Compatibility Strategies of Asymmetric Digital Platforms

Abstract

We develop a three-stage game-theoretic model within a duopoly setting to investigate the profit-maximizing compatibility strategies of firms that produce revenue-generating asymmetric digital platforms and asymmetric digital application products which are offered as a bundle. For each compatibility strategy we also examine: by how much should the firm that wishes to offer its application product on a rival platform enhance the intrinsic value of the compatible system (i.e., incremental compatibility value). We find that the profit-maximizing compatibility choice depends on the adoption costs of a bundle and on the intrinsic value difference between the two digital platforms and/or application products. An incompatibility strategy is optimal when the adoption costs are low or the intrinsic value difference is small. Larger adoption costs and greater intrinsic value difference, provide greater incentives for both firms to pursue a one-way compatibility whereby the superior application product is compatible with the superior platform since this type of one-way compatibility increases the profitability of both firms. We also find that the greater the intrinsic value difference, the larger is the incremental compatibility value added to the superior application product when it is made compatible and is being customized to the superior platform.