Price screening with network effects and entry deterrence

This paper presents a model of price screening for goods with network effects, by a monopoly seller, and by an entry-deterring monopolist. These products are used in variable quantities by heterogeneous customers, the magnitude of network effects is influenced by gross consumption, rather than simply by user base, and the value derived from the network effects may be related to individual consumption and to customer type. Conditions under which fulfilled-expectations contracts exist and are unique are established. While network effects generally raise total prices in the optimal contracts, accompanying changes in consumption vary widely. Under the standard assumption of homogeneous network effects, there are no changes in consumption; in contrast, usage-dependent network effects increase the consumption of all types. Additionally, type-dependent network effects can cause downward distortions in consumption levels across a subset (and in special cases, all) types. The direction and extent of these distortions depend on the relative rates of variation in marginal intrinsic value and marginal network value with type. When network effects are homogeneous, the optimal entry-deterring contract is a flat fee that results in the efficient outcome. In contrast, when the network effects are usage-dependent, consumption increases only for a subset of lower types; however, when these network effects are strong enough, there are no changes in total surplus induced by the entry threat, but merely a transfer of surplus from the seller to its customers. The presence of network effects and of an entry threat also increase distributional efficiency by reducing the disparity in relative value captured by different customer types. Managerial, regulatory and policy implications of these results are discussed