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Vertical differentiation, network externalities and compatibility decisions : an alternative approach

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  • Hend Ghazzai

    () (CES - Centre d'économie de la Sorbonne - CNRS - Centre National de la Recherche Scientifique - UP1 - Université Panthéon-Sorbonne, LEGI - Laboratoire d'Economie et de Gestion Industrielle - Ecole Polytechnique de Tunisie)

  • Rim Lahmandi-Ayed

    () (LEGI - Laboratoire d'Economie et de Gestion Industrielle - Ecole Polytechnique de Tunisie)

Abstract

We characterize the equilibrium of a game in vertically differentiated market which exhibits network externalities. There are two firms, an incumbent and a potential entrant. Compatibility means in our model that the inherent qualities of the goods are close enough. By choosing its quality, the entrant chooses in the same time to be compatible or not. The maximal quality difference that allows compatibility i.e the compatibility interval is chosen by the incumbent which involves costs increasing with the width of that interval. We show that in order to have two active firms at price equilibrium, the sufficient condition on the market size of a standard vertical differentiation model remains valid under compatibility. However, an additional condition on the firms' qualities is needed under incompatibility. For a small quality segment, the incumbent can block entry choosing an empty compatibility interval. At the subgame perfect equilibrium, incompatibility prevails if the quality segment is large and the compatibility costs are high. Compatibility prevails for sufficiently large quality segments and low costs of compatibility. Finally there is no entry if the quality segment is small and the compatibility costs are high.

Suggested Citation

  • Hend Ghazzai & Rim Lahmandi-Ayed, 2006. "Vertical differentiation, network externalities and compatibility decisions : an alternative approach," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) halshs-00111166, HAL.
  • Handle: RePEc:hal:cesptp:halshs-00111166
    Note: View the original document on HAL open archive server: https://halshs.archives-ouvertes.fr/halshs-00111166
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    References listed on IDEAS

    as
    1. Baake, Pio & Boom, Anette, 2001. "Vertical product differentiation, network externalities, and compatibility decisions," International Journal of Industrial Organization, Elsevier, vol. 19(1-2), pages 267-284, January.
    2. repec:ebl:ecbull:v:12:y:2004:i:1:p:1-9 is not listed on IDEAS
    3. Jeanneret, Marie-Helene & Verdier, Thierry, 1996. "Standardization and protection in a vertical differentiation model," European Journal of Political Economy, Elsevier, vol. 12(2), pages 253-271, September.
    4. Navon, Ami & Shy, Oz & Thisse, Jacques-François, 1995. "Product Differentiation in the Presence of Positive and Negative Network Effects," CEPR Discussion Papers 1306, C.E.P.R. Discussion Papers.
    5. repec:adr:anecst:y:1998:i:49-50:p:13 is not listed on IDEAS
    6. Nicolas Jonard & Eric Schenk, 2004. "A note on compatibility and entry in a circular model of product differentiation," Economics Bulletin, AccessEcon, vol. 12(1), pages 1-9.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    network externalities; Vertical differentiation; compatibility; network externalities.; Différenciation verticale; effets de réseaux; compatibilité.;

    JEL classification:

    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
    • L15 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Information and Product Quality
    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection

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