A cellular automata model of competition in technology markets with network externalities

Abstract

In network markets, the utility a consumer gains from a product increases with the number of other consumers adopting that product. We examine the evolution of such markets using stochastic cellular automata (CA) models to simulate consumer adoption and pricing strategy decisions. Two firms, which lie outside of and interact with the CA model, sponsor incompatible technologies and compete for market dominance using various penetration pricing strategies. We study markets where the two technologies are equal in capability and where they have asymmetric capabilities. We find that the importance of the network to the consumer is critical in determining the financial success of enacting pricing strategies: penetration pricing in a market where network externalities are only moderately important to the consumer can be disastrous. We also find that while an inferior technology may gain substantial market share by price-cutting, it is not likely to gain financial rewards. Finally, we find that if a penetration pricing strategy is to be enacted, more aggressive strategies with larger price cuts lead to greater success. © Springer-Verlag Berlin Heidelberg 2005.