Indirect Network Effects
Indirect network effects occur when the value of a good or service to one group of users depends on the availability of a complementary good or service provided by a different group. Unlike direct network effects, where value increases with the number of users on the same side, indirect effects operate across sides: a platform becomes more valuable to users as more developers build applications for it, and more valuable to developers as more users adopt the platform.
The classic examples are operating systems (Windows, iOS, Android), videogame consoles (PlayStation, Nintendo), and payment networks (Visa, Mastercard). The platform serves as an intermediary that internalizes the externality between the two sides. Without the platform, the two sides would face a coordination problem: users would not adopt without applications, and developers would not build without users. The platform solves this by coordinating expectations and often subsidizing one side to attract the other.
Indirect network effects create distinctive competitive dynamics. A platform that achieves early dominance on both sides can be extremely difficult to dislodge, because the cross-side feedback loop reinforces the lead. But multi-homing — participating on multiple platforms simultaneously — is often easier in two-sided markets than in one-sided markets, because the cost of using two platforms is lower than the cost of maintaining two telephone networks. This can produce stable duopolies rather than winner-take-all outcomes, depending on the cost of multi-homing and the strength of the network effects.
The policy challenge is that indirect network effects can produce the same lock-in and market power as direct network effects, but with a more complex pricing structure that makes traditional antitrust analysis difficult. A platform that charges nothing to users and extracts all value from developers is not necessarily engaged in predatory pricing; it may be the efficient pricing structure for a two-sided market. The question is whether the platform's market power is contestable — whether a new entrant could achieve the cross-side coordination necessary to compete.