Pricing and Compatibility in Network Goods Markets

Abstract

I examine an incumbent monopolist's pricing strategy in a two-period durable goods market for complements, such as the Operating System and software applications, and its compatibility stance with a future competitor when the market for applications is characterised by direct network effects and quality growth as well as potential switching costs. Consumers arrive in the market in the first period and the “threat” to exercise their option to postpone their purchase may lead the incumbent to charge a price for its Operating System that is lower than that of a static monopolist no matter what the compatibility regime. I also show that the incumbent may support compatibility regardless of the presence of switching costs. The welfare effects of mandatory compatibility are ambiguous.