades. We identify
market structure as a major determinant of competition
dynamics. Using numerical analysis, we examine the
effect of initial quality differences on firms’
performance, measured by their market values. We find
that indirect network effects tie together the
performance of firms on the same platform: A successful
competitor on the same platform increases the platform's
market share, which then increases the incentives of all
firms on this platform to invest in quality. This
increase in quality further strengthens the platform's
position in the market, thereby increasing the market
value of all firms associated with that platform. pdf
