A note on compatibility and entry in a circular model of product differentiation

Consider an industry in which network goods are supplied by two horizontally differentiated firms facing the threat of a potential entrant. Firms' dilemma is between occupying the product space by selling very differentiated (incompatible) goods, and supplying compatible goods that offer higher utilities hence can be charged a higher price to consumers but are also closer substitutes. The compatibility-entry-price game is solved backward when firms and consumers are located on a circular product space. It turns out that strong externalities can favour entry, as merging the networks and accommodating entry can be preferred by the incumbents.