IS THERE MORE OR LESS COMPATIBILITY BETWEEN SYSTEMS WHEN CONSUMERS ARE KEENER ON A RIVAL SYSTEM’S SOFTWARE?

Abstract

A greater level of keenness on a rival system’s software intuitively motivates system manufacturers to raise their degrees of compatibility in order to capture more profit from selling software to rival system users. After constructing a game-theoretic model to investigate system manufacturers’ partial compatibility decisions, this paper surprisingly finds that when consumers are keener on a rival system’s software, hardware price competition is relaxed and system manufacturers reduce the degrees of compatibility. This paper also presents the following three results. First, partial compatibility occurs when the expenditure on system goods is relatively low. Second, the optimal degree of compatibility increases in the expenditure on system goods and decreases in hardware production cost. Third, system manufactures suffer losses on selling hardware when keenness on a rival system’s software is relatively low. According to Lee (2013), this result provides a theoretical interpretation of the phenomenon that platform providers often sell hardware platforms close or below cost in the US video game industry [Lee, R (2013). Vertical integration and exclusively platform and two-sided markets. American Economic Review, 103, 2960–3000].