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Avoiding Market Dominance: Product Compatibility in Markets With Network Effects
Abstract
As is well recognized, market dominance is a typical outcome in markets with network effects. A firm with a larger installed base offers a more attractive product which induces more consumers to buy its product which produces a yet bigger installed base advantage. Such a setting is investigated here but with the main difference that firms have the option of making their products compatible. When firms have similar installed bases, they make their products compatible in order to expand the market. Nevertheless, random forces could result in one firm having a bigger installed base, in which case the larger firm may make its product incompatible. We find that strategic pricing tends to prevent the installed base differential from expanding to the point that incompatibility occurs. This pricing dynamic is able to neutralize increasing returns and avoid the emergence of market dominance. Copyright (c) 2009, RAND..
... This would make e supermodular instead of having the single-crossing condition in (; ), thus yielding the same conclusions. 18 Lemma 5 reflects the extent to which the standard argument of (the smooth version of) the 29 Multiple equilibria in markets with network effects are more of a norm than an exception. They are due to the positive feedback associated with expectations: If consumers believe the good will not succeed, it will usually fail. ...
... The intuition is easy to grasp: when the quality of his signal is higher player i has more faith in the messages he receives, and this encourages him to make more extreme decisions later on. 29 Studying information acquisition and entry threat in a monopoly market, Dimitrova and Schlee Proof of Lemma 17: Assume players other than acquire profile α − at stage I, and follow σ − (s − ) at stage II. If player deviates from to 0 in the first stage, recall the definitions ...
... Although their analysis does not allow for counterfactual predictions-the sufficiently small and large quantiles are not identified-the framework they use could be a good starting point to extend our results. 29 The main difficulty will be to separate the distributions of the extremal equilibria from the other ones in the empirical evidence. The statistical literature on "the mixing problem" may shed light on this issue. ...
... In the same vein, Cremer, Rey and Tirole (2000) analyze competition between Internet backbone providers and predict that a dominant …rm may want to reduce the degree of compatibility with smaller market players. Similar results appear in Chen, Doraszelski and Harrington (2009), who consider a dynamic setting with product compatibility and market dominance. They …nd that if a …rm gets a larger market share, it may make its product incompatible. ...
... Absent innovative activity and although the literature has generically supported the view that incompatibility reduces welfare, as in Economides (2006), recent work in Chen, Doraszelski and Harrington (2009) has shown that in the long-run, a policy of mandatory compatibility is not preferable for consumers. Viecens (2009) concludes that compatibility in the applications may be harmful for users and social welfare, particularly when asymmetries are strong. ...
... In the same vein, Cremer, Rey and Tirole (2000) analyse competition between Internet backbone providers and predict that a dominant firm may want to reduce the degree of compatibility with smaller market players. Similar results appear in Chen, Doraszelski and Harrington (2009) , who consider a dynamic setting with product compatibility and market dominance. They find that if a firm gets a larger market share, it may make its product incompatible. ...
Competition Authorities consider market leaders'refusals to support compatibility with competitors as a potential abuse of dominance with detrimental e¤ects on consumer welfare and competition. A prime example is the 2008 European Commission case against Microsoft regarding its refusal to support compatibility of its Office software product with those of competitors. This paper investigates dominant firms' approach towards the compatibility of their durable network goods with that of a future innovative rival in the presence of overlapping generations of forward-looking consumers and the welfare effects from dominant firms' refusals to support compatibility. I consider sequential, substitutable product innovations, where a rival can build on a dominant firm's existing knowledge. I find that in the limiting case when the market leader's distribution of future innovation statewise dominates the rival's, dominant firms commit to support future compatibility with the rivals'future innovative products, while when the probability of the dominant firm is more innovative than the rival is relatively high, credible dominant firms currently announce they will support compatibility with the smaller rival in the future. On the normative side, future incompatible networks increase all groups ex-post surplus when the dominant firm lacks commitment power, while if it currently chooses to be incompatible in the future, this may lead to speculations regarding its lack of future innovative ideas but leads to incompatible future networks and more fierce competition that increases expected consumer suplus for all consumer groups.
... These novel results challenge the view that standardization – or compatible standards – decrease firms' R&D spending in new technologies (Cabral and Salant, 2014). Contrary to conventional wisdom suggesting that dominant firms are unlikely to support compatibility in markets with network effects (Malueg and Schwartz, 2006;Chen, Doraszelski, and Harrington, 2009;Cremer, Rey, and Tirole, 2000), I explain puzzling agreements that dominant firms sign with smaller competitors regarding the compatibility of their future products through their interrelated R&D and compatibility decisions. 4 ...
... In a static environment,Alexandrov (2015)shows that an economy mandating compatibility decreases welfare. Similarly, in an infinite horizon model with stochastic demand, Chen, Doraszelski, andHarrington (2009)show that in the absence of innovative activity, a laissezfaire market is preferable for consumers. These articles contrast the traditional view that compatibility is welfare-increasing, as in Economides (2006). ...
This paper looks at the relationship between standardisation and firms' incentives to invest in Research and Development in the market for implementations when direct network effects are present, such as the market application software. First, I show that future product innovation and intertemporal, strategic considerations lead incumbents to invest more under dual standards and reject standardisation. Second, both the probability of a successfully innovating market -- and thus, the expected value created -- as well as the expected consumer surplus are higher under dual standards.
... questionnaires and interviews), Varjú et al. (2014) suggested that integrating GIS in such evaluations is critical to efficiently assess their potential when they include a multiplicity of features with geographical relevance, such as in the case of wine trails. From the extant literature (Chen, Doraszelski, & Harrington, 2009;Kwan & Weber, 2003;Lumsdon & Page, 2004;Warfield, Hauser-Cram, Krauss, Shonkoff, & Upshur, 2000), six attributes were deemed important to develop such characterization: 1. Spatial Pattern, 2. Connectivity, and 3. Accessibility as geospatial attributes, and 4. Comprehensiveness, 5. Dominance, and 6. Complementariness as tourism attributes. ...
... Dominance refers to the strength of a brand, product, service or firm, relative to its competition in a specific geographical area (Aaker, 1996). A strong Dominance within a market, oftentimes suggests the presence of a monopoly (Chen et al., 2009). Although there are several ways of calculating the dominance of a product, market share calculated as a percentage of the total market achieved by a firm or brand, is the most direct way. ...
Wine trails have been studied insufficiently within the tourism literature despite of their recent rapid development worldwide. In response, this study examines residents' perceptions of wine tourism development in terms of personal benefits and community impacts. It also explores whether residents' socio-demographics and levels of wine enthusiasm, and wine trails' tourism characterization influence residents' perceptions. Following a stratified random sampling procedure, residents living along two wine trails in the Piedmont region of North Carolina (U.S.) were surveyed. Results indicate that residents are neutral in their perceptions of the Piedmont wineries in terms of both personal benefits and community impacts. Residents' socio-demographics and level of wine enthusiasm, as well as the comprehensiveness of wine trails' tourism amenities were significantly associated with residents' perceptions. Results also indicate that personal benefits mediate residents' perceptions of community impacts. In addition to the oretical and methodological contributions, this paper outlines management implications for wine trails.
... questionnaires and interviews), Varjú et al. (2014) suggested that integrating GIS in such evaluations is critical to efficiently assess their potential when they include a multiplicity of features with geographical relevance, such as in the case of wine trails. From the extant literature (Chen, Doraszelski, & Harrington, 2009;Kwan & Weber, 2003;Lumsdon & Page, 2004;Warfield, Hauser-Cram, Krauss, Shonkoff, & Upshur, 2000), six attributes were deemed important to develop such characterization: 1. Spatial Pattern, 2. Connectivity, and 3. Accessibility as geospatial attributes, and 4. Comprehensiveness, 5. Dominance, and 6. Complementariness as tourism attributes. ...
... Dominance refers to the strength of a brand, product, service or firm, relative to its competition in a specific geographical area (Aaker, 1996). A strong Dominance within a market, oftentimes suggests the presence of a monopoly (Chen et al., 2009). Although there are several ways of calculating the dominance of a product, market share calculated as a percentage of the total market achieved by a firm or brand, is the most direct way. ...
Wine trails have been the most commonly developed type of Themed Touring Routes (TTRs) around the world during the past decade. Despite such development, limited studies have examined their geospatial or tourism characteristics reducing marketing and managerial efficacy. To address this gap, this study measured six geospatial and tourism attributes of nine wine trails in North Carolina (USA) toward a characterization of TTRs. Results indicated a shared low Connectivity and good Accessibility among study wine trails regardless of their spatial patterns. Tourism-wise, services provided were Comprehensive within wine trails and Complementary across wineries. Results provided managerial intelligence to existing wine trails, such as the need to enhance local road network density and outbalance tourism dominance within trails. Results were also used to develop a geospatial-tourism classification of wine trails which provide managerial intelligence to optimize resources allocation and to shed light on characterizing other types of TTRs.
... In turn, the nature of competition feeds back to affect prices and consumer welfare. In the absence of innovation, economic theory asserts that a dominant market player is likely to refuse to be compatible with competitors both in the short-run (Malueg and Schwartz, 2006) and in the long-run (Chen, Doraszelski, and Harrington, 2009) when firms are sufficiently asymmetric in terms of installed bases or other traits. Yet monopolists sometimes sign compatibility agreements with future direct competitors, such as the 2007 Microsoft-Novell agreement. ...
