Compatibility and bundling of stand and No stand-alone use complements

Abstract

This study analyzes the profitability of compatibility and bundling for a duopolist introducing a new, monopoly complementary product of no individual use. In a market where there are both new consumers and legacies, I show the two-product seller's optimal product bundling strategy is compatibility between the complement and the single-product competitor's platform. Their optimal price bundling strategy is to offer the two products a la carte. If compatibility is not possible due to high costs, the two-product seller's profit maximizing strategy is dependent on (i) the relative size of its legacy base to the single-product seller's, (ii) the degree of differentiation between the competing products and (ii) the consumer valuation for the new product relative to the existing one.When competition is introduced in the complement market via a ”race to offer the complement first”, each firm chooses compatibility. Furthermore, the loser of the race finds it optimal to announce the characteristics and release date of its differentiated product at the same time the winner releases the complement, unless the consumers have a high discount factor for waiting or the valuation for the complement is high. The welfare implications for both consumers and producers are presented in both scenarios.