AIS Electronic Library (AISeL) Association for Information Systems. Taeha Kim The University of Arizona,

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1 Assocaton for Informaton Systems AIS Electronc Lbrary (AISeL) AMCIS 000 Proceedngs Amercas Conference on Informaton Systems (AMCIS) 000 Determnng Optmal Decsons for Investng n Connecton Qualty and Prcng Internet Servces: An Economc Model of Duopoly Competton Between Internet Servce Provders Taeha Km The Unversty of Arzona, tm@bpa.arzona.edu Matt E. Thatcher Unversty of Arzona, mthatcher@cm.arzona.edu Follow ths and addtonal wors at: Recommended Ctaton Km, Taeha and Thatcher, Matt E., "Determnng Optmal Decsons for Investng n Connecton Qualty and Prcng Internet Servces: An Economc Model of Duopoly Competton Between Internet Servce Provders" (000). AMCIS 000 Proceedngs Ths materal s brought to you by the Amercas Conference on Informaton Systems (AMCIS) at AIS Electronc Lbrary (AISeL). It has been accepted for ncluson n AMCIS 000 Proceedngs by an authorzed admnstrator of AIS Electronc Lbrary (AISeL). For more nformaton, please contact elbrary@asnet.org.

2 Determnng Optmal Decsons for Investng n Connecton Qualty and Prcng Internet Servces: An Economc Model of Duopoly Competton Between Internet Servce Provders Abstract Taeha Km, The Unversty of Arzona, tm@bpa.arzona.edu Matt E. Thatcher, The Unversty of Arzona, mthatcher@cm.arzona.edu As consumer demand for Internet access and onlne servces contnues to grow, so does the competton for maret share (.e., subscrptons) among Internet Servce Provders (ISPs). Accordng to recent surveys consumers rate two crtera as most mportant when decdng to subscrbe, or contnue a subscrpton, to an ISP: the connecton qualty provded to consumers by the networ nfrastructure. The connecton qualty refers to factors such as the accessblty, speed, and relablty of the Internet connecton. Connecton qualty depends on the nvestments made n the ISPs networ nfrastructure (e.g., networ bandwdth, router swtchng capacty, and server performance) and the number of subscrbers served by that nfrastructure. Decsons about connecton qualty affect the qualty of servces and, therefore, consumer demand for these servces. the prce charged by the ISP for access to ts Internet servces. In ths paper, we develop an economc model, based on the well-establshed model of R&D competton used by D Aspremont and Jacquemn (998) and Amr and Wooders (998), to examne the trade-offs between decsons made about nvestments n connecton qualty and decsons made about prcng the servces that result from these nvestments for frms competng n a duopoly maret for Internet access and servces. More specfcally, we address the followng research questons: How should an ISP determne the optmal nvestment n connecton qualty (or networ nfrastructure)? How should an ISP prce ts servces and respond to changes n the nvestment and prcng decsons made by competng frms? How wll fallng technology prces (e.g., for networ bandwdth, server capacty and performance, and other nfrastructure technologes) affect the optmal nvestment and prcng decsons by ISPs n ths maret? Two ey fndngs n ths analyss are that when consderng a maret for Internet servces n whch consumers are more senstve to dfferences n prce than dfferences n connecton qualty: Prces charged by ISPs should be postvely correlated wth each other (ndependent of dfferences n connecton qualty) Fallng technology prces should encourage ISPs to nvest more heavly n connecton qualty whch wll result n better access and servce qualty for consumers, but at hgher prces. The results of the analyses wll help decson-maers n the Internet servces maret better understand the mplcatons of ther nvestment and prcng decsons on consumer demand for servces and frm profts.. Introducton Recently, growth n consumer demand for Internet access and servces (e.g., emal, personal web space, newsgroups, message boards, and chat rooms) has been explosve, a trend that s expected to contnue over the next decade. In March of 999, Yanee Group, a maret research frm, estmated that about 5% of U.S. households had access to the Internet. However, the frm also predcted that the percent of U.S. households wth onlne access would grow to 33% by the end of 999 and to 66% by the end of 003 (Fusco, 999). In addton, t was estmated that over the next fve years the onlne servces maret wll grow at a compounded annual rate of % wth households