EconPapers    
Economics at your fingertips  
 

One-Way Essential Complements

Keith Chen and Barry Nalebuff

No 1588, Cowles Foundation Discussion Papers from Cowles Foundation for Research in Economics, Yale University

Abstract: While competition between firms producing substitutes is well understood, less is known about rivalry between complementors. We study the interaction between firms in markets with one-way essential complements. One good is essential to the use of the other but not vice versa, as arises with an operating system and applications. Our interest is in the division of surplus between the two goods and the related incentive for firms to create complements to an essential good. Formally, we study a two-good model where consumers value A alone, but can only enjoy B if they also purchase A. When one firm sells A and another sells B, the firm that sells B earns a majority of the value it creates. However, if the A firm were to buy the B firm, it would optimally charge zero for B, provided marginal costs are zero and the average value of B is small relative to A. Hence, absent strong antitrust or intellectual property protections, the A firm can leverage its monopoly into B costlessly by producing a competing version of B and giving it away. For example, Microsoft provided Internet Explorer as a free substitute for Netscape; in our model, this maximizes Microsoft's joint monopoly profits. Furthermore, Microsoft has no incentive to raise prices, even if all browser competition exits. This may seem surprising since it runs counter to the traditional gains from price discrimination and versioning. We also show that a essential monopolist has no incentive to degrade rival complementary products, which suggests that a monopoly internet service provider will offer net neutrality. There are other means for the essential A monopolist to capture surplus from B. We consider the incentive to add a surcharge (or subsidy) to the price of B, or to act as a Stackelberg leader. We find a small gain from pricing first, but much greater profits from adding a surcharge to the price of B. The potential for A to capture B's surplus highlights the challenges facing a firm whose product depends on an essential good.

Keywords: Bundling; Complements; Monopoly leverage; Net neutrality; Price discrimination; Tying; Versioning (search for similar items in EconPapers)
JEL-codes: C7 D42 D43 K21 L11 L12 L13 L41 M21 (search for similar items in EconPapers)
Pages: 39 pages
Date: 2006-11
New Economics Papers: this item is included in nep-com, nep-ipr, nep-pr~, nep-law, nep-mic and nep-net
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (23) Track citations by RSS feed

Downloads: (external link)
http://cowles.yale.edu/sites/default/files/files/pub/d15/d1588.pdf (application/pdf)

Related works:
Working Paper: One-Way Essential Complements (2006) Downloads
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cwl:cwldpp:1588

Ordering information: This working paper can be ordered from
Cowles Foundation, Yale University, Box 208281, New Haven, CT 06520-8281 USA
The price is None.

Access Statistics for this paper

More papers in Cowles Foundation Discussion Papers from Cowles Foundation for Research in Economics, Yale University Yale University, Box 208281, New Haven, CT 06520-8281 USA. Contact information at EDIRC.
Bibliographic data for series maintained by Matthew Regan ().

 
Page updated 2020-05-25
Handle: RePEc:cwl:cwldpp:1588