Incumbency advantage and its value

• Author: Jacques Crémer,Emilio Calvano,Gary Biglaiser
• Date: 01 January 2019
• DOI: http://doi.org/10.1111/jems.12307
• Published date: 01 January 2019

Received: 21 August 2018

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Accepted: 21 August 2018

DOI: 10.1111/jems.12307

Incumbency advantage and its value

Gary Biglaiser

1

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Emilio Calvano

2

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Jacques Crémer

3

1

Department of Economics, University

of North Carolina, Chapel Hill,

North Carolina

2

Dipartimento di Scienze Economiche,

Universita degli Studi di Bologna,

Bologna, Italy

3

Toulouse School of Economics,

Toulouse, France

Correspondence

Gary Biglaiser, Department of Economics,

University of North Carolina, Chapel Hill,

NC.

Email: gbiglais@email.unc.edu

Abstract

Markets with network effects are typically concentrated. The aim of this

paper is to discuss some recent work on “incumbency advantage.”That is,

the fact that firms already installed generate higher profits than entrants

even if the latter offer identical or even better terms (in terms of price and

quality) to consumers. In particular, we review recently known sources of

the advantage and potential mitigating factors and point to a number of open

issues.

KEYWORDS

data barrier, incumbency advantage, platform competition

The aim of this paper is to discuss some recent work on “incumbency advantage”and its importance for the analysis of

competition between platforms and its sources. In markets with network effects, it will typically be both efficient and

the normal outcome of the competition to have either one or a few platforms. We define incumbency advantage as the

fact that an incumbent, that is, a firm already with an installed base, will be able to generate higher profits than a new

firm (an entrant) even if the entrant offers identical terms to consumers, or even better terms (in terms of price and

quality). How much better the terms which the entrant must offer to attract consumers is a measure of incumbency

advantage.

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COORDINATION ISSUES AS A SOURCE OF INCUMBENCY

ADVANTAGE

A theme that runs through the work attempting to identify an incumbentʼs advantage is that consumers find it difficult

to coordinate on joining another platform. In their early survey of network effects, Katz and Shapiro (1994) state

“Asymmetries involving reputation, product differentiation, and installed base are especially likely when one of the

firms is an entrant and the other an incumbent.”The first two factors would, of course, give an advantage to the

incumbent, but this would be true in any industry. Assume, however, that they are absent, for instance, the entrants

were subsidiaries of large firms with an established reputation, and that the services which are offered were similar, the

intuition of most economists is that there would be incumbency advantage. It is the source of this advantage that we

explore in this paper.

To understand the puzzle that we are trying to solve, assume that a social media site has 10,000 consumers, and each

of these consumers derives a utility of 50 while on that site when the 9,999 others also are on it. A competitor offering a

better interface appears so that the utility of the consumers would rise to 65 if they all switched to the new site (such

that the only consumer who joins either one of these two platforms yields a utility of 0). So, from a collective viewpoint,

the consumers would all gain by coordinating a joint migration. Of course, no consumer wants to migrate on his or her

J Econ Manage Strat. 2019;28:41–48. wileyonlinelibrary.com/journal/jems © 2019 Wiley Periodicals, Inc.

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