Generational Transitions in Platform Markets – The Role of Backward Compatibility

Abstract

The introduction of a new product generation forces incumbents in platform markets to rebuild their installed base of complementary products. Using three different datasets on the US market for video game consoles, we show that incumbents can to some extent substitute for rebuilding their new installed base by making their new products backward compatible, which lets them draw on the installed base of software for the parent generation. However, while this positive direct effect of backward compatibility dominates in our setting, we also observe a (weaker) negative indirect effect working through the reduced supply of new software. We find that both effects are moderated by the age of the new technological generation and by the technological leap between generations: backward compatibility becomes less important with increasing console age and with larger technological improvement between generations.

Keywords: backward compatibility, platform markets, installed base, video games industry

JEL Classification: L15, L82, O33