... In the absence of innovative activity, the literature has explained dominant firms' position against compatibility (i.e., Katz and Shapiro, 1985; Cremer, Rey, and Tirole, 2000; Malueg and Schwartz, 2006;Chen, Doraszelski, and Harrington, 2009). In an environment where future innovation is deterministic, Anton and Biglaiser (2010) get somewhat different results: they showed that the control of compatibility does not benefit the monopolist. ...
I examine an incumbent monopolist's pricing and compatibility strategy with a future competitor in a two-period durable goods market with network effects and switching costs characterised by quality growth. Consumers arrive in the market in the first period and the “threat” to exercise their option to postpone their purchase due to the uncertainty of future innovation and their expectations to face prices off the equilibrium path lower than those charged in equilibrium provide a new rationale for the incumbent's inability to charge the static monopoly price regardless of the presence of switching costs. Moreover, the short-run average market prices are decreasing in the magnitude of switching costs. I also find conditions as regards the relative extent of network effects and switching costs under which compatibility is mutually supported and show that the likelihood of compatibility may be increasing in consumer mobility. Thus, a policy aiming to decrease switching costs may be sufficient for sizeable efficiency gains. The model is tested on the market for Operating Systems and computer software applications.
... The equilibrium we compute is the limit equilibrium of a finite-horizon game as the horizon grows to infinity. This selection criterion is often used in the literature (see, for instance, Chen et al. (2009)). When computing the finite horizon equilibria using symmetric terminal conditions, we naturally find symmetric strategy equilibria, that is, equilibria for which in state (c 1 , c 2 ) = (c , c ) firm 1 exerts the same R&D effort as firm 2 in state (c , c ). ...
... For small ε, as used in the article, the latter condition is usually not binding. 15 Indeed, many comparable papers in the field of dynamic games even a priori decide to compute only symmetric Markov perfect equilibria, e.g., Chen et al. (2009), Besanko et al. (2010. ...
We study a stochastic dynamic game of process innovation in which firms can initiate and terminate R&D efforts and production at different times. We discern the impact of knowledge spillovers on the investments in existing markets, as well as on the likely structure of newly forming markets, for all possible asymmetries between firms. We show that the relation between spillovers, R&D efforts, and surpluses is non-monotonic and dependent on both the relative and absolute efficiency of firms. Larger spillovers increase the likelihood that a new technology is brought to production, but they do not necessarily make the industry more competitive.
... One is the increasing dominance (ID), whereby the leading firm has a greater probability of winning the next sale; another is increasing dominance (IID), whereby a firm's probability of winning the next sale increases with the length of its lead. (Cabral and Riordan, 1994;Chen, Doraszelski, 2009). Market dominance is also considered as a typical outcome of markets with network effects (Posner, 1974, Chen, Doraszelski, 2009. ...
... (Cabral and Riordan, 1994;Chen, Doraszelski, 2009). Market dominance is also considered as a typical outcome of markets with network effects (Posner, 1974, Chen, Doraszelski, 2009. ...
Articles 101 and 102 of the Treaty on the Functioning of the European Union (TFEU) are aimed at regulation of competition, and preventing undertakings who hold a dominant position in a market from abusing that position respectively. The paper discusses the problem of abusing of market dominance position by enterprises. The objective is to analyze how the European Union and singular European states intervene to solve this kind of market problem to make sure that the objectives of perfect competition are saved. A qualitative investigation of four particular cases in the EU was carried out. The paper presents different cases of market dominance and the results of intervention of the EU Court of Justice, and other National courts. The study found out pronounced cases of Google and breach of Articles 101, and 102 of the TFEU i.e. over rival shopping services, Railway Freight Sector (SNCF), Orange and Outremer Telecom, and Société Nouvelle des Yaourts de Littée (SNYL) whose case have heard and their fines accorded for abusing their dominant position in the common market area. Ceteris paribus, the study concludes that, abusive behavior is a positional strategy and not as result of marketplace factors. The study recommends that competition offices in the member states carry out knowledge sharing activities for businesses/companies, but also keep a focus since abuse of dominant position is real.
... As such, the type of probabilistic analysis we carry out here for the underlying dynamic multi-period process may be useful in thinking about the strategic management of evolving reputations more generally -thought still of course in the highly reduced form in which we have expressed it. For example, it would be interesting to see whether our framework can be adapted to settings where related issues have been explored, including the study of product compatibility [6]. The issue of whether a weaker firm decides to directly compete with a stronger one, or to avoid direct competition, is also implicit in studies of the branding and advertising decisions firms make -including whether to explicitly acknowledge a second-place status, such as the example (discussed in [20]) of the Avis car rental company's "We Try Harder" campaign. ...
A fundamental decision faced by a firm hiring employees --- and a familiar one to anyone who has dealt with the academic job market, for example --- is deciding what caliber of candidates to pursue. Should the firm try to increase its reputation by making offers to higher-quality candidates, despite the risk that the candidates might reject the offers and leave the firm empty-handed? Or is it better to play it safe and go for weaker candidates who are more likely to accept the offer? The question acquires an added level of complexity once we take into account the effect one hiring cycle has on the next: hiring better employees in the current cycle increases the firm's reputation, which in turn increases its attractiveness for higher-quality candidates in the next hiring cycle. These considerations introduce an interesting temporal dynamic aspect to the rich line of research on matching models for job markets, in which long-range planning and evolving reputational effects enter into the strategic decisions made by competing firms.
The full set of ingredients in such recruiting decisions is complex, and this has made it difficult to model the fundamental strategic tension at the core of the problem. Here we develop a model based on two competing firms to try capturing as cleanly as possible the elements that we believe constitute this strategic tension: the trade-off between short-term recruiting success and long-range reputation-building; the inefficiency that results from underemployment of people who are not ranked highest; and the influence of earlier accidental outcomes on long-term reputations.
Our model exhibits all these phenomena in a stylized setting, governed by a parameter $q$ that captures the difference in strength between the top candidate in each hiring cycle and the next best. Building on an economic model of competition between parties of unequal strength, we show that when $q$ is relatively low, the efficiency of the job market is improved by long-range reputational effects, but when $q$ is relatively high, taking future reputations into account can sometimes reduce the efficiency. While this trade-off arises naturally in the model, the multi-period nature of the strategic reasoning it induces adds new sources of complexity, and our analysis reveals interesting connections between competition with evolving reputations and the the dynamics of urn processes.
... Buying a ready-made product generally provides the customer a lower degree of psychological ownership [29]. Therefore, many companies consider the "I designed it myself" effect and allow customers to design their unique products [2] [30]- [32]. Along with the "I designed it myself" effect, customers are empowered by designing their own products using the interactive platforms provided by online retailers. ...
... As this draws more users into the market, firms have a mutual interest in making their products compatible. Second, when firms have different installed bases (e.g., Crémer et al. (2000), Malueg and Schwartz (2006); Farrell and Klemperer (2007); Chen et al. (2009)), the larger firm loses its competitive advantage with compatibility. In contrast, the smaller firm always prefers products to be compatible because it benefits from a larger demand and can catch up with the large firm. ...
This thesis addresses two issues facing regulators in the digital economy: the informational challenge generated by the use of new artificial intelligence technologies and the problem of the market power of large digital platforms. The first chapter of this thesis explores the implementation of a (costly and imperfect) audit system by a regulator seeking to limit the risk of damage generated by artificial intelligence technologies as well as its cost of regulation. Firms may invest in explainability to better understand their technologies and, thus, reduce their cost of compliance. When audit efficacy is not affected by explainability, firms invest voluntarily in explainability. Technology-specific regulation induces greater explainability and compliance than technology-neutral regulation. If, instead, explainability facilitates the regulator's detection of misconduct, a firm may hide its misconduct behind algorithmic opacity. Regulatory opportunism further deters investment in explainability. To promote explainability and compliance, command-and-control regulation with minimum explainability standards may be needed. The second chapter studies the effects of implementing a coopetition strategy between two two-sided platforms on the subscription prices of their users, in a growing market (i.e., in which new users can join the platform) and in a mature market. More specifically, the platforms cooperatively set the subscription prices of one group of users (e.g., sellers) and the prices of the other group (e.g., buyers) non-cooperatively. By cooperating on the subscription price of sellers, each platform internalizes the negative externality it exerts on the other platform when it reduces its price. This leads the platforms to increase the subscription price for sellers relative to the competitive situation. At the same time, as the economic value of sellers increases and as buyers exert a positive cross-network effect on sellers, competition between platforms to attract buyers intensifies, leading to a lower subscription price for buyers. The increase in total surplus only occurs when new buyers can join the market. Finally, the third chapter examines interoperability between an incumbent platform and a new entrant as a regulatory tool to improve market contestability and limit the market power of the incumbent platform. Interoperability allows network effects to be shared between the two platforms, thereby reducing the importance of network effects in users' choice of subscription to a platform. The preference to interact with exclusive users of the other platform leads to multihoming when interoperability is not perfect. Interoperability leads to a reduction in demand for the incumbent platform, which reduces its subscription price. In contrast, for relatively low levels of interoperability, demand for the entrant platform increases, as does its price and profit, before decreasing for higher levels of interoperability. Users always benefit from the introduction of interoperability.
