Pricing and Compatibility in Network Goods Markets

Abstract

I examine an incumbent monopolist's pricing strategy in a two-period durable goods market for complements with network effects, such as the Operating System and software applications, and its compatibility stance with a future competitor when the market for applications is characterised by quality growth. Consumers arrive in the market in the first period and the “threat” to exercise their option to postpone their purchase may lead the incumbent to charge a price for its Operating System lower than that of a static monopolist no matter what the compatibility regime. I also show that the incumbent may support compatibility regardless of the presence of switching costs. The welfare effects of mandatory compatibility are ambiguous.

Keywords: Pricing; Compatibility; Innovation; Network Effects; Intertemporal Choice; Expectations; Collective Decision-Making; Antitrust Law

JEL Classification: D4; L15; D62; K21