Abstract
In a software industry based on a platform firm and two firms producing differentiated applications complementary to the platform, we investigate the effects on profits and welfare of the choice of different contracts (price versus quantity) by the application firms. In contrast to the traditional result, (1) equilibrium profits are higher under Cournot or Bertrand competition depending upon the degree of complementarity between platform and application producers as well as the degree of substitutability between applications; (2) the social welfare may be higher under Cournot when the application products are highly substitutable.
Highlights
In contrast to the traditional result, (1) equilibrium profits are higher under Cournot or Bertrand competition depending upon the degree of complementarity between platform and application producers as well as the degree of substitutability between applications; (2) the social welfare may be higher under Cournot when the application products are highly substitutable
This paper compares Cournot and Bertrand equilibria in a software industry based on a platform firm and two firms producing differentiated applications that are complementary to the platform, which may compete between them on price or quantity
We show that the standard result that Cournot equilibrium profits exceed those under Bertrand competition, when the differentiated duopoly game is played with imperfect substitutes, may be reversed
Summary
This paper is mainly related to two recent industrial organisation literature themes: (1) the profitability and efficiency properties of the duality of prices and quantities in differentiated duopoly, early analysed by Singh and Vives [1], and (2) the economics of networks and two-sided markets (e.g., [2,3,4,5]). We deal with a network industry and analyse a setting of a platform firm (selling, for example, operating systems) with two complementary applications produced by two independent firms (selling, for example, application software). We analyse the industry implications in terms of prices, output, profitability, and social welfare of the two Cournot and Bertrand modes of competition. Since more than one application is compatible to the same platform, we determine how the interaction between the applications in terms of complementarity or substitutability affects the equilibrium under Bertrand and Cournot competition in the application market, and we compare the profitability and social welfare of the two modes of competition.
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