spendng more than $56 bllon on Internet access and servces durng ths perod. Presently, the maret for onlne servces s domnated by Amerca Onlne (AOL) whch accounted for about 57% of the U.S. maret as of March of 999. Three other provders, Mcrosoft Networ (MSN), AT&T WorldNet, and Earthln (whch recently merged wth MndSprng) compete for the second poston n the U.S. Internet access maret, accountng for about 6%, 5%, and 4% of the maret respectvely. These Internet servce provders (ISPs) are competng aggressvely for U.S. maret share wth a sgnfcant focus on targetng and attractng new (or potental) users of Internet servces. Accordng to Emly Meehan, analyst n the Yanee Group s Internet Maret Strateges practce area, Any company serous about obtanng double-dgt maret share must focus on the newbe maret; the 75 percent of households who have yet to get onlne. In 786

3 fact, AOL Chef Executve Steve Case has sad that even AOL s attemptng to ncrease ts subscrber base by focusng on the 95% of people out there who are not subscrbers." (Rchards, 999) Therefore, many ISPs are attemptng to develop servces and prcng strateges that wll not only attract exstng Internet users but also attract new users. However, for a potental customer of Internet servces comparng ISPs s often dffcult gven all of the dfferent servces and prcng strateges avalable n the maret. Several studes have attempted to dentfy the set of crtera that potental customers consder most mportant when decdng whether to subscrbe, contnue a subscrpton, or dscontnue a subscrpton to an ISP. In partcular, PC Magazne surveyed thousands of ts subscrbers to gauge customer satsfacton wth ther ISP (Mller, 999). Respondents rated prce (40%) as the most mportant crtera n choosng an ISP. Speed of access(33%), avalable local access numbers(9%) and reputaton(6%), measures related to connecton qualty, followed prce as mportant factors n choosng an ISP. These fndngs suggest that whle respondents are wllng to pay for mprovements n networ avalablty and performance. However, despte the mportance of networ crtera n customers decson mang, many ISPs rate poorly along these crtera. In fact, U.S. Internet users are fed up wth busy sgnals, leadng to wdespread dssatsfacton wth Internet servce provders and hgher rates of users who swtch ISPs (Wel, 998). Based on these observatons, ISPs attemptng to grow maret share and attract subscrbers should focus on developng strateges that carefully consder the trade-offs between the qualty of networ servces provded to ther subscrbers and the prce charged for those servces. In ths paper we develop an economc model to examne the trade-offs between nvestments n connecton qualty and prcng of servces for frms competng n a duopoly maret for Internet access and servces. Secton and 3 further motvate the focus on frm decsons about nvestments n connecton qualty and prcng of servces. Secton 4 presents the ey research questons to be examned. Secton 5 presents the model assumptons. Secton 6 presents the ntal model results. Fnally, Telechoce and Inter@actve had over 000 busnesses complete an ISP Customer Satsfacton Survey n 998. Respondent rated connecton avalablty, networ performance, and reputaton for speed of dagnoss and repar as the most mportant crtera n evaluatng an ISP. Prce closely followed n mportance wth 80% of the respondents ctng prce as mportant n choosng an ISP. Secton 7 concludes the paper and dentfes some areas of future research.. Investng n Connecton-Qualty ISPs may attract more customers by mprovng the qualty of networ servces provded to subscrbers. The connecton-qualty refers to factors such as the amount of up-tme and accessblty, speed of Internet access, the relablty of connecton, the amount of delays or pacet loss, and the amount of personal web space made avalable to subscrbers. The connecton-qualty (and, therefore, the qualty of networ servces) depends on the ISPs nvestments n networ nfrastructure that s, the bandwdth of the networ meda, the swtchng capacty of routers, and the performance (e.g., ds and CPU capacty) of servers used by the ISP 3. Investments n these networ nfrastructure components wll generally lead to hgher user satsfacton. For example, users desre broader networ bandwdth (.e., broadband networ technology currently enabled by dgtal subscrber lnes (DSL), cable-modems, and satelltes) to meet ther growng needs, ncludng support for more dynamc web page usage, rcher on-lne multmeda