The Interactive Impact of Demand Sharing Effect and Reduced Misfit Effect on Application Compatibility

Abstract

In this article we study compatibility choices of two competing applications from an alternative perspective that considers demand sharing effect and reduced misfit effect to explain differences between the compatible and incompatible cases. We construct a game-theoretic model in which an application with two main businesses tries to share its exclusive demand of its unique business with its rival application on their competing business. We find that incentives to establish one-way compatibility—the application with exclusive demand grants access to its competitor—arise from the decrease of the reduced misfit cost while it may either arise or disappear from the decrease of the shared demand. In addition, consumer surplus increases in the reduced misfit cost and the shared demand. Moreover, we find the compatible case generates more social welfare than the incompatible case. And we find when the reduced misfit cost is beyond a threshold, the horizontal differentiation of the two applications is reduced to a lower level in the compatible case and the price competition is intensified in this situation. However, when the reduced misfit cost is less than a threshold, the price competition of the two applications can either be softened or intensified by compatibility, depending on the degree of shared demand.