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A cross-market network effect exists in many industries (e.g., newspaper publishing, media, software) in which a seller sells both a primary and a secondary product (e.g., a newspaper publisher sells newspapers to readers and advertising space to advertisers), and the value of the secondary product depends on the size of the user base of the primary product. This paper examines the competitive implications of asymmetric customer loyalty in such markets. In traditional markets, an advantage in customer loyalty generates a profit advantage. We show here, however, that in the presence of a cross-market network effect, a midlevel of loyalty advantage in the primary product market can lead to an overall profit disadvantage. This surprising result is derived from the interdependence of the two markets, whereby a profit in one market may be gained at the cost of the other, and by the positive relationship between a larger loyalty segment and a higher opportunity cost of price competition in the product of the primary market. Extending our model to a two-period entry game also shows that under certain conditions, the entrant with disadvantage in customer loyalty can outperform the incumbent in profit and market share. This result suggests that asymmetry in customer loyalty can be a source of "first-mover" advantage or disadvantage.
Key words: cross-market network effect; customer loyalty; competitive advantage; first-mover advantage; two-sided markets; newspaper industry
History: This paper was received December 19, 2002, and was with the authors 32 months for 3 revisions; processed by Chakravarthi Narasimhan.
1. Introduction
In some industries, a firm produces two different products sold in two different markets and the value of one product depends on the demand for the other. We refer to this type of dependence as a cross-market network effect.1 The cross-market network effect is widespread across many different industries. For example, a newspaper publisher produces newspapers sold to readers and advertising space sold to advertisers. The value of the newspaper as a medium for advertisers to reach their potential buyers increases with its level of circulation. Consequently, the newspaper's revenue from the advertising market depends on its demand in the readers' market. The cross-market network effect is also present in the computer software industry. For example, Adobe Acrobat and RealPlayer each have two different...