Compatible or Incompatible: The Interplay of Vertical Differentiation Competition and Third-Party Marketplace Openness

Abstract

Whereas the cooperation between a software application and a new marketplace could benefit both the two parties, the situation would be significantly perplexed by the competition in a market with two competing applications and a third-party (3P) marketplace. This article develops a game-theoretic model to examine the strategic interactions between two competing software applications and a 3P marketplace in the dimension of compatibility. For the additional segment of consumers, the competing applications decide whether to be compatible with a 3P marketplace. In the meantime, the 3P marketplace decides whether to open and open to which application(s) considering the commission fees from the applications compatible with it. We offer insights into how an application should cooperate with a 3P marketplace by considering compatible choice of its competitor and openness choice of the 3P marketplace. We show that the 3P marketplace will open to either of the two applications or just open to the high-quality application by weighing the awareness level of the consumers for both applications. Both applications will choose to be compatible with the 3P marketplace if its competitor is not available on the 3P marketplace. In addition, our results suggest that competition in the 3P marketplace may benefit the high quality firm under certain conditions, depending on the awareness level of consumers for both applications. However, the low-quality application will never be compatible with the 3P marketplace when the high-quality application is available on the 3P marketplace.