Andreas Kemper

Complex Networks Theory

This chapter provides a summary of relevant insights into complex networks theory. It is the foundation for the development of network theoretical hypotheses and the respective network methodology. In the first step, a brief overview on the background of complex networks research is provided, before relevant structural and locations properties of networks are presented. The network measures are used to illustrate insights into the structure and on the dynamics of networks. At the end of this chapter, research hypotheses are developed concerning the open research questions on network network-centric valuation in software markets. They are challenged with the complex networks diffusion simulator that is developed in the following chapter.

Implications of Results

While the pursued customer network-centric valuation approach contains a variety of implications, this chapter summarizes the most relevant issues with respect to the outlined target group. First, findings relevant to managers of companies operating in software markets are presented, before implications for financial sponsors are depicted. Then, the consequences for various streams of research conclude this chapter. In this first section the most relevant implications for managers are investigated. All in all, managers should note that the outlined approach supports decision making in software markets based on a better understanding of customer networks, their topologies and their dynamics. This has implications on various aspects of management, such as strategic management, marketing and turnaround management. It is important to note that the following categories are not mutually exclusive and collectively exhaustive as some of the following implications are relevant to more than one cluster.

Investment and Company Valuation

The most relevant concepts of the valuation literature are reviewed in this first chapter of the theoretical framework. First, the background of the relevant conventional valuation approaches is depicted, before the more innovative Real Options Valuation approach and the underlying Option Pricing Theory are summarized. The insights in this chapter provide the financial background for the subsequent design of a framework for valuations in software markets.

Reconsideration of Complex Customer Networks in Software Markets

The pursued complex networks approach provides a variety of additional insights to valuation in software markets. A vital contribution of this research perspective is to underline the existence of various network topologies and network dynamics, which significantly influences the adoption and diffusion processes of customer networks in software markets. This implies that the topology of customer networks has a decisive impact on the development of sales in general and on valuations of software companies in particular. Traditional valuation methods, in turn, frequently implicitly assume that customer networks have unrealistic homogeneous random network topologies. This can result in significant distortions. Particularly, if strong network effects are present. Instead, it is necessary to investigate the properties of the customer networks with the developed complex networks adoption and diffusion simulator. For this reason, the relevant complex networks insights were integrated into a complex networks framework for valuations in software markets. This modification allows one to investigate the properties and dynamics of large-scale customer networks in detail. Despite such contributions, it is also important to note the limitations of the approach. These are comprised of, but are not limited, to the following three aspects.

Network Economics in Software Markets

The prior analysis revealed that network effects in customer networks are valuable drivers of growth opportunities in software markets. Therefore, the literature on network economics is reviewed in the following chapter. First some fundamental principles of network economics are depicted before a typology of network effects is suggested. Then, the most relevant characteristics and dynamics of software markets are outlined, before insights of empirical research are reviewed. Finally, network effects are investigated on a finer level of detail in selected software market segments. A reconsideration of network effects in software markets concludes this chapter.

Network Effects Valuation Framework For Software Markets

The previous review of the valuation literature review revealed that currently there are no convincing solutions that account for network effects in software markets. The goal of the following chapter is to integrate the previously derived insights into a process framework for valuation in software markets. First, an overview of all phases of the framework is provided before the respective phases are depicted in detail.

Customer-Equity Valuation in Software Markets

The previous investigations revealed the importance of network effects for valuations in software markets. In the next step the findings on network effects are linked to valuations in software markets based on a customer-centric valuation approach. First, the background of customer-based valuation is presented. Then, a DCF customer equity model is outlined before a real options version is reviewed. As both models reveal the importance of reliable software market models based on solid adoption and diffusion models, these are investigated in the next chapter. Respective insights provide the basis for the development of a network effects framework for valuations in software markets at the end of this part.

Reconsideration of Valuation in Software Markets

The previous analysis outlined the challenge of precise valuation in dynamic software markets. In this chapter, various valuation approaches are compared with the requirements for valuation in software markets. According to this comparison, the real option approach is perfectly suited as it best accounts for the uncertainties and flexibilities in software markets. Since the real option approach can be implemented by various option pricing models, possible alternatives are matched with the requirements for valuation in software markets. As numerical simulations are identified as the preferential method, the modeling of the respective input parameters is investigated. Volatility and price of the underlying are identified as particularly important and challenging parameters. Hence, they are analyzed in the following part.

Modern Software Markets

The focus of the second chapter of the theoretical framework is to profile modern software markets. First, a brief review of the history is presented which illustrates the background of the main research objects, before fundamental trends in software markets are summarized. In the next step, essential characteristics are identified and outlined. As the profile indicates that software markets are governed by network effects, their impact on valuation in software markets will be reconsidered more closely in Chap. 4.

Reconsideration of Network Effects in Software Markets

The first important step was to identify the relevance of networks effects for valuations in software markets, as they are frequently ignored in the traditional literature. The failure to consider network effects can incite suboptimal underinvestment strategies, particularly if software companies operate in customer networks close to the critical mass. In order to develop a network effects framework for valuations in software markets, research on network economics, customer-equity valuation as well as on adoption and diffusion research was reviewed. The result is a framework that allows one to quantify network effects with software market models based on underlying adoption and diffusion models. In summary, the developed network effects model for valuation in software markets is the first step to close some of the identified research gaps, but it also reveals a variety of further research opportunities.