experences, and faster fle downloadng and messagng. These nvestments n networ and server capacty are usually consdered fxed, long-term nvestments because t s techncally dffcult and expensve to ncrease or modfy capacty n the short-term. Once a networ bandwdth type, such as a 56K telephone lne based servce, has been adopted by an ISP sgnfcant nvestments must be made to change to a hgher bandwdth type such as DSL, cable, or satellte. For The Internet uses a technology called pacet-swtchng. The term pacets (or frames, or cells) refers to the fact that data stream from a computer s broen up nto pacets of about 00 bytes (on average), whch are then sent out onto the networ. Ths technology s connectonless, meanng there s no end-toend setup for a sesson; each pacet s ndependently routed to ts destnaton. Wth current technology, pacets are generally accepted onto the networ on a frst-come/frst-served bass. Routers are devces or softwares n a computer that determnes the next networ pont to whch a pacet should be forwarded towards ts destnaton. When traffc s heavy, the only way the Internet can handle the congeston s ether by delayng traffc or by droppng (or dscardng) pacets so that some nformaton must be resent by the orgnatng software (Mace-Mason and Varan, 994; Noguera and Cavalcant, 998). 3 Accordng to (Odlyzo, 998): A study carred out n 997 by Chrstan Hutema about accessng some popular servers showed that 0% were not reachable. Among the 80% that could be reached, 4% of the delays were caused by networ transmsson, wth DNS [doman name server] accountng for 3% and servers for the remanng 45%. 787

4 example, had to sgn up wth 3 cable TV partners n 999 n order to begn provdng cable-based servces to ts subscrbers (Nee, 999). In response to ths and smlar nvestments n bandwdth made by compettors, AOL announced n January 000 a merger wth Tme Warner, a meda company that owns the U.S. s second largest cable systems; ths merger would enable AOL to offer smlar cable-based servces. Investments such as these would generally be consdered long-term nvestments. One factor affectng an ISP s decson to nvest n networ nfrastructure s the cost assocated wth these nvestments. The costs of broader networ bandwdth, ds and CPU capacty of servers, memory, web space, and other nfrastructure components have decreased dramatcally over recent years. For example, prces for DSL servce, a form of hgh-speed connecton, are declnng due n part to competton from cable-modem servces. The aggressve launch of the cable-modem servce, whch le DSL offers speeds up to 00 tmes faster than conventonal dalup servce, has forced DSL provders to lower prces. However, there s some debate regardng the mpact of the declnng costs assocated wth these nfrastructure components on prces charged by ISPs. On one hand, accordng to Davd Pne, vce presdent of cable-modem provder Excte@Home, "Wth cable and phone companes, not to menton wreless and satellte provders, sluggng t out wth competng varetes of broadband Internet servce, consumers can bet on lower prces, more features and more nnovaton." (Woo, 999). Alternatvely, declnng technology costs may encourage ISPs to nvest n more networ nfrastructure than they would otherwse, leadng to mprovements n networ qualty. Ths, n turn, may lead to an ncrease n prces as proft-maxmzng ISPs attempt to recover ther nvestment costs and to tae advantage of the ncreased demand for ther faster and more relable servces. 3. Prcng Internet Access and Servces Flat-rate prcng refers to a prcng strategy adopted by many ISPs n recent years n whch frms charge customers a fxed fee for unlmted or lmted access to Internet servces. Ths has been a common prcng strategy among ISPs n the U.S. maret snce 996 (Swsher, 999; Rafter, 998). The fxed-rate charged by an ISP depends on: Investments n networ nfrastructure Most of the costs of provdng Internet servces are the fxed costs assocated wth the networ nfrastructure. The ncremental cost of sendng addtonal pacets (or nformaton) s essentally zero f the networ s not saturated. Therefore, the sze of nvestment n networ nfrastructure wll sgnfcantly affect the prcng of Internet servces. Demand for the ISP s servces Customer demand wll also drve prces. As dscussed earler, demand partally depends upon the connecton-qualty and content provded by the ISP (and, of course, the prce) and consumers senstvty to these factors. 