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Compare and Contrast Direct and Indirect Network Effects

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Network effects represent a huge motivation for users in selecting popular software products, and preferring providers who can offer them those strong network effects. According to Buxmann, Diefenbach & Hess (2013) network effects lead to demand-sided economies of scale and to what is known as a positive feedback. Direct network effects arise from the fact that by employing the same software standards or common technologies, users can communicate with each other more simply and, therefore, and it costs less (Buxmann, Diefenbach & Hess, 2013). Indirect network effects, by contrast, result from the dependency between the consumption of a basic good and the consumption of complementary goods and services.

Indirect network effects occur in the context of standard software and complementary consulting services, operating systems with compatible application software, or with regard to the availability of programming language experts and tools (Buxmann, Diefenbach & Hess, 2013). On the other hand, Picot, Reichwald & Wigand (2008) noted that direct network effects mainly occurs in I&C infrastructure area in electronic markets, for example, on the WWW as an electronic marketplace, and with communication services and products such as an e-mail service. Unlike direct network effects, indirect network effects occur in a large number of digital products such compression standards for digital music and software to create texts and pictures (Picot, Reichwald & Wigand, 2008).  

Direct network effects are generated through a direct physical effect from the number of purchasers, whereas indirect network effects are market mediated effects. Kemper (2009) underlined that direct network effects are characterized by compatibility which increases the utility of the product with a growing number of installations. An example of direct network effect is the keyboard standard QWERTY. On the other hand, indirect network effects derive from complementary products which are beneficial for all network participants, such as PC and software (Kemper, 2009).

From an economic point of view, the increasing number of network participants in both direct and indirect network results in an increasing return to scale, which allows the development of additional competitive advantages from lower prices or investments, but  higher quality (Kemper, 2009). Both direct and indirect network effects are an important criterion for the decision to purchase software. Picot, Reichwald & Wigand (2008) noted that with regard to both indirect and direct network effects, various products’ compatibility and the certainty that the product will be compatible with future products are all crucial factors for the decision to purchase software products.   

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