Platform Competition, Compatibility, and Social Efficiency

Abstract

We study competitive interaction between two platform providers (such as two suppliers of videogame consoles or operating systems) that mediate between sellers of platform-based products (developers of games or applications) and buyers of such products (users of games or applications). Users and developers first trade with one of the platforms (users purchase videogame consoles and developers software development kits) and then with each other (users buy games from developers). We show that the unique equilibrium under platform compatibility exhibits more intense price competition for developers, softer price competition for users, and higher profits than the symmetric equilibrium under incompatibility (which may involve user subsidization to join a platform). Compatibility leads to higher profits because it induces more entry by developers, lower application prices, and larger user surplus that platforms capture through higher user access prices. Incompatibility, however, naturally gives rise to asymmetric equilibria with a dominant platform that captures all users and earns more than in the compatible equilibrium. The model also allows a detailed analysis of social efficiency, and we show that entry by developers is socially excessive (insufficient) if competing platforms are compatible (incompatible).