4. Research Questons Therefore, as ISPs attempt to attract more subscrbers, they must decde how to most approprately nvest n connecton-qualty and how to prce the resultng Internet servces they are offerng; as we wll see later, these decsons nvolve complex trade-offs. In ths paper, we wll examne the optmal nvestment and prcng decsons for frms competng n a duopoly maret for Internet servces n whch subscrbers gan access to these servces through dal-up modem, DSL, or cable modem. More specfcally, we develop an economc model to address the followng research questons derved from the dscusson above: ) How should an ISP determne the optmal nvestment n networ nfrastructure? Ths rases the queston of whether or not an ISP should nvest n more bandwdth and better server performance. That s, answerng ths queston should help dentfy whether or not AOL should nvest n relatonshps wth Tme Warner, Bell Atlantc Corp., and SBC Communcatons Inc. to provde DSL and cable-modem servces or just stay wth ts exstng nfrastructure of dal-up telephone lnes. ) How should an ISP prce ts servces and respond to changes n the flat-rate prces charged by competng ISPs? In 998, AOL rased ts monthly subscrpton rate by $, from $9.95 to $.95 (Qustgaard, 998). At the tme, many observers expected compettors to qucly follow sut, rasng the prce of Internet access for everyone. However, after the rate he, most ISPs ept ther prcng the same whle some even lowered ther monthly rates to attract more subscrbers (Hed, 998). We wll attempt to examne such dynamc behavors n our models. 3) How wll fallng technology prces (e.g., for networ bandwdth, server CPU capacty, memory, and other nfrastructure technologes) affect ISPs nvestment and prcng strateges n ths maret? As suggested earler, whle some beleve that declnng technology costs should lead to lower prces for Internet access, others beleve that 788

5 declnng costs wll encourage much larger nvestments n nfrastructure (and, therefore, networ qualty), leadng to prce ncreases to cover the costs and accommodate for changes n demand. Whle these questons are mportant to answer for ISPs, research on optmal nvestment and prcng decsons for ISPs has receved lttle attenton n the nformaton systems and economcs lterature. In ths paper we present an economc model to analyze the relatonshp between nvestments n connecton-qualty and prcng of Internet servces. Model Assumptons We consder a two-stage model of duopoly competton n a maret n whch each frm provdes consumers wth unlmted Internet access and unlmted usage of servces at a flat-rate prce. We assume that subscrbers access these servces through dal-up modem, DSL, or cable modem 4. In the frst stage, the frms smultaneously nvest n the networ nfrastructure (e.g., networ bandwdth and server capacty) that enables and supports ther servce offerngs. Ths nvestment essentally dfferentates the connecton-qualty offered by each frm. In the second stage, each ISP observes the connecton qualty of ts compettor. Then, based on these observatons and the demand functons facng each frm, both frms smultaneously determne a flat-rate prce to charge for access to ther Internet servces 5. The servces offered by each frm are somewhat dfferentated (e.g., personalzed content, personalzed nterface, specal chat rooms, etc.), but can be substtuted to some extent. To analyze ths two-stage game of duopoly we wll adopt the well-establshed R&D competton model used by D Aspremont and Jacquemn (988) and Amr and Wooders (998). We assume complete and perfect nformaton n ths model; that s, we assume that the payoff functon for each frm s common nowledge and that frms can observe ther past decsons and those of the competng frm. These assumptons are reasonable snce: The technology nvestment optons avalable for provdng Internet access are standardzed and the costs of techncal support and software development are common nowledge. Ths mples that frms can estmate each other s proft functons. 4 The assumpton of duopoly competton seems reasonable snce a small number of frms serve a large percent of the consumers of Internet access and servces. 