THE GROWTH OF INTERORGANIZATIONAL SYSTEMS IN THE PRESENCE OF NETWORK EXTERNALITIES

We develop a model of network growth in the presence of network extern alities for the case where a buyer initiates an interorganizational sy stem with its suppliers. In our two-stage model, suppliers joining the network in the first stage can gain economic benefit from increased m arket share or higher price for the primary product. Suppliers encount er negative externalities since the economic benefit accruing to parti cipating suppliers is less for increasingly larger networks. In the fi rst stage, the buyer may experience initial supplier adoption of the n etwork followed by a ''stalling'' problem due to negative externalitie s. In order to overcome this stalling problem, the buyer may find it o ptimal to subsidize some suppliers' costs to join the network in the s econd stage. We characterize the buyer's optimal second stage subsidy policy and show the conditions under which the buyer will find it opti mal to offer a subsidy. If the suppliers have some positive ex ante ex pectation of a second stage subsidy, the growth of the network will be retarded in the first stage resulting in suboptimal profits for the b uyer.