Compatibility and Proprietary Standards: The Impact of Conversion Technologies in IT Markets with Network Effects
Charles Z. Liu
University of Texas at San Antonio
University of Pittsburgh - Katz Graduate School of Business
Chris F. Kemerer
University of Pittsburgh - Katz Graduate School of Business; Carnegie Mellon University - School of Computer Science
Michael D. Smith
Carnegie Mellon University - H. John Heinz III School of Public Policy and Management
March 1, 2011
Information Systems Research, v. 22, n. 1, pp. 188-207, March 2011
In markets that exhibit network effects, the presence of digital conversion technologies provides an alternative mechanism to achieve compatibility. This study examines the impact of conversion technologies on market equilibrium in the context of sequential duopoly competition and proprietary technology standards. We analyze this question by departing from the extant literature to endogenize the decision to provide a converter and incorporate explicit negotiations between firms concerning the extent of conversion. We argue that these choices better reflect the environment facing firms in digital goods industries and find that these decisions change some of the established results in the literature.
Specifically, we find that unless network effects are very large, the subgame-perfect equilibrium (SPNE)
involves firms’ agreeing to provide digital converters at a sufficiently low price to all consumers. At this equilibrium, both the entrant and the incumbent are better off because the provision of converters alleviates price competition in the market and leads to both higher product revenues and higher proceeds from the sale of converters. Moreover, under some circumstances, the provision of converters is welfare enhancing. These findings have important implications for research and practice in the adoption of new digital goods as the introduction of conversion technologies can reduce the social costs of standardization without compromising the benefits of network effects.
Keywords: Network Effects, Conversion Technologies, Compatibility, Technology Standards, Digital Goods, Network Externalities
JEL Classification: C70, D43, D62, L11, L13
Date posted: April 18, 2007 ; Last revised: August 31, 2014
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