Diffusion of a new product under network effects: the US DVD market

We formulate a model that captures the inter-dependence between hardware demand and software supply – indirect network effect – in the DVD industry. The identification of the network effect comes from the difference in software availability across two different formats: VHS and DVD. We find that a 1% increase in the number of DVD titles raises the demand for DVD players by 0.87%. Simultaneously, a 1% increase in video player ownership leads to a 0.14% increase in the variety of video titles. Our simulations show that hardware manufacturers might be able to internalize the network externality to increase total industry revenues.