Network Externalities, Mutuality, and Compatibility

Interoperability and Competition Policy and Antitrust

Article Snapshot


Matthew Nagler


NET Institute Working Paper #08-37, 2008


Comparing incentives for compatibility under regimes involving user-positive and nonuser negative externalities.

Policy Relevance

The analysis of this paper can help policymakers understand when compatability should be encouraged and when it should not be.

Main Points

  • This paper finds that under both user-positive and nonuser-negative regimes, incentives for compatibility tend to be suboptimal when firms’ networks are close in size, and excessive for the small firm when the networks differ greatly in size.


  • Positive network externalities can arise when consumers benefit from the consumption of compatible products by other consumers (user-positive consumption externalities) or, alternatively, when they incur costs from the consumption of incompatible products by other consumers (nonuser-negative consumption externalities).


  • This paper finds that public policy has a role in encouraging compatibility when competing products have near-equal network sizes.  Conversely, policymakers may need to dampen unilateral private incentives for compatibility when network sizes are lopsided.


  • Beyond pure compatibility considerations, the broader implications of the results indicate that the wisdom that external costs are provided excessively in the market and should be reduced is called into question when the consideration is made that, in many cases, such costs have implications for the competitive equilibrium in markets.

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