Strategic product compatibility in network industries

The degree of compatibility is a crucial feature of network goods. This article considers the degree of product compatibility as a strategic variable in a Cournot duopoly with network consumption externalities. For doing this, it develops a non-cooperative “compatibility decision game” (CDG) in which choosing whether letting products being (in)compatible occurs at the first stage. When compatibility is costless, the unique (Pareto efficient) sub-game perfect Nash equilibrium (SPNE) of the CDG predicts that both firms choose product compatibility. When there exist quasi-fixed costs of compatibility, the spectrum of SPNE of the CDG greatly increases. The equilibrium outcomes change depending on whether the extent of product compatibility is endogenous (i.e., it is a profit-maximising variable) or exogenous (e.g., it is given by technical constraints) on the firm side. In the former case, the emerging SPNE implies ranging from a unique regime to multiple regimes of (in)compatibility allowing the emergence of different scenarios: deadlock, prisoner’s dilemma and coordination game. In the latter case, the CDG can also become an anti-coordination game. This allows us to provide a novel explanation for the well-known and widespread case according to which Apple products in the computer market (based on macOS) can also be used with Windows OS, but Microsoft products (based on Windows OS) cannot be used with macOS. The article also pinpoints the welfare outcomes corresponding to the SPNE.