... Dynamic stochastic models with network externalities have been recently studied in the industrial organization literature, mainly using numerical methods. Examples are Markovich (2008) and Markovich and Moenius (2009) which study the dynamics caused by the iterations between hardware and software; Jenkins, Liu, Matzkin, and Mc (2004) studies a stylized version of the browser war between Netscape and Microsoft, where the entrant may have "grabbed" market shares from the incumbent and thereby tipped the market; Chen, Doraszelski, and Harrington (2009) studies competing firms' incentives to make their products compatible and the possible effects that may prevent market dominance; and Arie and Grieco (2014) investigate the effect of switching costs on market dominance and equilibrium prices. A framework for numerically analyzing dynamic interactions in imperfectly competitive industries is proposed by Doraszelski and Pakes (2007) , which provides an excellent summary of the main approach for models of this kind. ...
This paper uses a dynamic stochastic model to solve for the optimal pricing policy of music recordings in the presence of P2P file-sharing networks eroding their sales. We employ a policy iteration algorithm on a discretized state space to numerically compute the optimal pricing policy. The realistically calibrated model reflects the real-world figures we observe and provides estimates of the optimal pricing policy as well as comparative statics figures. The pricing policy is such that, for a given P2P network size, prices are increasing in the number of buyers of the product and, for a given number of buyers of the product, prices are non-monotonic in the P2P network size. Surprisingly, in the presence of P2P networks, increases in production costs and decreases in the valuation of the product increase the consumer and total surplus. A higher valuation of the product leads to a lower steady state price. Increased switching costs have a negative effect on prices and profits, so the long term incentive to attract new consumers dominates the short term incentive to harvest loyal consumers. The full enforcement of intellectual property rights has adverse effect on both consumer surplus and total welfare.
... Network effects of connectivity are well known (Wang, Chen & Xie, 2010;Chen et al, 2009), and are caused by the nonlinearity relationship between input and output. One additional member added to the network may lead to a geometric increase in cross connectivity of all members, and structural complexity leads to network effects. ...
Much of complexity is hidden in structures of organizations, and the market forces significant adjustments to these structures during the dynamics of interactions as the market lifecycle unfolds. Market customer based profiles drive strategic choices, which in turn, exercise pressures on the alignment of organizations and their alliances or special delivery subsystems, such as projects. Early market strategies seek the right positioning and are effectiveness focused, and forgive mistakes and inefficiencies, whereas late market strategies search for alignment with the looming final cost leadership strategy by relentlessly concentrating on efficiency. Firms progress from many strategic choices to just one, and live the rest of their market lives under the inexorable dictates of efficiency, unless the market is rejuvenated by some disruptive intrusion. Both effectiveness and efficiency have their organization structure counterparts that best respond to these market signals. This paper will examine the rise of complexity due to stakeholders’ structures in projects and the implications for the type of results delivered for host firms by the process.
... In fact, environmental issues are addressed in IO as externalities (Lipczynski and Wilson, 2004). Furthermore, the importance of networks and services to meet customer needs is discussed by Katz and Shapiro (1985) within the Fulfilled Expectations Cournot equilibrium (FECE) concept (Chen et al., 2009;Kwon, 2007;Shy, 2001). No filter was needed for the second literature review, and «fulfilled expectations» AND «industrial organization» were used as search terms. ...
This literature review puts forward a comparison between the traditional seller, usually represented
by classic Industrial Organization (IO) models, and system providers, which are illustrated by Product
Service System (PSS) models. A multidisciplinary systematic literature review, that compares PSS and
IO models, is conducted, and ends up in to define PSS as a technology highlights the differences and
similarities between classic IO and classic PSS and evaluate the weakness and strengths of different
models. In total, 148 articles from different disciplines have been investigated, and a different
understanding of PSS is provided. A new IO framework, that considers classic sellers and PSSs
providers, is established to preserve PSS specificities and stress the role of policy maker and
competition for PSSs expansion.
... Besides the aforementioned models of learning-by-doing, Dasgupta & Stiglitz (1988) and Cabral & Riordan (1997) also study price competition when there is learning by doing. Price also serves as an investment in the models of network effects in Mitchell & Skrzypacz (2006), Chen, Doraszelski & Harrington (2009), Dube, Hitsch & Chintagunta (2010), and Cabral (2011; habit formation in Bergemann & Välimäki (2006); and switching costs in Rossi (2009) andChen (2011). This work has generally focused on characterizing the properties of equilibria rather than anatomizing the welfare properties of competition. ...
We study industries where prices are not limited to their allocative and distributive roles, but also serve as an investment into lower costs or higher demand. While our model focuses on learning-by-doing and the cost advantage that it implies, our conclusions also apply to industries driven by network externalities. Existing literature does not have a clear verdict on whether the investment role of prices benefits or hurts the overall welfare, as there are a number of economic forces at work, e.g. motivation to move down the learning curve faster could be offset by the ease of driving a weaker rival out of the market. We compute both market equilibrium and first-best solution. The resulting deadweight loss appears small, in the sense that eliminating the investment motive from pricing decisions leads to much worse outcomes. Further investigation into components of deadweight loss shows that while pricing distortions are the most important driver of the deadweight loss, these distortions can be fairly small. Entry-exit distortions that arise from duplicated set-up and fixed opportunity costs also contribute to the deadweight loss, but these distortions are partially offset by more beneficial industry structure, as the market equilibrium tends to result in more active firms than the first-best solution.
... The Pakes and McGuire (1994) model has been widely used as a template for dynamic models of investment in the Markov perfect equilibrium framework of Ericson and Pakes (1995). It has been adapted to study mergers (Gowrisankaran 1999;Gowrisankaran and Holmes 2004;Mermelstein et al. 2014); capacity accumulation (Besanko and Doraszelski 2004;Besanko et al. 2010); advertising (Doraszelski and Markovich 2007;Dube et al. 2005); network effects (Markovich 2008;Markovich and Moenius 2009;Chen et al. 2009); research joint ventures (Song 2011); durable goods (Goettler and Gordon 2011); investment in both vertical and horizontal product differentiation (Narayanan and Manchanda 2009); the timing of version releases (Borkovsky 2017a); and brand equity (Borkovsky et al. 2017b, c). ...
We reformulate the quality ladder model of Pakes and McGuire, Rand Journal of Economics, 25(4), 555–589 (1994) as a dynamic stochastic game with random moves in which each period one firm is picked at random to make an investment decision. Contrasting this model to the standard version with simultaneous moves illustrates the computational advantages of random moves. In particular, the quality ladder model with random moves avoids the curse of dimensionality in computing firms’ expectations over all possible future states and is therefore orders of magnitude faster to solve than its counterpart with simultaneous moves when there are more than just a few firms. Perhaps unexpectedly, the equilibria of the quality ladder model with random moves are practically indistinguishable from those of the model with simultaneous moves. © 2018 Springer Science+Business Media, LLC, part of Springer Nature
... Whereas we focus on the competitive effects of interconnectivity in a differentiated market, these papers mostly focused on the path of technology adoption and competitor entry (Farrell and Saloner 1986, Katz and Shapiro 1986, Xie and Sirbu 1995 and dynamic profit maximization by a monopolist Shapiro 1992, Choi 1994). Katz and Shapiro (1985) derive results about compatibility choice in a competitive industry similar to our results about interconnectivity, but they consider Cournot competition in an undifferentiated product market, whereas we consider Bertrand competition in differentiated product 4 Similar results have been shown in infinite-period (e.g., Cabral 2011) and continuous-time (e.g., Driskill 2007) models, although the main emphasis of dynamic models is mostly on entry-exit (e.g., Fudenberg and Tirole 2000), market share dynamics (e.g., Mitchell and Skrzypacz 2006, Markovich 2008, Markovich and Moenius 2009, Doraszelski et al. 2009, Cabral 2011, or technology adoption (e.g., Shapiro 1986, Farrell andSaloner 1986). Recent literature also extended the consideration of the effects of network externalities to channel coordination (Li 2005), product strategies (Basu et al. 2003 andSun et al. 2004), cross-market network competition (Chen and Xie 2007), and bundling (Prasad et al. 2010). ...
This paper analyses firms' decisions to provide connectivity to their customers. We distinguish between intraconnectivity — the ability of one firm's customers to connect to each other— and interconnectivity — the ability of one firm's customers to connect with another firm's customers. The profitability implications of allowing connectivity are not a straightforward consequence of the consumer value of connectivity, because connectivity affects not only the customer value but also the intensity of competition by creating or changing network externality. We find that if sales are driven by brand switching rather than by category expansion, a firm may find it optimal not to provide intraconnectivity even if providing it is not costly and may find it optimal to provide interconnectivity even at a cost exceeding the consumer value of connectivity. On the other hand, if category expansion is possible, providing intraconnectivity may be profitable. In this case, either the equilibrium intraconnectivity provision may be asymmetric or both firms may find it (individually) optimal to provide intraconnectivity. Under certain conditions in the latter case, the firms' choice of intraconnectivity is a prisoner's dilemma game.
... The equilibrium we compute is the limit equilibrium of a finite-horizon game as the horizon grows to infinity. This selection criterion is often used in the literature (see, for instance, Chen et al. (2009) ). When computing the finite horizon equilibria using symmetric terminal conditions, we naturally find symmetric strategy equilibria, that is, equilibria for which in state ( c 1 , c 2 ) = ( c , c ) firm 1 exerts the same R&D effort as firm 2 in state ( c , c ). ...
