Optimal policies for subsidizing supplier interorganizational system adoption

Abstract

We develop a static two‐stage model of network externalities where the buyer has adequate information about the suppliers’ costs to join the network such that it is able to make differential subsidy payments. If the expected network size is small, suppliers encounter negative externalities as the buyer rewards the suppliers joining the system, but at a decreasing rate. On the other hand, if the expected network size is large, the buyer can exert increasing pressure on the few remaining suppliers to join the network, thus forcing positive externalities on these suppliers. We show that if the buyer can make differential subsidy payments, it may need to subsidize only a fraction of the nonjoiners up to a “spontaneous expansion point,”; after which the positive externalities force the remaining suppliers to join the network. We also examine a dynamic model where the suppliers’ costs to join the network decrease over time. We show that in this case, the buyer should incorporate a “bang‐bang”; strategy, such that after some specified time period the buyer should immediately pay for the costs to join the network of all suppliers needed to reach the spontaneous expansion point.

Keywords:

• differential subsidy payments
• electronic data interchange
• interorganizational systems
• network externalities