NET Institute Working Paper #08-20, September 2008
This paper examines social networks’ incentives to establish compatibility under fee and ad-sponsored business models.
The market of internet advertising is a multi-billion dollar industry. This paper provides key information regarding ad-sponsored business models that have begun to dominate this industry.
This paper finds that, when networks operate using fee-based business models, they have no incentives to be compatible as profits would be driven to zero by intense price competition with compatibility. In contrast, when using ad-sponsored business models, networks may have incentives to be compatible, provided that their membership prices are bounded by zero and their installed bases have similar prices.
This paper also looks at the competition between two ad-sponsored networks in the presence of direct network effects on the user side and focus on compatibility decisions.
This paper suggests that firms’ business models may be an important determinant of their decisions to form strategic alliances.