We study a stochastic dynamic game of process innovation in which firms can initiate and terminate R&D efforts and production at different times. We discern the impact of knowledge spillovers on the investments in existing markets, as well as on the likely structure of newly forming markets, for all possible asymmetries in production costs between firms. While an increase in spillovers may improve the likelihood of a competitive market, it may at the same time reduce the level to which a technology is developed. We show that the effects of spillovers on investments and surpluses crucially depend on the stage of technology development considered. In particular, we show that high spillovers are not necessarily pro-competitive as they can make it harder for the laggard to catch up with the technology leader.
... whether competition encourages or deters technology firms from adopting compatible standards for their technology (Farrell and Klemperer, 2007). Work on standards deployment, such as Augereau et al. (2006)'s paper on ISPs' adoption of modem standards, has documented that ISPs are less likely to choose compatible systems in a symmetric firm setting. Chen et al. (2009) built a dynamic model that can explain why in the long run some firms make their technology compatible despite gaining market dominance. Similarly to the empirical findings in this paper, their model emphasizes that there is a tension for a firm with many in-network customers. Their size may lead them to want to lock customers in, but t ...
There are many technology platforms that bring benefits only when users share data. In healthcare, this is a key policy issue, because of the potential cost savings and quality improvements from 'big data' in the form of sharing electronic patient data across medical providers. Indeed, one criterion used for federal subsidies for healthcare information technology is whether the software has the capability to share data. We find empirically that larger hospital systems are more likely to exchange electronic patient information internally, but are less likely to exchange patient information externally with other hospitals. This pattern is driven by instances where there may be a commercial cost to sharing data with other hospitals. Our results suggest that the common strategy of using 'marquee' large users to kick-start a platform technology has an important drawback of potentially creating information silos. This suggests that federal subsidies for health data technologies based on 'meaningful use' criteria, that are based simply on the capability to share data rather than actual sharing of data, may be misplaced.
... On the other hand, there are some studies that incorporate consumers who lack the ability to form forward-looking expectations, such that the utility of every consumer depends on the number of users at the moment of purchase, and is not affected by the future network size. (e.g., Arthur, 1989;Chen et al., 2009;Doganoglu, 2003;Makhdoumi et al., 2017;Mitchell and Skrzypacz, 2006). 6 However, there has been little investigation of the dynamic pricing when consumers are heterogeneous with respect to their expectations about the future network size of a durable good. ...
This paper studies the optimal pricing and diffusion of durable goods that exhibit positive network externalities, when consumers are heterogeneous in their expectations about future network sizes. We consider the existence of naive consumers, as well as of sophisticated consumers having fulfilled expectations. We find that the firm charges the sequential-diffusion pricing that makes sophisticated consumers function as early adopters, unless consumers quickly become bored with using the goods and/or unless the firm heavily discounts its future profits. We also compare the profitability of three possible pricing strategies with different commitment powers: fixed, responsive, and pre-announced pricing.
... In the case of pharmaceuticals, there is evidence of increasing returns (Henderson and Cockburn 1996). 25 However, if network compatibility is endogenous, firms have an incentive to invest more in technologies where competitors are strong so that the competitor maintains product compatibility (Chen et al. 2008). ...
This dissertation consists of three essays on strategic and tactical issues in product design. The first essay presents a dynamic investment game in which firms that are initially identical develop assets which are specialized to different market segments. The model assumes there are increasing returns to investment in a segment, for example, due to word-of-mouth or learning curve effects. In equilibrium, firms that are only slightly different focus all of their investment in different segments, causing small random differences to expand into large permanent differences. Even though firms do not cooperate and do not make threats to punish each other, in the long run they divide the market, reaching the same outcome that they would if they cooperated to maximize joint profits. This second essay develops a model in which an incumbent has expertise in an old business format (e.g., running a full service airline), and a new firm enters the market with the possibility of using a new business format (e.g., running a "no frills" airline). Firms play a dynamic investment game in which the incumbent can invest in the new format and the entrant can invest in either format. If brand and format preferences are strong, and if it is easy to implement a format, then a firm already using one format does not invest in the other format, since such an attack would be met with swift retaliation. In this case, the entrant invests in the new format, while the incumbent avoids investing in order to retain the threat of investment as a punishment mechanism. The third essay shows that improved accuracy in conjoint analysis has important strategic implications. Even if two models provide unbiased part-worths, competitive game theory shows that the more accurate model (with lower error variance in an HB CBC model) implies that differentiation from competitors is more profitable. On the other hand, a less accurate model implies that each firm should forego differentiation and choose feature levels that provide customers the greatest utility (adjusting for marginal cost). I illustrate the theory by varying accuracy in a student-apparel application.
... Third, while a growing body of work highlights conditions under which winner-takes-all dynamics occur in platform markets (e.g. Cennamo and Santalo, 2013;Chen, Doraszelski and Harrington, 2009;Dubé, Hitsch and Chintagunta, 2010), much less is known about how and why dominant platforms get displaced (Rietveld and Schilling, 2020). Some studies explored the 'David and Goliath'type competition between digital platforms (Li, 2019;Zeng and Glaister, 2016), but it is not clear how this differs from technological disruptions observed outside the realm of platform competition (Christensen, 1997). ...
The world's most valuable public companies today are built on digital platforms. While American digital platforms (ADPs) have successfully dominated many international markets, some Chinese digital platforms (CDPs) have managed to survive and thrive in China, with European digital platforms (EDPs) largely absent both at home and abroad. Using comprehensive longitudinal data over 6 years, this study examines the platform competition between ADPs and CDPs in China, and explores how digital platforms challenge traditional ways of thinking about strategy and international competition. Some ADPs initially dominated the Chinese market, but some CDPs used their institutional advantages in China to offset the competitive advantages of ADPs based on superior resources and capabilities and strong market positions. Their competition evolved over three distinctive episodes so far, and CDPs used successive temporary advantages to achieve sustainable competitive advantages dynamically and accomplished radical changes cumulatively through incremental changes. A new dynamic equilibrium model of platform competition – ‘the spiral model’ – between global and native digital platforms is developed, which highlights a trajectory that is different from the dominant models of change in the literature. Limitations of the study and new areas for future research are highlighted.
... Markovich and Moenius [89] develop an industry computing model including "hardware" and "software" components, which assumes that consumers live for two periods and benefit from indirect network effects through the quality of existing products. Chen et al. [90] develop a computational dynamic model in which it is assumed that consumer benefits are a growing function of the size of the network at the time of purchase (consumers are not forward-looking). ese assumptions assume that consumer behavior is relatively simple. ...
Since the 1990s, the increasing development of digital-driven technologies such as the Internet, cloud computing, big data, and the Internet of Things and the popularization of computers and mobile electronic devices have accelerated the evolution of global business organizations, thus making a new form of business organization, platform economy. As the most important form of industrial organization in the new economic era, the development of the platform has received extensive attention from the academia. Through literature analysis and inductive deduction, this paper reviews the connotation of platform economy, the historical context of development, the competition and monopoly (differentiation) of multilateral platforms, the evaluation mechanism of platform, antimonopoly governance, and research methods, and provides theoretical references and new ideas for future research directions.
... While a growing body of work has highlighted conditions under which "winner-takesall" dynamics occur in platform markets (e.g., Cennamo & Santalo, 2013;Chen, Doraszelski & Harrington, 2009;Dubé, Hitsch & Chintagunta, 2010;Schilling, 2002), much less is known about how and why dominant platforms eventually get displaced. Research in this area is scant at best, despite scholarly and empirical relevance. ...
Over the past three decades, platform competition—the competition between firms that facilitate transactions and govern interactions between two or more distinct user groups who are connected via an indirect network—has attracted significant interest from the fields of management and organizations, information systems, economics, and marketing. Despite common interests in research questions, methodologies, and empirical contexts by scholars from across these fields, the literature has developed mostly in isolated fashion. This article offers a systematic and interdisciplinary review of the literature on platform competition by analyzing a sample of 333 articles published between 1985 and 2019. The review contributes by (a) documenting how the literature on platform competition has evolved; (b) outlining four themes of shared scholarly interest, including how network effects generate “winner-takes-all” dynamics that influence strategies, such as pricing and quality; how network externalities and platform strategy interact with corporate-level decisions, such as vertical integration or diversification into complementary goods; how heterogeneity in the platform and its users influences platform dynamics; and how the platform “hub” orchestrates value creation and capture in the overall ecosystem; and (c) highlighting several areas for future research. The review aims to facilitate a broader understanding of the platform competition research that helps to advance our knowledge of how platforms compete to create and capture value.
... The theoretical literature of dynamic competition and compatibility in markets with network externalities has largely considered single-sided networks, and this prevents the consideration of endogenously developed switching costs through multi-sided pricing strategies. For example, Cabral (2011) considers dynamic single-sided network competition and does not consider switching costs; Chen et al. (2009) consider network pricing and compatibility decisions when networks compete in a single-sided market without switching costs; and Hałaburda et al. (2016) develop a model with network effects where the platform that "won" in the previous period is focal in the current period. That is, consumers observe which platform was available in the previous period and form favorable beliefs about that platform in the current period. ...
This paper considers intra-platform technologies that allow a consumer’s content and preferences to carryover across platform generations. In many platform industries, content consumed on a platform’s previous generation can be used on the platform’s new generation. Naturally, a consumer with more content incurs a greater cost to switch platforms. Instead of discounting the first-period consumer price (the standard result), I find that a platform subsidizes content procurement. This still provides a bargain to first-period consumers in the form of more content, but it also generates a more extensive second-period markup to consumers. To further highlight the usefulness of the model, data from the video game market is used to provide additional insights on consumer primitives and to explain how Sony generated endogenous switching costs which allowed them to dominate the video game market in the early 2000s.
