How Can Platforms Decrease Their Dependence on Traditional Indirect Network Effects? Innovating Using Platform Envelopment
B. J. Allen, Deepa Chandrasekaran, and Richard T. Gretz
kHUB post date: June 27, 2022
Originally published: September 7, 2021 (PDMA JPIM • Vol. 38, Issue 5 • September 2021)
Read time: 55 minutes
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Platform-based industries are characterized by indirect network effects, wherein the utility of the platform (e.g., computer), and thus its sales, increases as more complements (e.g., software) become available. In platform markets, new product entrants and firms with smaller indirect networks are at a major disadvantage. Managers have been given little guidance on how to decrease their dependence on indirect network effects and still grow their markets. We examine the impact of platform envelopment—an innovation strategy in which one platform absorbs the main functionality of another (e.g., video game consoles absorbing the functionality to play DVDs)—on indirect network effects and the platform's dependence on complementary software. Despite its promise, existing envelopment research focuses mainly on how envelopment impacts competition in the enveloped market (i.e., the new industry it is enveloping), thus overlooking how envelopment allows the platform to better compete in its original, focal (nonenveloped) market. In helping to fill this research gap, our contribution lies in answering two critical questions. First, how can platforms decrease their dependence on indirect network effects stemming from complementary products? Second, how can platform envelopment help platforms better compete in the focal (nonenveloped) industry? We demonstrate that platform envelopment makes the platform less-sensitive to software supply, a phenomenon we call decreasing indirect network sensitivity. We investigate this relationship with two empirical studies focusing on gaming platforms. We find that the presence of platform envelopment not only increases demand for the platform but also decreases the importance of software supply to platform demand. We also show that the indirect network strength of platform sales on software supply is not affected by platform envelopment. Finally, we provide theoretical and managerial implications of our research.
Practitioner Points
- Platform envelopment is an innovation strategy in which one platform absorbs the main functionality of another (e.g., video game consoles absorbing the functionality to play DVDs).
- New entrant firms in platform markets can adopt a platform envelopment strategy to decrease their dependence on indirect network effects, such that the size of the software supply is less critical for the platform's performance (decreasing indirect network sensitivity).
- Platform envelopment can help new entrants and smaller-networked firms overcome the large network advantage enjoyed by an established incumbent in the focal market.