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

See all articles by Filomena Garcia

Filomena Garcia

Indiana University; ISEG - Technical University of Lisbon; UECE - Research Unit in Economics and Complexity

Cecilia Vergari

University of Bologna - Department of Economics

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

Suggested Citation

Garcia, Filomena and Vergari, Cecilia, Revealing Incentives for Compatibility Provision in Vertically Differentiated Network Industries (March 6, 2015). CAEPR Working Paper #2015-005, Available at SSRN: https://ssrn.com/abstract=2575608 or http://dx.doi.org/10.2139/ssrn.2575608

Filomena Garcia (Contact Author)

Indiana University ( email )

Wylie Hall
Bloomington, IN 47405-6620
United States

ISEG - Technical University of Lisbon ( email )

R. Miguel Lupi, 20
Lisbon, 1200
Portugal

UECE - Research Unit in Economics and Complexity ( email )

Rua Miguel Lupi, 20
Lisboa, 1200-781
Portugal

Cecilia Vergari

University of Bologna - Department of Economics ( email )

Piazza Scaravilli 2
Bologna, 40100
Italy

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