... While a growing body of work has highlighted conditions under which "winner-takesall" dynamics occur in platform markets (e.g., Cennamo & Santalo, 2013;Chen, Doraszelski & Harrington, 2009;Dubé, Hitsch & Chintagunta, 2010;Schilling, 2002), much less is known about how and why dominant platforms eventually get displaced. Research in this area is scant at best, despite scholarly and empirical relevance. ...
Over the past three decades, platform competition—the competition between firms that facilitate transactions and govern interactions between two or more distinct user groups who are connected via an indirect network—has attracted significant interest from the fields of management and organizations, information systems, economics, and marketing. Despite common interests in research questions, methodologies, and empirical contexts by scholars from across these fields, the literature has developed mostly in isolated fashion. This article offers a systematic and interdisciplinary review of the literature on platform competition by analyzing a sample of 333 articles published between 1985 and 2019. The review contributes by (a) documenting how the literature on platform competition has evolved; (b) outlining four themes of shared scholarly interest, including how network effects generate “winner-takes-all” dynamics that influence strategies, such as pricing and quality; how network externalities and platform strategy interact with corporate-level decisions, such as vertical integration or diversification into complementary goods; how heterogeneity in the platform and its users influences platform dynamics; and how the platform “hub” orchestrates value creation and capture in the overall ecosystem; and (c) highlighting several areas for future research. The review aims to facilitate a broader understanding of the platform competition research that helps to advance our knowledge of how platforms compete to create and capture value.
... Because in each period only one consumer chooses a platform, the issue of coordination between consumers does not arise. Some authors have used similar models to study compatibility between platforms (for instance, Chen, Doraszelski, and Harrington, 2009) or introduce some simple version of two sided competition (Zhu and Iansiti, 2012;Laussel and Resende, 2014a,b). In this tradition, several platforms compete over an infinite horizon. ...
... Casadesus-Masanell and Ruiz-Aliseda, for example, explained large platform firms' preference for incompatibility in terms of the quest for market dominance [22], and Viecens showed that compatibility will always be preferred by a platform firm with smaller standalone value and never by its competitor [23]. Several studies in this literature examined compatibility incentives where one firm has a larger installed base (e.g., [24], [25], [26] and [27]) and found that it is less willing to be compatible because, with compatibility, it has to share its network, while with incompatibility, it can maintain its market dominance. Dou found, in a model with vertically differentiated platforms and content, that when an inferior platform firm owns premium content, it is optimal for the inferior platform firm to offer such content to a superior platform firm [28]. ...
Compatibility or competition is a key strategic decision for multihoming software developers. Compatibility is a strategy by which companies set up their software to be more compatible with their competitors’ products, while competition is an opposite strategy by which the companies set up their software without any compatibility. We study the strategic decision of a multihoming software company that competes with two firms on different operating systems, (such as Windows and Mac). By formalizing a game-theoretic model to capture the motivation of a multihoming software developer, we find that the compatibility strategy is mainly incentivized by the trade-off between the spillover effect and the compatibility cost. We then solve for reasonable software prices and compatibility level given the market potential from the software firms’ perspective. Several managerial guidelines are obtained to determine the optimal decision in the software development economy. Interestingly, when both the spillover effect and the compatibility cost are low enough, the multihoming software firm still chooses the competing strategy. Finally, by reporting the numerical analysis, we verify the effectiveness of the theoretical results derived in our model.
Adoption processes in network effect markets – like the ICT industry – often lead to so-called “lock-ins” which means that one single standard or technology gets adopted by almost all market participants. Based on the work of Arthur [1] we present a simulation based model explaining a market’s tendency to lock-in by means of two factors: the strength of network effects and the network topology of potential adopters. In order to obtain a better understanding of the interconnection of the actors’ decisions we developed an approach to compare markets that show the same network effect strength but face different actor network topologies. We found that the predisposition of a market to show a lock-in induced by network effects generally increases with growing network effect strength and network density. However, our analysis shows that the way these two factors affect a market’s tendency to lock-in varies between random topologies and real life social topologies.
Product compatibility is becoming increasingly important especially in the IT industry due to a high level of network effect in this industry. This study empirically examines the business value of IT product compatibility initiatives with respect to the nature of the compatibility achieved (i.e., horizontal compatibility, vertical compatibility) and the type of focal product (i.e., software, hardware) for which compatibility is achieved. Using event study methodology, this paper investigates the market reaction to announcements of compatibility initiatives over a three-year period. The results show that business announcements associated with horizontal compatibility yield higher abnormal returns than the ones with vertical compatibility. Also compatibility initiatives for software products tend to be associated with a more positive stock market reaction than those for hardware products. Our findings reveal the nuances in IT product compatibilities and the need to develop a richer theory to enhance our understanding of the various IT compatibilities. Our findings also provide business insights to strategic planners and help them understand how and when to invest in IT product compatibilities to obtain positive reactions from investors.
This paper investigates the expansion of the network of a monopolist firm that produces a durable good and is also involved in the corresponding aftermarket. We characterize the Markov Perfect Equilibrium of the continuous time dynamic game played by the monopolist and the forward-looking consumers, under the assumption that consumers benefit from the subsequent expansion of the network. The paper contributes to the theoretical discussion on the validity of the Coase conjecture, analyzing whether Coase’s prediction that the monopolist serves the market in a "twinkling of an eye" remains valid in our setup. We conclude that the equilibrium network development may actually be gradual, contradicting Coase’s conjecture. We find that a necessary condition for such a result is the existence of aftermarket network effects that accrue (at least partly) to the monopolist firm.
Purpose ‐ Given the increasingly saturated information and communication technology (ICT) market and the intensification of competition among ICT firms, there is a need for a better understanding of entry barriers in the ICT market. The purpose of this paper is to examine the overall characteristics of these entry barriers and identify firms' strategies for achieving market dominance. Design/methodology/approach ‐ The authors examined the overall characteristics of these entry barriers and identified firms' strategies for achieving market dominance by tracking the actual patterns of firms' ICT market entry based on the Bass diffusion model. Findings ‐ The results indicate that the saturation of the ICT market reduced entry barriers, which strengthened the imitation effect. In addition, entry barriers were lower for ICT firms than for non-ICT ones. Furthermore, entry barriers were higher for the manufacturing sector than for the service sector, indicating that the innovation effect was stronger for the manufacturing sector than for the service sector, whereas the opposite was true for the imitation effect. Originality/value ‐ These results suggest that those firms that are planning to enter or are already in the ICT market should develop better strategies for gaining a competitive advantage.
The present paper shows that in the absence of fair, reasonable, and non-discriminatory (FRAND) licensing terms, the adoption of a standard depends on the degree of network effects. If the degree of network externalities is low, patent holders may opt for developing incompatible technologies in order to avoid the entry deterrence in the downstream market and the resulting decrease in the royalty income. If the degree of network externalities is sufficiently high, patent holders may prefer developing a common standard even though it has a negative impact on the market entry in the downstream market. Generated network externalities are then sufficiently high to create additional demand compensating the losses from the entry deterrence. The application of FRAND terms eliminates the entry deterrence problem and by consequence stimulates the standard adoption. The use of the FRAND commitment has beneficial effects for consumer surplus and total welfare.
This paper studies the dynamic price competition between two firms that sell horizontally differentiated durable goods and, subsequently, provide exclusive complementary goods and services to their customers. The paper analyzes how optimal pricing strategies are affected by the existence of network effects associated with the size of firms’ consumer base. The interaction is thoroughly analyzed as a continuous time linear–quadratic differential game. We provide a necessary and sufficient condition for the existence of a unique duopoly equilibrium in affine strategies. When this condition holds, we show that optimal pricing strategies crucially depend on the nature of the network effects.
We examine the inefficiency of uncoordinated environmental regulation of CO2 emissions from electricity generation for a large regional U.S. wholesale electricity market that spans multiple states. We estimate a dynamic structural model of production and investment to compare the social welfare of two counterfactual regulatory scenarios. In both scenarios, emissions targets set by the regulator are met via endogenously determined CO2 prices in markets aiming to correct the externality. In the first scenario, the CO2 prices are state-specific. In the second scenario, there is a regional CO2 price. According to our social welfare estimates, the inefficiency of uncoordinated regulation is mitigated substantially because of the firms’ participation in an integrated product market in two main ways. First, firms reallocate output from states with high CO2 prices to states with low prices. Second, this reallocation spurs investment in cleaner capacity that is exempt from CO2 regulation. Our finding regarding the mitigation and, potentially, elimination of the inefficiency is robust to alternative models of optimal investment behavior.
We determine the incentives for compatibility provision of firms that produce network goods with different intrinsic qualities when firms do not have veto power over compatibility. When network effects are strong, 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 degree is zero, except under very strong network effects, where one of the equilibria has all consumers buying the low-quality good. In this case, a partial degree of compatibility is optimal.
There are two puzzles in the software competition literature: whether both proprietary and open source software will survive and how producers of proprietary software differentiate themselves from open source competition. I address both puzzles by analyzing competition between a firm producing proprietary software and a community producing open source software. If the firm faces no competition, then the software caters to less technologically savvy individuals. When facing competition, the open source software caters to the most technologically savvy individuals, leading the firm to target even less savvy individuals than it would when acting as a monopolist in order to differentiate its software from the open source option. The open source movement, then, may not be an unalloyed success as the growth in open source can be tied to deterioration in the proprietary software. Given that both types of software survive by catering to different segments of the market, an important avenue for research will be to analyze the stability of the underlying segments and the corresponding welfare implications.
