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Avoiding Market Dominance: Product Compatibility in Markets with Network Effects

Ulrich Doraszelski, Joe Harrington and Jiawei Chen
Additional contact information
Ulrich Doraszelski: Harvard
Joe Harrington: Johns Hopkins

No 30, 2009 Meeting Papers from Society for Economic Dynamics

Abstract: As is well-recognized, market dominance is a typical outcome in markets with network effects. A firm with a larger installed base offers a more attractive product which induces more consumers to buy its product which produces a yet bigger installed base advantage. Such a setting is investigated here but with the main difference that firms have the option of making their products compatible. When firms have similar installed bases, they make their products compatible in order to expand the market. Nevertheless, random forces could result in one firm having a bigger installed base in which case the larger firm may make its product incompatible. We find that strategic pricing tends to prevent the installed base differential from expanding to the point that incompatibility occurs. This pricing dynamic is able to neutralize increasing returns and avoid the emergence of market dominance.

Date: 2009
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