The Value of Incumbency When Platforms Face Heterogeneous Customers

Article Source: American Economic Journal: Microeconomics, Vol. 12, No. 4, pp. 229-269, 2020
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Policymakers are unsure how much competition between platforms like Microsoft or Apple is possible or desirable. Consumers are reluctant to switch platforms, giving incumbent firms an advantage.


Policy Relevance:

Competition between platforms benefits consumers. Incumbents may earn less profits than predicted.


Key Takeaways:
  • Competition for the market occurs when only one platform remains; competition within the market occurs when two platforms adopt differing strategies and consumers join different platforms.
  • Consumers often prefer to join the same platform as other consumers, creating positive network externalities; some consumers value network externalities more than others.
  • Conventional analysis concludes that competition harms consumers overall by spurring them to join too many different platforms, resulting in a loss of network externalities.
  • Actually, competition benefits consumers overall, because incumbents react strategically.
    • Competition spurs the incumbent to lower prices, ensuring that consumers who value network externalities remain on its platform.
    • Consumers enjoy lower prices, but remain on the incumbent platform.
  • The attached consumer model captures consumers’ reluctance to change platforms.
    • Reluctance to switch depends on platform pricing and how consumers are initially allocated among rival platforms.
    • Incumbents enjoy considerable power because of attached consumers.
    • Incumbents do not necessarily enjoy substantially greater profits.
  • Dynamic models, which show the effect of competition in the long run, predict that consumers will join different platforms less often than static models; the dynamic models are more accurate.
  • When incumbents allow customers who do not value network externalities to join rival platforms, the incumbent enjoys less intense competition; however, incumbents generally benefit from retaining customers, because customers who value network externalities will then pay more.
  • When consumers’ tastes are similar, price cuts reduce the incumbent’s profits; when consumers are heterogeneous, dynamic models predict larger incumbent profits, but the difference is limited.
    • Incumbency is less valuable than some predict.
    • Policymakers should not react aggressively in markets with network externalities.



Gary Biglaiser

About Gary Biglaiser

Gary Biglaiser is a Professor with the Department of Economics at the University of North Carolina – Chapel Hill. He has wide-ranging research interests in applied microeconomic theory with a concentration on industrial organization and regulation. His most recent research is focused on durable goods monopoly (with James Anton), Moonlighting (with Albert Ma) and dynamic oligopoly (with Nikos Vettas).

Jacques Cremer

About Jacques Crémer

Jacques Crémer is a Toulouse School of Economics (TSE) Research Faculty and Professor of Economics at the Toulouse School of Economics (TSE). He has done fundamental work on planning theory, the theory of auctions and organization theory. Professor Crémer’s current research interests are the theory of organizations, political economy, and networks, software and the internet.