Network Effects and the Impact of Free Goods: An Analysis of the Web Server Market

Theory suggests that the role of network externalities is critical to transforming new businesses from market entrant to market leadership positions. However, there have been relatively few empirical studies of network externalities in E-commerce contexts. Building on the theory of networks and technology standards, this paper develops and tests three propositions related to network effects and the provision of free goods in Web server markets. Hedonic pricing models estimated on the basis of comprehensive time-series data are used to examine the factors that determine price and to gauge the impact of network effects and free goods. The market for Windows Web servers reflects the influence of network externalities even after the entry of a viable free-market alternative. The UNIX market, dominated by open-source and other free software products through the course of this study, does not exhibit network effects. The research reported here advances the theoretical literature by testing new propositions in a new and unstudied context. Its empirical findings contribute to an understanding of the dynamics of the Web's software market and, thus, of future competition in E-commerce markets.