Revealing Incentives for Compatibility Provision in Vertically Differentiated Network Industries
CAEPR Working Paper #2015-005
56 Pages Posted: 10 Mar 2015 Last revised: 7 Apr 2015
Date Written: March 6, 2015
Abstract
We determine the incentives for compatibility provision of firms that produce network goods with different intrinsic qualities. We consider the case in which both firms have the power to veto compatibility and the case in which none has this power. We obtain that if consumers have a strong preference for the network, there are multiple equilibria in pricing and consumer decisions. We show that in some equilibria, it is the high quality firm that invests in compatibility, whereas in others, the low quality firm triggers compatibility. The socially optimal compatibility level is zero, except under strong network effects, where one of the equilibria has all consumers buying the low quality good. In this case, a partial level of compatibility is optimal. Comparison between the privately and the socially optimal levels of compatibility depends on whether or not firms have veto power over compatibility.
Keywords: Compatibility, vertical
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