5 As suggested earler, ISPs typcally nvest n networ nfrastructure (whch s usually consdered a fxed cost because t s techncally dffcult and expensve to modfy) and then prce servces based on these nvestments (and consumer demand) ISPs nvestment decsons are generally made publc to attract nvestors n the stoc maret. In addton, maret ntermedares typcally provde past nvestment nformaton at a low cost. The competton between ISPs s analyzed by solvng subgame perfect equlbra of the two-stage game. After provng the exstence of equlbra, we wll use statc analyss to analyze the mpact of the model parameters on the equlbrum nvestment and prcng decson made by each frm. In ths two-stage model, Frm faces a demand functon for ts Internet servces, Q, whch depends on the followng: Its own prce (p ) and the competng frm s prce (p ) the demand functon mples that a decrease n p or an ncrease n p wll ncrease consumer demand for Frm s servces. Its nvestment ( ) n connecton-qualty and the competng frm s nvestment ( ) n connectonqualty the demand functon mples that an ncrease n or a decrease n wll ncrease consumer demand for Frm s servces The demand functon s symmetrc for each frm and s assumed to be lnear n prce and connecton qualty. The demand functon for Frm s: Q = a p + bp j + c It s assumed that Internet servces (e.g., emal, newsgroups, chat rooms, and nstant messagng) offered by each frm n the second stage are not perfect substtutes; that s, they are dfferentated servces to some extent. For example, ISPs may provde access to personalzed content. The parameter values b (prce senstvty) and c (connecton-qualty senstvty) attempt to capture ths dmenson. In addton, a represents the sze of the maret. These parameter values are assumed to be fxed, symmetrc across frms, and exogenously gven. The cost functon facng Frm exhbts decreasng returns to scale n (note that the cost functon s symmetrc for Frm ). α s a technology cost coeffcent characterzng trends n the costs of nfrastructure technologes. As the costs to purchase and nstall broader networ bandwdth and better server capacty fall over tme, α becomes smaller; f α approaches zero networ nfrastructure would be free to purchase and nstall. v s the varable costs per subscrpton assocated wth servng addtonal customers; more subscrbers requre more techncal support whch, n turn, requres more techncal support assstants and phone numbers. In ths model, we wll nterpret v as the ndustry standard support level per j 789

6 subscrpton and we wll tae t as fxed, symmetrc across frms, and exogenously gven. The total cost functon s symmetrc for each frm. The total cost functon for Frm s: C = α + v Q Fnally, the proft functon s symmetrc for each frm. The proft functon for Frm s: Π = ( p v )( a p + bp j + c ) j α Parameter Assumptons: () a > v, () 0 < b, c <, and () α > 8/9 The assumpton that a > v s trval but requred to ensure that optmal nvestments n connecton qualty are non-negatve. The assumpton that 0 < b, c < allows us to focus on a maret n whch a frm s own nvestment and prcng decsons have a greater mpact on consumer demand for ts servces than do the decsons made by ts compettor. The fnal assumpton, α > 8/9, ensures that the costs of technology are suffcently large to mae the frm s proft functon exhbt decreasng returns to scale. In addton, when examnng ths model we wll assume that consumer demand for Internet access and servces s more senstve to changes n prce than to changes n connecton-qualty. We wll term ths maret a prce-senstve maret. Defnton: A maret s defned as a prce-senstve maret f b > c We assume a prce-senstve maret because, even though networ crtera are mportant, changes n connecton-qualty are not as salent to consumers of Internet servces than are changes n prce. That s, consumers are typcally are not fully nformed about the connecton qualtes of each ISP. In addton, most consumers must ncur some search costs to fnd ths nformaton ether from magaznes, consumer reports, or frends and famly. Wthout precse nformaton about connecton qualtes, many dal-up ISPs appear to provde smlar content and features (and typcally a standard 56K dal-up connecton). However, prce dfferences are easer to dentfy. Therefore, consumers are lely to be more senstve to changes n prce than to changes n connecton-qualty (but consumer demand s stll senstve to both n absolute terms). Ths may be especally true for frst-tme subscrbers to Internet servces, an mportant target of many ISPs. In addton to ssues of salency, the analyss of the prce-senstve maret s more straghtforward analytcally that that of the connectonqualty senstve maret Model Results Based on these assumptons, we wll now present the subgame perfect equlbrum n the two-stage model of duopoly competton 7. In the frst stage, the frms smultaneously determne levels of