The growth of interorganizational systems in the presence of network externalities

The authors develop a model of network growth in the presence of network externalities for the case where a buyer initiates an interorganizational system with its suppliers. In the present two-stage model, suppliers joining the network in the first stage can gain economic benefit from increased market share or higher price for the primary product. Suppliers encounter negative externalities since the economic benefit accruing to participating suppliers is less for increasingly larger networks. In the first stage, the buyer may experience initial supplier adoption of the network followed by a ‘stalling’ problem due to negative externalities. In order to overcome this stalling problem, the buyer may find it optimal to subsidize some suppliers’ costs to join the network in the second stage. The authors characterize the buyer’s optimal second stage subsidy policy and show the conditions under which the buyer will find it optimal to offer a subsidy. If the suppliers have some positive ex ante expectation of a second stage subsidy, the growth of the network will be retarded in the first stage resulting in suboptimal profits for the buyer.