The ever-expanding Internet and fast-growing pace of online shopping push companies to implement online customization. Rather than customizing on the information delivery, transaction handling, and product features, companies also start to offer different specific privileges to different types of customers. In this regard, we would like to examine how these different forms of customization affect customer satisfaction.
When network effects are important and technology is rapidly improved, this paper explores the relative optimality of five product introduction strategies of a durable goods manufacturer: (1) replacement, (2) skipping, (3) a delayed line, (4) shelving, and (5) line-extension. Using a two-period analytical model, we show how the type of compatibility—either full or backward compatibility—and the magnitude of the network effect influence the manufacturer's preference for the above strategies. Our analysis reveals that only the strategies (1)-(3) above can be optimal; and the optimal strategy varies with network strength. Further, the type of compatibility can dramatically change the profitability under each optimal strategy; for instance, while backward compatibility can increase the profitability of replacement under certain conditions, it always reduces the profitability of a delayed line. We also illustrate that if compatibility were a choice, although backward compatibility may be observed widely in practice, the parametric region for its optimality is relatively more restricted than that of full compatibility. This article is protected by copyright. All rights reserved.
This article provides evidence on the role of subcontracting in the auction-based procurement setting with private cost variability and capacity constraints. We demonstrate that subcontracting allows bidders to modify their costs realizations in a given auction as well as to control their future costs by reducing backlog accumulation. Restricting access to subcontracting raises procurement costs for an individual project by 12% and reduces the number of projects completed in equilibrium by 20%. The article explains methodological and market design implications of subcontracting availability.
Network effects encourage original equipment manufacturers (OEMs) to expand their market size by changing their relationships with third-party manufacturers who provide compatible products from competition to coopetition. Moreover, network effects render consumer valuation inherently dynamic. Consumer perceptions of the sales quantity are continuously updated, causing the impact of the network effect to change dynamically over time. To this end, we examine technology licensing and price competition in a dynamic duopoly including an OEM and a third-party manufacturer, considering that consumer utility increases with the dynamic and evolving impact of network effects. However, because of limited product technology, the lower compatibility of third-party products reduces network effects. Thus, the third-party manufacturer licenses technology from the OEM. Because the OEM can strategically choose a static or dynamic royalty under technology licensing in a dynamic pricing game, we derive the firms’ subgame-perfect Nash equilibrium decisions and profits and analyze the effects of licensing mechanisms and market factors on firms’ instantaneous and steady-state equilibrium decisions and profits. Technology licensing enhances firms’ profits when firms’ and consumers’ dynamic behaviors are more significant by exerting stronger network effects. A dynamic royalty is more effective for mitigating price competition intensity and for helping firms maintain higher sales margins. A static royalty induces a lower royalty chosen by the OEM and firms lower prices, which increases the impact of network effects and thus is generally more advantageous for the firms and for social welfare.
We study compatibility decisions of two competing platform owners that generate profits through both hardware sales and royalties from content sales. We consider a game-theoretic model in which two platforms offer different standalone utilities to users. We find that incentives to establish one-way compatibility—the platform owner with smaller standalone value grants access to its proprietary content application to users of the competing platform—can arise from the difference in their profit foci. As the difference in the standalone utilities increases, royalties from content sales become less important to the platform owner with greater standalone value, but more important to the other platform owner. One-way compatibility can thus increase asymmetry between the platform owners’ profit foci and, given a sufficiently large difference in the standalone utilities, yields greater profits for both platform owners. We further show that social welfare is greater under one-way compatibility than under incompatibility. We also investigate how factors such as exclusive content and hardware-only adopters affect compatibility incentives.
This paper was accepted by Chris Forman, information systems.
We study the impact of standard-setting by introducing an externality that increases product compatibility in the presence of asymmetric returns to investment in a dynamic quality-ladder-type model. We classify the long-run, multi-modal probability distributions over different market structures that arise from this model. In some cases, the lagging firm may remain in the market in the long-run depending on the strength of the externality. In the case where only the laggard invests in compatibility, it is possible that the laggard becomes a monopolist if the leader has a relatively low R&D capability and the two firms are almost symmetric in this same regard. This variety of multi-modal long-run distributions may have important consequences for the estimation and the simulation of this class of dynamic models.
I study affirmative action subcontracting regulations in a model where governments use auctions to repeatedly procure goods and services at the lowest possible price. Through using disadvantaged subcontractors, prime contractors build relationships over time, resulting in lower subcontracting costs in future periods. I find that regulation in the form of a minimum subcontracting requirement expands bidder asymmetries, favoring prime contractors with stronger relationships over those with weaker ones. Simulations show that the manner in which relationships evolve determines not only the utilization of disadvantaged subcontractors but also the procurement costs attained under affirmative action.
We study how quality uncertainty among consumers affects price competition in the presence of network effects. Our main result is that quality uncertainty has non-monotonic effects on firms’ price setting behavior. Prices and industry profit is first falling, then increasing, in quality uncertainty. In addition we show that quality uncertainty can force a high quality provider to be aggressive to the point where its price in the first period is below that of a low quality provider. We also analyse the incentives for compatibility under quality uncertainty, and find that when quality uncertainty is sufficiently high, compatibility may be used as a means of softening price competition.
Platform markets have enormous economic significance in society and global economy, and platform research attracts scholars from different communities. In this paper, we conduct a bibliometric analysis of 3490 platform papers which appear in top business, economics, and management journals from 1990 to 2019. Influential journals, institutions, landmark papers, citation bursts are identified from the analysis. In addition to scholars from economics, strategy, and technology management communities, scholars from marketing, information systems, and operations management also participate in platform research. Moreover, the results indicate that the research focus of platform evolves from supply-side product development, product design and open innovation, goes through demand-side two-sided markets, and centers on sharing economy in recent years. The viewpoint of platform research experiences a conversion from a research object to a research context. We further develop a future research agenda for platforms, the associated technologies and social impacts. Our bibliometric analysis contributes to the literature by offering an objective and systematic overview of platform research.
A classic R&D rivalry is compared to R&D cooperation while embedded in a model of endogenous network compatibility. We show that complete incompatibility is more likely to occur with cooperative R&D. Complete incompatibility increases the advantage in R&D and profitability of the incumbent over the entrant. In our initial illustration, cooperation in network industries with endogenous compatibility generates no higher (and often lower) welfare than in non‐network industries. In our generalization, cooperation in network industries generates welfare loss for a wider range of R&D spillovers. This suggests that R&D cooperation should receive stricter policy scrutiny in network industries with endogenous compatibility.
Ökonomische Modelle verdichten die Komplexität von realen Märkten auf die wesentlichen Merkmale und ermöglichen so eine zielführende Analyse. Bevor wir Medienmärkte anhand von ökonomischen Modellen analysieren, werden zunächst wichtige industrieökonomische Modelle eingeführt. Damit werden die Grundlagen für die später verwendeten Ansätze geschaffen. Die Modelle zeigen ganz allgemein, wie sich Unternehmen optimal verhalten. Die Ergebnisse können somit später mit denen der medienspezifischen Modelle verglichen werden. Erst dadurch können dann die Besonderheiten von Medienmärkten aufgezeigt und genauer abgebildet werden.
Das Monopolmodell zeigt, wie sich ein monopolistisches Unternehmen verhält und welche Probleme dabei für den Konsumenten und die Gesellschaft entstehen. Die dann diskutierten Wettbewerbsmodelle berücksichtigen, wie sich Unternehmen verhalten, die im Wettbewerb zueinander stehen. Für das Ergebnis ist dabei ausschlaggebend, ob die Unternehmen in Preisen oder in Mengen konkurrieren. Durch Produktdifferenzierung können Unternehmen diesen Wettbewerb wieder abschwächen.
Nach den grundlegenden Ansätzen, werden die ersten medienrelevanten Fragestellungen betrachtet. Im Zentrum stehen dann Fragen, wie sich z.B. direkte Netzeffekte auf die Preissetzung von Unternehmen auswirken, wie ein Monopolist seine Werbemenge festlegen sollte oder auch wie sich Kompatibilität im Wettbewerb auswirkt.
Allowing for innovation dynamics in the software market, this paper studies the conditions under which standardization in the hardware market arises and persists over time. In the model, software firms repeatedly invest in quality upgrades, compete in the product market, and make exit as well as entry decisions. The results show that, in general, excess inertia does not occur. A platform becomes the standard in a market only if it is better than the competing platforms. Furthermore, low overall rates of innovation always lead to variety; conversely, the higher the speed of innovation, the more likely standardization is.
In this article we develop and illustrate a simple algorithm for computing Markov-perfect Nash equilibria. The advantage of the Markov-perfect framework is that it is flexible enough to reproduce important aspects of reality in a variety of market settings. As a result, we hope that our article and (perhaps improved) versions of the associated algorithms will eventually be a part of a tool kit that allows researchers to go back and forth between the implications of economic theory and the characteristics of alternative datasets.
