Compatibility Incentives of a Large Network Facing Multiple Rivals

Abstract

Under network effects, we analyze when a firm with the largest market share of installed-base customers prefers incompatibility with smaller rivals that are themselves compatible. With incompatibility, consumers realize that intra-network competition makes the rivals' network more aggressive than a single-firm network in adding customers. Consequently, under incompatibility the unique equilibrium can entail tipping away from the largest firm whatever its market share. The largest firm is more likely to prefer incompatibility as its share rises (above fifty percent is necessary) or the potential to add consumers falls; the number of rivals and strength of network effects have ambiguous implications.

Keywords: Network Effects, Compatibility, Interconnection, Exclusion

JEL Classification: L13, L41, L86, L96