The role of strategic consumers and vertical differentiation on platform compatibility in growing markets

Abstract

This paper considers pricing decisions and optimal timing to support platform compatibility in a dynamic duopoly when consumers enjoy network effects. We contribute to the literature by introducing consumer rationality, market growth,  and quality asymmetry. We find that compatibility support occurs faster when consumers are myopic rather than rational both in the absence of vertical differentiation and for moderate quality differences. When consumers are rational, compatibility is delayed until firms' market shares are sufficiently asymmetric. We also find that platforms are eager to support compatibility earlier when they are sufficiently differentiated. Then, the threat of the dominant platform's rival attracting consumers is sufficiently reduced. In addition, we find that firm value has a U-shaped relationship with the degree of vertical differentiation, and downgrading quality provision from the low-quality seller might lead to higher firm value for both competitors. In such a situation, imposing a minimum quality standard leads to a higher consumer surplus.  Our work encompasses one-sided and two-sided markets with network effects. It also provides insights into Sony's decision to delay consumer multihoming for the game Fortnite on their platform Playstation--the dominant player in the market for gaming platforms--alongside dynamics in several markets, such as that in the European market for gaming consoles.

Keywords: Market Growth, Vertical differentiation, Compatibility, Multihoming, Network Effects, Duopoly. JEL Classifications: L15, D43

JEL Classification: L15, D43