Network goods are usually sold by monopolies or oligopolies, but what makes these markets different from standard monopolies and oligopolies is the ease and speed by which the monopoly can change hands. In 1988, the spreadsheet program Lotus 1–2-3 held a 70% share of the market, but it faced competition from Quattro Pro and Excel. At first Quattro Pro, with sales twice that of Excel, appeared to be gaining, but comparative reviews of all three programs gave the edge to Excel. By 1998, Excel had 70% of the market and Lotus 1–2-3 was heading toward irrelevance.

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Microsoft Word is the dominant word processor today, but the authors of this book remember when WordStar and then WordPerfect were the market leaders. When it comes to network goods, consumer loyalties can switch quickly and this reintroduces significant competition into these markets. Currently, Facebook is the dominant social network today but less than five years ago, it was not clear whether MySpace, Friendster, or Facebook would become Number 1. Facebook eventually pulled away from the pack, as it offered a cleaner page, more and better apps, and better ability to tag and track your friends.2

One firm, or a handful of them, has dominated the market for network goods like spreadsheets, word processors, and social networking sites at each point in the history of their evolution, but the dominant firm has changed over time. We have had serial monopolies rather than a single, stable monopoly. Microsoft’s share of the word processing and spreadsheet market appears to be strong today, but the history of this market reminds us that leaders can fall behind very quickly. Microsoft faces a number of Web-based competitors that hope to dethrone the king. Google looks dominant in search, but Microsoft is betting that Bing will grab some market share. Facebook is growing, but Google+ is a potential threat. Maybe today’s dominant firm will be dethroned, maybe not, but it’s a mistake to think that a large market share, taken alone, implies that competition is absent. Competition for the market can dethrone market leaders very quickly.

Since Facebook and other network firms could be dethroned by a new entrant, these firms must make choices in light of potential competition. Markets in which potential competition disciplines firms are called “contestable.”

A market is contestable if a competitor could credibly enter and take away business from the incumbent. Contestability does not require that such entry actually occurs, only that it can potentially occur.

Contestability disciplines an incumbent firm even if the incumbent has a large market share because the mere threat of entry acts as a competitive force. For instance, fear of potential competitors motivates Facebook to keep its prices low (free!) and to keep advertising relatively unobtrusive. To the extent a market, even a network market, is contestable, it is hard for everyone to get locked into the wrong network, as explained previously.

Facebook, of course, doesn’t want its market to be contested. They remember what happened to Friendster, even if no one else does. So incumbent firms often try to limit the contestability of the markets they operate in. Facebook, for instance, encourages its users to load as many photos onto the site as possible. The company doesn’t charge you for adding more photos, even though the viewing of those photos increases their server costs. Why does Facebook allow so many free photos? In part, they want to attract more users, but it’s not just that. Facebook knows that if you load a lot of your photos onto their site, it will be more costly for you to switch to another networking site.

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If a new social networking site came along that was 3% better than Facebook, but all your photos were loaded onto your Facebook profile, would you switch? Maybe not. If you haven’t kept copies of all those old photos, in a neat and organized way, you are especially unlikely to switch (recall that we gave some other examples of how firms increase switching costs to increase market power in Chapter 15).

Here’s another example. Apple has pursued a similar strategy of increasing switching costs with its iPad, but they have gone further to make the export of content difficult. It is easy to download music, videos, TV shows, and other forms of media content onto your iPad. That makes more people want to buy an iPad, which can serve as a traveling movie theater, museum, and music hall, all in one. Yet once all that material is on your iPad, it is difficult to export it to other systems. You can’t send it from your iPad to your television or to your personal computer or to your Blackberry, even though technologically, such transfers should be quite easy, if only the operating system would allow them. Apple wants to increase the costs of your switching to a competitor’s product line.