10 - Price and market share dynamics in network industries

Summary

Introduction

This chapter addresses the economics of certain types of value-added networks (VANs) that are common in the financial sector and are becoming widespread in other sectors. It investigates the effect of different pricing regimes on allocative efficiency, and studies the nature of competition between vendors of these services. It emerges that there is a very strong tendency toward monopoly in VAN industries. VANs appear to be a classic case of natural monopoly, although this is not dependent on increasing returns in their technologies. The main cause is externalities between users, which lead to a “critical mass” phenomenon. A VAN is only economically viable after a certain critical mass of users is achieved. Standard prescriptions for achieving efficiency in such situations, such as marginal cost pricing and interconnection, are of limited value.

The classic example of a VAN in the financial sector is the Reuters FX monitor, a network system very widely used in trading foreign currencies by all major foreign exchange dealers. SWIFT, the international interbank communications network, is another very important example.

Reuters and SWIFT provide the infrastructure on which international capital markets run: They process transactions totaling tens of billions of dollars daily. They are to financial markets what roads and bridges are to transportation systems. Electronic mail systems, facsimile transmission networks, securities settlement networks, and electronic data interchange (EDI) networks provide further examples. VANs are also important in the travel industry. Airline reservation systems are VANs, whose strategic importance is already widely recognized in the travel business.