Network Effects, Standardization, and the Internet: What Have We Learned From The DVD Vs. DIVX Battle?

Two important welfare implications of network effects are that (1) market forces often result in suboptimal standardization, that is, left alone the market may fail to achieve standardization when it is socially desirable and (2) even if the market settles on a standard, the chosen standard may be inferior. Some policy makers have interpreted these results to mean that when there are strong network effects, regulators should play an active role in setting standards. Others have urged regulators not to intervene despite the presence of network effects, unless owners of proprietary standards take strategic actions to influence the adoption decisions of consumers. One action that has raised regulatory (antitrust) concerns is strategic product preannouncements or 'vaporware'. In this paper, we empirically test for network effects and vaporware effects in the DVD market and examine the role played by the Internet.