In this paper we examine the diffusion of a hardware/software system. For such systems there is interdependence between the hardware adoption decisions of consumers and the supply decisions of software manufacturers. Hence there can be bottlenecks to the diffusion of the system which stem not from high prices but from the fact that the complementary product is not available. We consider the CD-industry and estimate the (direct) elasticity of adoption with respect to CD prices and (the cross) elasticity with respect to the variety of CD-titles. Our results show that the cross elasticity is indeed significant so that the presence of complementarities poses a serious bottleneck problem for the diffusion of the base product. We illustrate two applications of our methodology: (i) the business-policy question of how to subsidize a new base product which is contingent on a sufficiently large supply of complementary products & (ii) the public-policy question of what are the benefits of imposing backward compatibility on a new technology (e.g., high definition televisions).
Can advertising lead to a sustainable competitive advantage? To answer this question, we propose a dynamic model of advertising competition where firms repeatedly advertise, compete in the product market, and make entry as well as exit decisions. Within this dynamic framework, we study two different models of advertising: in the first model, advertising influences the goodwill consumers extend toward a firm ("goodwill advertising"), whereas in the second model it influences the share of consumers who are aware of the firm ("awareness advertising"). We show that asymmetries may arise and persist under goodwill as well as awareness advertising. The basis for a strategic advantage, however, differs greatly in the two models of advertising. We show that tighter regulation or an outright ban of advertising may have anticompetitive effects and discuss how firms use advertising to deter and accommodate entry and induce exit in a dynamic setting.
This paper estimates the importance of indirect network effects in the US video cassette recorder (VCR) market between 1978 and 1986. Estimation reveals the significant role of networks in the format competition between VHS and Beta. The paper also finds that if Sony, the system sponsor of Beta, had aggressively introduced its VCRs at the early stage of competition, Beta would likely have dominated the market in 1985; instead, the format disappeared in 1989. Finally, the paper measures consumer welfare for the value of network effects in VCRs, and assesses the consumer welfare effect of standardization.
We examine the importance of indirect network effects in the U.S. video game market between 1994 and 2002. The diffusion of game systems is analyzed by the interaction between console adoption decisions and software supply decisions. Estimation results suggest that introductory pricing is an effective practice at the beginning of the product cycle, and expanding software variety becomes more effective later. We also find a degree of inertia in the software market that does not exist in the hardware market. This observation implies that software providers continue to exploit the installed base of hardware users after hardware demand has slowed.
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 per cent is necessary) or the potential to add consumers falls; the number of rivals and strength of network effects have ambiguous implications.
We test empirically for network effects and preannouncement effects in the DVD market. We do this by measuring the effect of potential (incompatible) competition on a network undergoing growth. We find that there are network effects. The data are generally consistent with the hypothesis that the preannouncement of DIVX temporarily slowed down the adoption of DVD technology.
I consider a dynamic model of competition between two proprietary networks. Consumers die and are replaced with a constant hazard rate, and firms compete for new consumers to join their network by offering network entry prices. I derive a series of results pertaining to (a) existence and uniqueness of symmetric equilibria, (b) monotonicity of the pricing function (e.g. larger networks set higher prices), (c) network size dynamics (increasing dominance vs. reversion to the mean), and (d) firm value (how it varies with network effects). Finally, I apply my general framework to the study of termination charges in wireless telecommunications. I consider various forms of regulation and examine their impact on firm profits and market share dynamics. Copyright 2011, Oxford University Press.
In this paper we analyze the demand for mobile telecommunication services in Germany in the period from January 1998 to June 2003. During this time, the subscriber base grew exponentially by about 700% while prices declined only moderately by about 41%. We believe that prices alone cannot account for such rapid diffusion and network effects have influenced the evolution of the industry. We put this view to the test by using publicly available data on subscriptions, price indices and churn rates. Using churn rates gave us approximate sales levels which enabled us to use standard methods to investigate the effect of network size on demands. Our estimates of a system of demand functions show that network effects played a significant role in the diffusion of mobile services in Germany.
Switching costs and network effects bind customers to vendors if products are incompatible, locking customers or even markets in to early choices. Lock-in hinders customers from changing suppliers in response to (predictable or unpredictable) changes in efficiency, and gives vendors lucrative ex post market power – over the same buyer in the case of switching costs (or brand loyalty), or over others with network effects. Firms compete ex ante for this ex post power, using penetration pricing, introductory offers, and price wars. Such “competition for the market” or “life-cycle competition” can adequately replace ordinary compatible competition, and can even be fiercer than compatible competition by weakening differentiation. More often, however, incompatible competition not only involves direct efficiency losses but also softens competition and magnifies incumbency advantages. With network effects, established firms have little incentive to offer better deals when buyers' and complementors' expectations hinge on non-efficiency factors (especially history such as past market shares), and although competition between incompatible networks is initially unstable and sensitive to competitive offers and random events, it later “tips” to monopoly, after which entry is hard, often even too hard given incompatibility. And while switching costs can encourage small-scale entry, they discourage sellers from raiding one another's existing customers, and so also discourage more aggressive entry. Because of these competitive effects, even inefficient incompatible competition is often more profitable than compatible competition, especially for dominant firms with installed-base or expectational advantages. Thus firms probably seek incompatibility too often. We therefore favor thoughtfully pro-compatibility public policy.
The U.S. antitrust law enforcement agencies often base their assessment of mergers on a model with asymmetric costs. However, in many near-homogeneous product industries there is evidence that cost differences are minor and capacity differences seem a more reasonable explanation of firm heterogeneity. Based on simulations from a dynamic model of capacity accumulation, I find that mergers are welfare-reducing and that their long-run effects are worse than their short-run effects. If instead the simulated data is fit to an asymmetric costs model, the long-run welfare-reducing effects of mergers will be systematically underestimated, which can give rise to misguided antitrust policies.
Learning-by-doing and organizational forgetting are empirically important in a variety of industrial settings. This paper provides a general model of dynamic competition that accounts for these fundamentals and shows how they shape industry structure and dynamics. We show that forgetting does not simply negate learning. Rather, they are distinct economic forces that interact in subtle ways to produce a great variety of pricing behaviors and industry dynamics. In particular, a model with learning and forgetting can give rise to aggressive pricing behavior, varying degrees of long-run industry concentration ranging from moderate leadership to absolute dominance, and multiple equilibria. Copyright 2010 The Econometric Society.
This paper examines the importance of indirect network effects in the U.S.video game market between 1994 and 2002. The diffusion of game systems is analyzed by the interaction between console adoption decisions and software supply decisions. Estimation results suggest that introductory pricing is an effective practice at the beginning of the product cycle, and expanding software variety becomes more effective later. The paper also finds a degree of inertia in the software market that does not exist in the hardware market. This observation implies that software providers continue to exploit the installed base of hardware users after hardware demand has slowed.
We briefly review the rationale behind technological alliances and provide a snapshot of their role in global competition, especially insofar as it is based around intellectual capital. They nicely illustrate the increased importance of horizontal agreements and thus establish the relevance of the topic. We move on to discuss the organisation of industries in a dynamic context and draw out consequences for competition policy. We conclude with an outlook on the underlying tensions between technology alliances, competition policy, and industrial policy.
We study a dynamic duopoly model with network externalities. The value of the product depends on the current and past network size. We compare the market outcome to a planner. With equal quality products, the market outcome may result in too little standardization (i.e. too many products active in the long run) but never too much. The potential inefficiency is non-monotonic in the strength of the network effect, being most likely for intermediate levels. When products differ in quality, an inferior product may dominate even when the planner would choose otherwise, but only if the discount factor is sufficiently large
We examine the diffusion of a hardware/software system. For such systems there is interdependence between the hardware-adoption decisions of consumers and the supply decisions of software manufacturers. Hence there can be bottlenecks to the diffusion of the system. We consider the CD industry and estimate the (direct) elasticity of adoption with respect to CD player prices and the (cross) elasticity with respect to the variety of CD titles. Our results show that the cross elasticity is significant. Our model can be used to quantify the effect of various policies aimed at speeding up the diffusion of a system.
I consider a dynamic model of competition between two proprietary networks. Consumers die with a constant hazard rate and are replaced by new consumers. Firms compete for new consumers to join their network by offering network entry prices (which may be below cost). New consumers have a privately known preference for each network. Upon joining a network, in each period consumers enjoy a benefit which is increasing in network size during that period. Firms receive revenues from new consumers as well as from consumers already belonging to their network. I discuss various properties of the equilibrium, including the pricing function, the system’s expected motion, and the stationary distribution of market shares. I derive several results analytically. I then confirm and extend these results by numerical computation. Finally, I use the model to estimate the barrier to entry create by network effects.
In markets where advantages, e.g., network ex ternalities, are significant, firms' product compatibility choices are an import ant determinant of industry performance. This paper compares the private and soc ial incentives to achieve compatibility in a two-period duopoly model with (poss ible stochastic) technological progress. Earlier analysis using static models fo und that the social incentives to achieve industrywide compatibility always exce ed the private incentives. Here the authors find that private firms may have soc ially excessive compatibility incentives because compatibility serves as a means of relaxing price competition during early stages of industry growth. Copyright 1986 by Royal Economic Society.
We study the incentives for a "diagonal" merger between two Internet Service Providers, one a wireless retail only ISP in two origination markets, and the second a vertically integrated wired retailer in one market and an upstream provider in the other. The merger's effects depend on differentiation in access modalities; only with high differentiation does the merger have positive welfare effects. We focus on post-merger foreclosure, which, when it happens, only takes place in the market where the merger is horizontal and not where the merger is vertical. The Network architecture used is meant to capture Internet routing.
