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One-Way Essential Complements

Author

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  • Chen, M. Keith

    (Yale U)

  • Nalebuff, Barry

Abstract

While competition between firms producing substitutes is well understood, less is known about rivalry between complementors. We study the interaction between firms in markets with one-way essential complements. One good is essential to the use of the other but not vice versa, as arises with an operating system and applications. Our interest is in the division of surplus between the two goods and the related incentive for firms to create complements to an essential good. Formally, we study a two-good model where consumers value A alone, but can only enjoy B if they also purchase A. When one firm sells A and another sells B, the firm that sells B earns a majority of the value it creates. However, if the A firm were to buy the B firm, it would optimaly charge zero for B, provided marginal costs are zero and the average value of B is small relative to A. Hence, absent strong antitrust or intellectual property protections, the A firm can leverage its monopoly into B costlessly by producing a competing version of B and giving it away. For example, Microsoft provided Internet Explorer as a free substitute for Netscape; in our model, this maximizes Microsoft's joint monopoly profits. Furthermore, Microsoft has no incentive to raise prices, even if al browser competition exits. This may seem surprising since it runs counter to the traditional gains from price discrimination and versioning. We also show that an essential monopolist has no incentive to degrade rival complementary products, which suggests that a monopoly internet service provider will offer net neutrality. There are other means for the essential A monopolist to capture surplus from B. We consider the incentive to add a surcharge (or subsidy) to the price of B, or to act as a Stackelberg leader. We find a small gain from pricing first, but much greater profits from adding a surcharge to the price of B. The potential for A to capture B's surplus highlights the challenges facing a firm whose product depends on an essential good.

Suggested Citation

  • Chen, M. Keith & Nalebuff, Barry, 2006. "One-Way Essential Complements," Working Papers 22, Yale University, Department of Economics.
  • Handle: RePEc:ecl:yaleco:22
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    References listed on IDEAS

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    Cited by:

    1. León, Omar de, 2013. "Regional and international connectivity," Libros de la CEPAL, Naciones Unidas Comisión Económica para América Latina y el Caribe (CEPAL), number 37061, May.
    2. Ramon Casadesus-Masanell & Gastón Llanes, 2011. "Mixed Source," Management Science, INFORMS, vol. 57(7), pages 1212-1230, July.
    3. Juliane Fudickar, 2015. "Net Neutrality, Vertical Integration, and Competition Between Content Providers," Working Papers 2015014, Berlin Doctoral Program in Economics and Management Science (BDPEMS).
    4. Economides, Nicholas & Tåg, Joacim, 2011. "Network Neutrality and Network Management Regulation: Quality of Service, Price Discrimination, and Exclusive Contracts," Working Paper Series 890, Research Institute of Industrial Economics.
    5. repec:eee:indorg:v:52:y:2017:i:c:p:358-392 is not listed on IDEAS
    6. Barrantes, Roxana & Jordán, Valeria & Rojas, Fernando, 2013. "The shifting digital paradigm in Latin America," Libros de la CEPAL, Naciones Unidas Comisión Económica para América Latina y el Caribe (CEPAL), number 37059, May.
    7. -, 2013. "Broadband in Latin America: Beyond Connectivity," Libros de la CEPAL, Naciones Unidas Comisión Económica para América Latina y el Caribe (CEPAL), number 120 edited by Eclac, May.
    8. Broos, Sébastien & Gautier, Axel, 2014. "Competing one-way essential complements: the forgotten side of net neutrality," CORE Discussion Papers 2014064, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    9. Matteo Alvisi & Emanuela Carbonara & Francesco Parisi, 2011. "Separating complements: the effects of competition and quality leadership," Journal of Economics, Springer, vol. 103(2), pages 107-131, June.
    10. Katz, Raúl L. & Galperin, Hernán, 2013. "The demand gap: drivers and public policies," Libros de la CEPAL, Naciones Unidas Comisión Económica para América Latina y el Caribe (CEPAL), number 37060, May.
    11. Laura Nurski, 2012. "Net Neutrality, Foreclosure and the Fast Lane: An empirical study of the UK," Working Papers 12-13, NET Institute.
    12. Economides, Nicholas & Tåg, Joacim, 2012. "Network neutrality on the Internet: A two-sided market analysis," Information Economics and Policy, Elsevier, vol. 24(2), pages 91-104.
    13. Ganuza, Juan José & Viecens, María Fernanda, 2013. "The challenge of over-the-top content and services," Libros de la CEPAL, Naciones Unidas Comisión Económica para América Latina y el Caribe (CEPAL), number 37069, May.
    14. Colciago, Andrea & Etro, Federico, 2013. "Cloud computing, structural change and job creation in SMEs," Libros de la CEPAL, Naciones Unidas Comisión Económica para América Latina y el Caribe (CEPAL), number 37064, May.
    15. Vladimir I. Soloviev & Natalia A. Iliina & Marina V. Samoyavcheva, 2009. "Cournot Equilibrium In A Model Of Hardware And Software Manufacturers’ Interaction," Annales Universitatis Apulensis Series Oeconomica, Faculty of Sciences, "1 Decembrie 1918" University, Alba Iulia, vol. 1(11), pages 1-4.
    16. Lleras, Juan S. & Miller, Nathan H., 2011. "The entry incentives of complementary producers: A simple model with implications for antitrust policy," Economics Letters, Elsevier, vol. 110(2), pages 147-150, February.
    17. Quint, Daniel, 2014. "Imperfect competition with complements and substitutes," Journal of Economic Theory, Elsevier, vol. 152(C), pages 266-290.

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    JEL classification:

    • C7 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory

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