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Optimal Compatibility in Systems Markets

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  • Sang-Hyun Kim

    (University of East Anglia)

  • Jay Pil Choi

    (University of New South Wales)

Abstract

We analyze private and social incentives for standardization to ensure market-wide system compatibility in a two-dimensional spatial competition model. It is shown that there is a fundamental conflict of interest between consumers and producers over the standardization decision. Consumers prefer standardization with full compatibility because it offers more variety that confers better match with their ideal specifications. However, firms are likely to choose the minimum compatibility to maximize product differentiation and soften competition. This is in sharp contrast to the previous literature that shows the alignment of private and social incentives for compatibility. We also characterize the free-entry equilibria under the maximum and the minimum compatibility. With free entry, more firms enter without standardization, but the number of available system variety is less than the one under standardization.

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Paper provided by School of Economics, University of East Anglia, Norwich, UK. in its series University of East Anglia Applied and Financial Economics Working Paper Series with number 057.

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Date of creation: Feb 2014
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Handle: RePEc:uea:aepppr:2012_57

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  1. IRMEN, Andreas & THISSE, Jacques-Francois, 1997. "Competition in multi-characteristics spaces: hotelling was almost right," CORE Discussion Papers 1997053, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  2. Chen, Yongmin, 1997. "Equilibrium Product Bundling," The Journal of Business, University of Chicago Press, vol. 70(1), pages 85-103, January.
  3. Economides, Nicholas, 1989. "Desirability of Compatibility in the Absence of Network Externalities," American Economic Review, American Economic Association, vol. 79(5), pages 1165-81, December.
  4. d'ASPREMONT, Claude & GABSZEWICZ, Jean J. & THISSE, Jacques-François, . "On Hotelling's "Stability in competition"," CORE Discussion Papers RP -385, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  5. Yi, Sang-Seung, 1997. "Stable Coalition Structures with Externalities," Games and Economic Behavior, Elsevier, vol. 20(2), pages 201-237, August.
  6. Barry Nalebuff, 2004. "Bundling as an Entry Barrier," The Quarterly Journal of Economics, MIT Press, vol. 119(1), pages 159-187, February.
  7. Carmen Matutes & Pierre Regibeau, 1988. ""Mix and Match": Product Compatibility without Network Externalities," RAND Journal of Economics, The RAND Corporation, vol. 19(2), pages 221-234, Summer.
  8. Steven C. Salop, 1979. "Monopolistic Competition with Outside Goods," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 141-156, Spring.
  9. Bonanno, Giacomo & Vickers, John, 1988. "Vertical Separation," Journal of Industrial Economics, Wiley Blackwell, vol. 36(3), pages 257-65, March.
  10. Denicolo, Vincenzo, 2000. "Compatibility and Bundling with Generalist and Specialist Firms," Journal of Industrial Economics, Wiley Blackwell, vol. 48(2), pages 177-88, June.
  11. Besanko, David & Perry, Martin K., 1994. "Exclusive dealing in a spatial model of retail competition," International Journal of Industrial Organization, Elsevier, vol. 12(3), pages 297-329, September.
  12. Michael L. Katz & Carl Shapiro, 1994. "Systems Competition and Network Effects," Journal of Economic Perspectives, American Economic Association, vol. 8(2), pages 93-115, Spring.
  13. Matutes, Carmen & Regibeau, Pierre, 1992. "Compatibility and Bundling of Complementary Goods in a Duopoly," Journal of Industrial Economics, Wiley Blackwell, vol. 40(1), pages 37-54, March.
  14. Joseph Farrell & Hunter K. Monroe & Garth Saloner, 1998. "The Vertical Organization of Industry: Systems Competition versus Component Competition," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 7(2), pages 143-182, 06.
  15. Bloch, Francis, 1996. "Sequential Formation of Coalitions in Games with Externalities and Fixed Payoff Division," Games and Economic Behavior, Elsevier, vol. 14(1), pages 90-123, May.
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