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Platform Competition, Compatibility, and Social Efficiency

In their seminal 1985 paper, Katz and Shapiro study systems compatibility in settings with one-sided platforms and direct network effects. We consider systems compatibility when competing platforms are two-sided and there are indirect network effects to develop an explanation why markets with two-sided platforms are often characterized by incompatibility with one dominant player who may subsidize access to one side of the market. Specifically, we model competitive interaction between two platform providers that act as intermediaries between developers of platform-based products (applications) and users of such products. We show that the unique equilibrium under platform compatibility leads to higher profits than the symmetric equilibrium under incompatibility. Notwithstanding, incompatibility naturally gives rise to asymmetric equilibria with a dominant platform that captures all users and earns more than under compatibility. Our model allows a detailed analysis of social efficiency, and we show that entry by developers is socially excessive (insufficient) if competing platforms are compatible (incompatible). We conclude that while society would be better off if platforms were compatible, the quest for market dominance by competing platform providers prevents them from agreeing to a common standard.

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File URL: http://www.netinst.org/Casadesus-Masanell_Ruiz-Alisedaz_08-32.pdf
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Paper provided by NET Institute in its series Working Papers with number 08-32.

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Length: 50 pages
Date of creation: Oct 2008
Date of revision:
Handle: RePEc:net:wpaper:0832
Contact details of provider: Web page: http://www.NETinst.org/

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  1. Novshek, William, 1980. "Equilibrium in simple spatial (or differentiated product) models," Journal of Economic Theory, Elsevier, vol. 22(2), pages 313-326, April.
  2. repec:hal:journl:hal-00173715 is not listed on IDEAS
  3. repec:rje:randje:v:37:y:2006:3:p:645-667 is not listed on IDEAS
  4. Mark Armstrong, 2005. "Competition in Two-Sided Markets," Industrial Organization 0505009, EconWPA.
  5. David S. Evans & Richard Schmalensee, 2005. "The Industrial Organization of Markets with Two-Sided Platforms," NBER Working Papers 11603, National Bureau of Economic Research, Inc.
  6. Economides, Nicholas, 1989. "Desirability of Compatibility in the Absence of Network Externalities," American Economic Review, American Economic Association, vol. 79(5), pages 1165-81, December.
  7. repec:rje:randje:v:37:y:2006:3:p:720-737 is not listed on IDEAS
  8. Andrei Hagiu, 2009. "Two-Sided Platforms: Product Variety and Pricing Structures," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 18(4), pages 1011-1043, December.
  9. David A. Malueg & Marius Schwartz, 2006. "COMPATIBILITY INCENTIVES OF A LARGE NETWORK FACING MULTIPLE RIVALS -super-* ," Journal of Industrial Economics, Wiley Blackwell, vol. 54(4), pages 527-567, December.
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