Competing in Markets with Digital Convergence

Abstract

The last couple of decades have witnessed widespread digitization of information and content, increasing incorporation of digital technologies into the products of diverse industries, and often, an accompanying shift to using von-Neumann-like platform-based product architec- tures. This phenomenon has been termed digital convergence, and has been observed in technology industries as diverse as handheld computing, wireline and mobile telecommunications, consumer electronics, networking equipment, residential broadband and broadcast video. Digital convergence results in substantially more valuable and flexible products and services, but also leads to increased substitutability between products in previously distinct markets. This paper analyzes the economic implications of this trade-off between increasing value and increasing substitutability. We present a new general model of imperfect competition that enables us to capture specific economic aspects that characterize digital convergence — flexible product scope, variability in consumer requirements, and non-exclusionary product choice. We derive four types of equilibrium configurations — local monopoly, kinked, competitive and non-exclusive — that emerge as outcomes of the model, and describe how each equilibrium structure characterizes a distinct stage of digital convergence. Our analysis establishes that as markets converge, prices rise initially even as competing prod- ucts become less differentiated. However, when platform scope is largely dictated by exogenous factors, prices and profits eventually fall as the stage of convergence progresses, though consumer surplus and total surplus rise. Furthermore, while digital convergence has the expected effect of shifting consumption patterns from multiple specialized products purchases to single general- purpose product purchases, we describe examples of equilibria in which consumers may buy mul- tiple general-purpose products, using each for a specialized subset of their requirements. Pricing responses to changes in variable costs and consumer functionality needs are also discussed. When firms can strategically choose platform scope, we show that in any subgame perfect equilibrium, duopoly prices are always higher than monopoly prices, and industries may sustain high levels of profitability even when their boundaries blur.