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One-Way Compatibility, Two-Way Compatibility and Entry in Network Industries

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Author Info
Manenti, Fabio M. (Universitý di Padova)
Ernesto Somma (Universitý degli Studi di Bari)

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Abstract

We study the strategic choice of compatibility between two initially incompatible software packages in a two-stage game by an incumbent and an entrant firm. Consumers enjoy network externality in consumption and maximise expected surplus over the two periods. Compatibility may be achieved by means of a converter. We derive a number of results under diÆerent assumptions about the nature of the converter (one-way vs two-way) and the existence of property rights. In the case of a two-way converter, which can only be supplied by the incumbent, incompatibility will result in equilibrium and depending on the strength of network externalities the incumbent may deter entry. When both firms can build a one-way converter and there are no property rights on the necessary technical specifications, the only fulfilled expectations subgame perfect equilibrium involves full compatibility. Finally, when each firm has property rights on its technical specifications, full incompatibility and preemption are again observed at the equilibrium. Entry deterrence will then occur for su±ciently strong network eÆects. The analysis generalises to any market where network externalities are present.

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Paper provided by Royal Economic Society in its series Royal Economic Society Annual Conference 2002 with number 136.

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Date of creation: 29 Aug 2002
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Handle: RePEc:ecj:ac2002:136

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  3. Erik Brynjolfsson & Chris F. Kemerer, 1993. "Network Externalities in Microcomputer Software: An Econometric Analysis of the Spreadsheet Market," Working Paper Series 158, MIT Center for Coordination Science. [Downloadable!]
  4. Liebowitz, S J & Margolis, Stephen E, 1994. "Network Externality: An Uncommon Tragedy," Journal of Economic Perspectives, American Economic Association, vol. 8(2), pages 133-50, Spring. [Downloadable!] (restricted)
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  6. Szidarovszky, F & Yakowitz, S, 1977. "A New Proof of the Existence and Uniqueness of the Cournot Equilibrium," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 18(3), pages 787-89, October. [Downloadable!] (restricted)
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  8. Chris Forman & Pei-yu Chen, 2003. "Network Effects and Switching Costs in the Market for Routers and Switches," Working Papers 03-03, NET Institute, revised Oct 2003. [Downloadable!]
  9. Øystein Foros, 2007. "Price Strategies and Compatibility in Digital Networks," International Journal of the Economics of Business, Taylor and Francis Journals, vol. 14(1), pages 85-97. [Downloadable!] (restricted)
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  12. Katz, Michael L & Shapiro, Carl, 1994. "Systems Competition and Network Effects," Journal of Economic Perspectives, American Economic Association, vol. 8(2), pages 93-115, Spring. [Downloadable!] (restricted)
  13. Nicholas Economides, 1997. "The Economics of Networks," Brazilian Electronic Journal of Economics, Department of Economics, Universidade Federal de Pernambuco, vol. 1(0), December. [Downloadable!]
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  14. Katz, Michael L & Shapiro, Carl, 1985. "Network Externalities, Competition, and Compatibility," American Economic Review, American Economic Association, vol. 75(3), pages 424-40, June. [Downloadable!] (restricted)
  15. Katz, Michael L & Shapiro, Carl, 1986. "Technology Adoption in the Presence of Network Externalities," Journal of Political Economy, University of Chicago Press, vol. 94(4), pages 822-41, August. [Downloadable!] (restricted)
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  17. Gandal, Neil, 1995. "Competing Compatibility Standards and Network Externalities in the PC Software Market," The Review of Economics and Statistics, MIT Press, vol. 77(4), pages 599-608, November. [Downloadable!] (restricted)
  18. de Palma, Andre & Leruth, Luc, 1996. "Variable willingness to pay for network externalities with strategic standardization decisions," European Journal of Political Economy, Elsevier, vol. 12(2), pages 235-251, September. [Downloadable!] (restricted)
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  1. Pehr-Johan Norbäck & Lars Persson & Joacim Tåg, 2008. "Entrepreneurial Innovations in Network Industries," Working Papers 08-02, NET Institute, revised Sep 2008. [Downloadable!]
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