connecton-qualty through nvestments n networ nfrastructure. In the second stage, each frm observes each other s connecton qualty; they then smultaneously set flat-rate prces for unlmted access to ther Internet servces. We wll begn our analyss n the second stage and dentfy the equlbrum prce set by each frm. Optmal Prcng Decsons (Stage ) The optmal prcng decsons, p * and p *, n stage gven the nvestment decsons, and, made n stage are: p p * * ( (,, ( b + )( a + v) + ( b c) ) = 4 b ( b + )( a + v) + ( b c) ) = 4 b + ( bc ) + ( bc ) These equatons show that n a prce-senstve maret Frm s Nash equlbrum prce, p *, ncreases not only wth but also wth ; that s, the coeffcents for these two varables, (b c) and ( bc) respectvely, are both postve gven Assumpton () and the defnton of a prce senstve maret presented n Secton 5. More specfcally, these equlbrum prce equatons mply that f Frm maes an ncremental nvestment n connectonqualty (.e., ncreases ) t wll also ncrease p to compensate for ts ncremental nvestment and to respond to changes n consumer demand for ts mproved servces. However, Frm s proft-maxmzng response would be to ncrease ts own prce, p (wthout mang an ncremental nvestment of ts own). However, the ncrease n p should be less than the ncrease n p. Ths s because from the equatons we see that: p = ( bc)* and p = (b c)* 6 When consderng a prce-senstve maret, each subgame at the second stage of the two-stage model shows a unque, nteror, Nash equlbrum. However, when consderng a connecton-qualty senstve maret both nteror and boundary Nash equlbra exst. Whle we have performed the analyss for the connecton-qualty senstve maret, we are unable to present the results here due to the complexty of the analytcs and the space lmtatons. 7 Due to space lmtatons we are unable to present the dervatons of these results. However, they can be obtaned by contactng the authors. 790

7 Gven Assumpton () we now that ( bc) > (b c) whch mples that Frm wll respond to an ncrease n by ncreasng ts prce, p (despte mang no changes to ts own connecton qualty, ), but by an amount less than Frm ncreases ts prce. The ntuton s that n a prce senstve maret Frm has an opportunty to ncrease ts margns (by ncreasng p ) whle stll attractng swtchers from Frm (by not ncreasng p by too much). Agan, ths result reles on the assumpton that these frms compete n a maret n whch consumer demand s more senstve to dfferences n prce that to dfferences n connecton qualty. These prcng equatons also mply that an ncrease n v, the ndustry standard varable costs per subscrpton, wll lead to an n ncrease n the equlbrum prces charged by both frms, gven the nvestment decsons, and, made n stage. Ths result s ntutve as the frms would need to ncrease ther flat-rate prces to compensate for (or cover) the hgher varable costs assocated wth provdng servce and support to consumers. Optmal Investment Decsons (Stage ) equatons and shown n Fgure ); n fact, frms ncrease ther nvestments, and, so much that ther total nvestment costs ncrease despte the reducton n α. In turn, ths wll mply an ncrease n prces charged (see Fgure ), and an ncrease n proft earned, for both frms n stage. The ntuton s as follows: as α decreases, an ncrease n connecton qualty wll now have a smaller affect on prcng decsons made n stage (although the effect s stll postve). Ths wll encourage frms to ncrease ther nvestment n connecton qualty to ncrease ther profts n stage. Ths result suggests that as nvestments costs, such as those assocated wth changng a 56K modem connecton to a cable-modem connecton, declne that ths maret wll result n better connecton qualty for consumers, but at hgher prces. Fgure. Impact of decreasng technology cost on connecton qualty connecton qualty The optmal nvestment decsons, * and *, n stage are: * = * ( bc )( a v( b)) = α ( b + )( b ) ( c)( bc ) technology cost coeffcent That s, n equlbrum both frms wll nvest equally n connecton-qualty n stage. Of course, ths also mples that both frms wll charge the same equlbrum prce n Stage. Fgure. Impact of decreasng technology cost on prce These equatons also mply that an ncrease n v wll lead to a decrease n the optmal nvestments decsons, * and *, made n Stage. Ths reducton s desgned to partally offset the postve correlaton between v and equlbrum prces n Stage. By mang a smaller nvestment n stage, the frms wll cushon the mpact of v on prce n stage ; ths result s crtcal for frms competng n a prce senstve maret