Potential Competition and the Prices of Network Goods: Desktop Software

Abstract

Potential competition restrains the prices of an incumbent seller when the incumbent can alter the environment perceived by an entrant in a way that both discourages entry and lowers prices. When the product has network effects, the incumbent can make its product ubiquitous and place the potential entrant at a disadvantage because customers have experience with the incumbent's product. A primary tool for making a product ubiquitous is low pricing. Hence potential competition lowers the prices of network products. We develop a quantitative model for the desktop software business embodying these principles.

Keywords: oligopoly, markov-perfect equilibrium, limit pricing, potential competition, Microsoft

JEL Classification: D43, C73