Competing ecosystems and quality investment

Traditional firms competing in a primary market may expand into a secondary market that generates user data and enhances the quality of the primary product. This paper examines how competition between such rival ecosystems affects market outcomes and welfare. Using a Hotelling framework with two symmetric ecosystems that each offer a primary product and a secondary data-rich product, I show that the size of the secondary market is key. When the secondary market is small, ecosystems invest less in quality than in a benchmark with only a primary market and earn higher profits at the expense of consumers. As the secondary market grows, quality investment rises and the welfare ranking can reverse. I further show that expansion into a secondary market need not create a trade-off between profits and consumer surplus: when the ecosystems’ secondary products are sufficiently differentiated, both profits and consumer surplus can exceed their benchmark levels. These findings inform policy debates on digital adoption, market structure, and ecosystem regulation.