In most cases, the premature announcement of a future product cannot be anti-competitive. When there are network effects, however, firms may have incentives to strategically prenannounce products; such preannouncements are often referred to as "vaporware." Anticompetitive vaporware allegations have been leveled at IBM and Microsoft. Despite the antitrust concern about vaporware, there is no empirical work on the issue. In this paper, we empirically test for network effects and vaporware effects in the DVD market. We find that there are network effects in the DVD market and that the preannouncement by DIVX indeed slowed down the adoption of DVD technology.
Most types of networks, over time, spawn the creation of complementary stocks that enhance network value. Computer operating systems, for example, induce the development of the complementary stock of software applications that increase the value of the operating system. In this paper, we challenge the conventional wisdom that a large network, which induces the creation of large complementary stocks, serves as a barrier to entry that protects the incumbent from competition or network capture. We show that a larger network may either deter or attract entry depending on the relation between the network quality and the cost of an innovator's network product. The probability of entry also depends on the level of compatibility between the potential entrant's technology and existing complementary stocks, which in turn is influenced by the strength of the intellectual-property-rigths environment. Intellectual property rigths and the associated threat of entry may affect and incumbent's choice of network size in counterintuitive ways.
This paper analyzes the process of transition in standards between incompatible technologies when converters are available. Contrary to a common presumption that converters facilitate the transition from an old technology to an otherwise incompatible new technology, I find circumstances in which the possibility of transition is blockaded by the existence of converters. In the welfare analysis of converters, a distinction is made between ex ante and ex post efficiency effects. Finally, I also analyze the equilibrium behavior in the provision of converters and compare it to the socially optimal outcome.
This paper is an attempt to identify some of the factors that affect the evolution of market structure in a model of dynamic
competition between two firms. The stochastic evolution of the state of competition depends on the respective effort rates
of the firms. The question is whether the current leader works harder than the laggard—does the ‘gap’ between firms tend to
increase or decrease? We show that several effects are at work. The state tends to evolve in the direction where joint payoffs
are greater. Since joint payoffs are related to joint product-market profits less joint effort costs, there are two classes
of effect: the joint-profit effect and various joint-cost effects. The latter result in part from the pattern of profits, and in part from endpoint effects that give relief from efforts. Asymptotic
expansions illuminate these influences. Moreover, we show by numerical simulation that there is another kind of joint-cost
effect. The pattern of joint effort costs can influence the pattern of evolution of market structure, and the evolution of
the pattern of market structure can influence the pattern of efforts, in a mutually self-reinforcing manner. In particular,
there may be equilibria in which this last effect means that the laggard works harder than the leader even though all the
other effects work in favour of the leader.
This paper introduces a stochastic algorithm for computing symmetric Markov perfect equilibria. The algorithm computes equilibrium policy and value functions, and generates a transition kernel for the (stochastic) evolution of the state of the system. It has two features that together imply that it need not be subject to the curse of dimensionality. First, the integral that determines continuation values is never calculated; rather it is approximated by a simple average of returns from past outcomes of the algorithm, an approximation whose computational burden is not tied to the dimension of the state space. Second, iterations of the algorithm update value and policy functions at a single (rather than at all possible) points in the state space. Random draws from a distribution set by the updated policies determine the location of the next iteration's updates. This selection only repeatedly hits the recurrent class of points, a subset whose cardinality is not directly tied to that of the state space. Numerical results for industrial organization problems show that our algorithm can increase speed and decrease memory requirements by several orders of magnitude.
Strategic implications of the learning curve hypothesis are analyzed in the context of a price-setting, differentiated duopoly selling to a sequence of heterogeneous buyers with uncertain demands. A unique Markov perfect equilibrium is characterized and sufficient conditions are provided for market dominance to be self-reinforcing. Increasing market dominance implies that learning is privately disadvantageous. Finally, introducing avoidable fixed costs and possible exit into the model yields a new theory of predatory pricing based on the learning curve hypothesis. Copyright 1994 by The Econometric Society.
This paper provides a survey on studies that analyze the macroeconomic effects of intellectual property rights (IPR). The first part of this paper introduces different patent policy instruments and reviews their effects on R&D and economic growth. This part also discusses the distortionary effects and distributional consequences of IPR protection as well as empirical evidence on the effects of patent rights. Then, the second part considers the international aspects of IPR protection. In summary, this paper draws the following conclusions from the literature. Firstly, different patent policy instruments have different effects on R&D and growth. Secondly, there is empirical evidence supporting a positive relationship between IPR protection and innovation, but the evidence is stronger for developed countries than for developing countries. Thirdly, the optimal level of IPR protection should tradeoff the social benefits of enhanced innovation against the social costs of multiple distortions and income inequality. Finally, in an open economy, achieving the globally optimal level of protection requires an international coordination (rather than the harmonization) of IPR protection.
This paper contributes empirically to our understanding of informed traders. It analyzes traders' characteristics in a foreign exchange electronic limit order market via anonymous trader identities. We use six indicators of informed trading in a cross-sectional multivariate approach to identify traders with high price impact. More information is conveyed by those traders' trades which--simultaneously--use medium-sized orders (practice stealth trading), have large trading volume, are located in a financial center, trade early in the trading session, at times of wide spreads and when the order book is thin.
We study the "backbone market" in the Internet. After discussing the structure of the Internet, we use an extension of the Katz-Shapiro network model to analyze the strategies that would be used by dominant backbone. We show that a larger backbone prefers a lower quality interconnection than the smaller one. We then analyze a "targeted degradation" strategy where the larger backbone lowers the quality of interconnection to its smaller rivals in turn. Finally, we show that the qualitative results are robust to the possibility of "multihoming" by clients. Copyright 2000 by Blackwell Publishing Ltd
This paper analyzes the dynamic provision of converters in the transition process between two incompatible technologies. The author derives the equilibrium behavior in the provision of converters and compares it to the socially optimal outcome. He finds that there can be two types of market inefficiency in the provision of converters. First, converters can be supplied by the 'wrong' group. Second, the timing of provision may be too late since the providers of converters ignore the positive externality that their provision would confer on the users of the rival technology. Copyright 1997 by Blackwell Publishing Ltd
Converters, emulators, or adapters can often make one technology partially compatible with another. The authors analyze the equilibrium market adoption of otherwise incompatible technologies when such converters are available and the incentives to provide them. While market outcomes without converters are often inefficient, the availability of converters can actually make matters worse. The authors also find that when one of the technologies is supplied only by a single firm, that firm may have an incentive to make conversion costly. This may lend some theoretical support to allegations of anticompetitive disruption of interface standards. Copyright 1992 by Blackwell Publishing Ltd.
Empirical evidence suggests that there are substantial and persistent differences in the sizes of firms in most industries. We propose a dynamic model of capacity accumulation that explains the observed facts. In our model, firms accumulate capacity over time and compete repeatedly in the product market. We assume that capacity is lumpy and that investment and depreciation are subject to idiosyncratic shocks. We highlight the mode of product market competition and the extent of investment reversibility as key determinants of the size distribution of firms in an industry. In particular, if firms compete in prices and the rate of depreciation is large, then the industry moves towards an outcome with one dominant firm and one small firm. Industry dynamics in this case resemble a rather brutal preemption race. 1
Working Paper Compatibility and Market Structure for Network Goods Working Paper, Stern School of Business Coordination and Lock-In: Competition with Switching Costs and Network Effects
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CHEN, DORASZELSKI, AND HARRINGTON / 465 that found in models with increasing returns such as arises with advertising (Doraszelski and Markovich, 2007) and learning by doing (Besanko et al. 2005). (20,20) (20,20) (20,20) (20,20) (20,20) (20,20).01 (20,20) (20,20) (20,20) (20,20) (20,20) (20,20).02 (19,20) (19,20) (20,20) (20,20) (20,20) (20,20).03 (16,16) (16,16) (18,18) (18,18) (18,20) (18,20).04 (6,16) (6,16) (5,20) (5,20) (4,20) (4,20).05 (3,15) (9,9) (3,18) (3,18) (2,20) (2,20).06 (3,11) (8,8) (2,16) (2,16) (1,20) (1,20).07 (4,5) (6,6) (1,15) (8,8) (1,17) (1,17).08 (3,4) (5,5) (1,14) (7,7) (1,16) (1,16).09 (3,3) (4,4) (1,12) (5,5) (0,15) (0,15).10 (2,3) (3,3) (1,9) (4,4) (0,15) (6,6).11 (2,2) (3,3) (3,3) (4,4) (0,14) (5,5).12 (2,2) (2,2) (2,3) (3,3) (0,13) (4,4).13 (2,2) (2,2) (2,2) (3,3) (0,11) (4,4).14 (1,2) (2,2) (2,2) (2,2) (0,9) (3,3).15 (1,1) (2,2) (1,2) (2,2) (2,2) (3,3) If the distribution is bimodal, then just one of the modes is reported. A framed box indicates that there is a bimodal distribution under λ = 0 and a unimodal distribution under λ = 1. θ ∈ {2, 3, 4}, λ ∈ {0, 1}, δ ∈ {0,.01,...,.15}. References ANDERSON, S.P., DE PALMA, A., AND THISSE, J.-F. Discrete Choice Theory of Product Differentiation. Cambridge, Mass.: MIT Press, 1992. BESANKO, D. AND DORASZELSKI, U. " Capacity Dynamics and Endogenous Asymmetries in Firm Size. " RAND Journal of Economics, Vol. 35 (2004), pp. 23–49.
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