Compatibility, Interoperability, and Market Power in Upgrade Markets

Interoperability and Competition Policy and Antitrust

Article Snapshot

Author(s)

James Anton and Gary Biglaiser

Source

Economics of Innovation and New Technology, Vol. 19, Issue 4 June 2010, pgs 373-385

Summary

This paper explains how innovation in software markets tends to limit price increases by leading firms.

Policy Relevance

Firms that release regular upgrades of their products can gain limited market power, because buyers can choose to stay with the older version instead of buying the new one.

Main Points

  • Sellers of some goods such as software regularly offer upgraded versions of a product. Microsoft and Apple periodically offer new versions of their operating systems.

  • The seller controls whether the new versions work with products designed for the old versions, its own products (“compatibility”) or those made by other firms (“interoperability”). Some fear that sellers can use this control to raise prices.

  • The model developed in this paper shows that controlling compatibility and interoperability does not allow firms to charge higher prices.

  • When a firm upgrades its product regularly, consumers can choose whether to buy the upgrade, or continue to use the earlier version.

  • Buyers’ willingness to pay for immediate upgrades is limited, because buyers do not necessarily expect other buyers to upgrade immediately, and they know that if they do not buy now, they can buy later if their technology falls behind.

  • If the seller makes its new good incompatible with the old good, buyers will be less willing to buy the new good even if it puts them ahead of other buyers, because of “network effects.”
    • “Network effects” mean that the good is more useful to every user, when more users use it. One fax machine is not very useful; the machines become more useful as the network grows.

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