where consumer demand s more senstve to changes n prce than to changes n connecton qualty. prce technology cost coeffcent The Impact of α, the Technology Cost Coeffcent, on Equlbrum Decsons A decrease n α mples that advances n technology have led to a reducton n computng prces and, therefore, a reducton n the costs of purchasng and nstallng networ nfrastructure. Accordng to the equatons for and such a decrease would encourage frms to ncrease ther nvestments n connecton qualty n stage (as mpled by the postve α n the denomnator of these 7. Future Research In ths paper we examned a two-stage model of duopoly competton n a maret n whch each frm provdes consumers wth unlmted Internet access and unlmted usage of servces at a flat-rate prce. Two ey fndngs n ths analyss are that when consderng a maret for Internet servces n whch consumers are more 79

8 senstve to dfferences n prce than dfferences n connecton qualty: Prces charged by ISPs should be postvely correlated wth each other Fallng technology prces should encourage ISPs to nvest more heavly n connecton qualty whch wll result n better access and servce qualty for consumers, but at hgher prces. The results of the analyses wll help decson-maers n the Internet servces maret better understand the mplcatons of ther nvestment and prcng decsons on consumer demand for servces and frm profts. In future research we plan several model extensons to better account for complextes (e.g., alternatve prcng strateges) n the maret for Internet servces. In addton, we wll develop models to address the followng research questons: ) How wll the results presented n ths paper change f the maret s assumed to be a connecton-qualty senstve maret (.e., b < c) as opposed to a prce senstve maret (.e., b > c)? Changng ths assumpton wll lead to a very dfferent set of results than presented n ths paper and, therefore, a very dfferent set of prescrbed strateges for proft-maxmzng ISPs. We wll examne these crtcal dfferences n detal n future research. ) Under what condtons wll an ISP decde to offer free Internet access and servces to the maret? Snce 998, the maret for Internet access and servces has seen the emergence and growth of free ISPs that s, frms that offer customers access to Internet servces for free (e.g., NetZero, Blulght.com, Freedom.com, and WorldSpy). Most of these frms earn profts through advertsng subsdes that s, by chargng sponsors fees for onlne advertsng space (e.g., advertsng banners or wndows). We wll address the emergence of free ISPs n more detal n future research. More specfcally, we wll examne the condtons under whch offerng free Internet access and servces wll be an equlbrum strategy. More specfcally, we wll attempt to characterze the advertsng subsdy that must be provded to sustan ths strategy n equlbrum. References D Aspremont, C. and Jacquemn, A., Cooperatve and Noncooperatve R&D n Duopoly wth Spllovers, The Amercan Economc Revew, December 988, pp Dewan, R., Fremer, M. and Sedman, A., Portal Kombat: The Battle between Web Pages to become the Pont of Entry to the World Wde Web, HICSS 998. Fusco, P., Research Frm Predcts Growth for ISPs, InternetNews.com ISO News, March 3, 999. Hed, J., AOL Rate He Igntes Internet Servce Prce War, PC World Magazne, May 998. Mller, M.J., Why Users are Satsfed (or Not) wth Ther ISPs, Specal Report, July 7, ZDNET. Nee, E., Is Excte@Home the AOL of broadband, Fortune , no., December 6, 999. Noguera, J. and Cavalcant, J., Prcng Networ Servces: The Case of the Internet, Frst Monday (:5). Odlyzo, A. The Internet and Other Networs: Utlzaton Rates and Ther Implcatons, Worng Paper, September 998. Parthasarathy, M. and Bhattacherjee, A. Understandng Post-adopton Behavor n the Context of Onlne Servces, Informaton Systems Research, December 998. Qustgaard, K., AOL Stoc Soars on Prce He, Wred News, February 9, 998. Rafter, M., Should ISPs Abandon Flat-Rate Prcng?, The Standard Intellgence for the Internet Economy, 0.html. Rchards, R., AOL Growth Slows; Stoc Taes Another Ht, USA Today Tech Report, February 8, 999. Swsher, K., aol.com, Tmes Busness, 999. Wel, N., Phony e-mal heats up Mcrosoft, AOL battle, Infoworld, no 35, August 30, 999. Wel, N., ISP Study Rans Top Ten Provders, IDG News Servce, February 9, 998. Woo, K., DSL Prce Drop Due, Newsbytes, October 9, 999. Amr, R. and Wooders, J. Cooperaton vs. Competton n R&D: The Role of Stablty of Equlbrum, Journal of Economcs, Volume 67, No., 998, pp