Dynamic Platform Competition with Malicious Users

Abstract

Many software products and information technology services are mediated by platforms. Often these platforms feature the simultaneous occurrence of both positive and negative network externalities, e.g. the most popular operating systems are the most attractive platforms for both application developers and hackers alike. In this context, consumers experience a negative network externality in the form of an increased probability of cyber attack (which the platform developer can mitigate by promptly issuing patches, a costly activity) and a positive network externality stemming from increased variety of compatible applications. In this paper, we analyze the interplay between market structure and the provision of quality (in the form of security) by platform developers. The analysis of a differential game model of duopolistic competition by platform developers points to an inherent tension between market structure and security. When hacking activity increases significantly with market share the industry evolves towards a less concentrated market structure even though the net network effect is positive. Increased hacking activity weakens competition as long-run equilibrium prices are increasing with hacking activity.

Keywords: platform competition, Product Differentiation, Differential Games, Cyber security

JEL Classification: C73, L13