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Avoiding market dominance: product compatibility in markets with network effects

  • Jiawei Chen
  • Ulrich Doraszelski
  • Joseph E. Harrington, Jr.

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..

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Article provided by RAND Corporation in its journal The RAND Journal of Economics.

Volume (Year): 40 (2009)
Issue (Month): 3 ()
Pages: 455-485

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Handle: RePEc:bla:randje:v:40:y:2009:i:3:p:455-485
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  1. Skrzypacz, Andrzej & Mitchell, Matthew F., 2005. "Network Externalities and Long-Run Market Shares," Research Papers 1879, Stanford University, Graduate School of Business.
  2. Ariel Pakes & Paul McGuire, 1992. "Computing Markov perfect Nash equilibria: numerical implications of a dynamic differentiated product model," Discussion Paper / Institute for Empirical Macroeconomics 58, Federal Reserve Bank of Minneapolis.
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  12. Choi, Jay Pil, 1996. "Do converters facilitate the transition to a new incompatible technology? A dynamic analysis of converters," International Journal of Industrial Organization, Elsevier, vol. 14(6), pages 825-835, October.
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