Competing with Network Externalities and Price Discrimination
This Paper examines competition between a dominant network and a challenging network with third-degree or perfect price-discrimination, allowing for arbitrary configurations of network externalities, as well as horizontal and vertical product differentiation. Domination in the coordination game played by consumers is achieved through an adequate resolution that favours one firm over the other, and is interpreted as a reputation effect. Price-discrimination in this context has a strong impact because cross-subsidisation allows a firm to coordinate the choices of consumers, reducing the impact of reputation effects. Competitive strategies subsidize the participation of some consumers in order to create a bandwagon effect on others. This drastically intensifies competition and reduces average equilibrium prices. Because bandwagon effects are due to the incompatibility of networks, under perfect price-discrimination, both networks prefer to be compatible. Price-discrimination promotes efficiency by reducing the extent of excess inertia, but new features of excess momentum and market instability appear. A network may also have incentives to unilaterally degrade the quality for some targeted group of consumers in order to weaken competition.
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