Theme: Leveraging Network Effects for Connected Products: Strategies and Implications for the Value Chain

Guest Speaker: Zhuoran Lu (Shanghai Jiao Tong University)

Time:  Tuesday, October 22, 2024, 10:00-11:15 am

Venue: 318, Business School Building

Organizer: Department of Economics

Guest Bio:

  Zhuoran Lu is an Assistant Professor at Antai College of Economics and Management, Shanghai Jiao Tong University, with a PhD in Economics from UCLA and a BA in Economics from Tsinghua University. His main research areas are contract theory, industrial organization theory, organizational economics, network economics, and digital economy. He is currently chairing an NSF Youth Program and participating in one NSF Major Program and one NSF Special Program.

Synopsis：

  This paper explores how value chain participants can leverage the business value generated by network effects in connected products. Using a classic two-tier framework, we first present a benchmark model of a decentralized value chain governed by a wholesale price contract, demonstrating how network effects enhance profitability. We then investigate two representative strategies that help exploit the value of network effects more effectively: network expansion via seeding and engineering network strength through investment. Our model offers three key takeaways: First, the presence of network effects incentivizes the upstream manufacturer to maintain a low wholesale price, enabling the downstream retailer to serve a larger network. This effectively transforms the wholesale price into a “quantity-forcing” contract, thus alleviating double marginalization problem. Second, compared with the centralized value chain, we show that the marginal returns on investment in connection strength can be greater in the decentralized value chain, suggesting that the investment in network effects may be more radical in that case. Third, these two strategies—seeding and investing—are both reinforced as marginal production costs decrease. This complementarity indicates that improvements in production efficiency can simultaneously trigger a business model change to embrace seeding and a strategic shift toward a "connectivity revolution." We also discuss the welfare implications of these findings.