Interoperability in Digital Markets : Boon or Bane for Market Contestability?

In an effort to ensure contestability and competition in digital markets, policymakers worldwide discuss whether interoperability obligations are an appropriate regulatory tool to achieve these goals. In particular, horizontal interoperability obligations have been proposed for messenger services and social networks, which would require the incumbent platform to be interoperable with a rival platform. The key feature of such horizontal interoperability is that it allows sharing of direct network effects, and similar regulation has been in place for telecommunications networks for decades. However, we show that horizontal interoperability obligations can be a harmful remedy in the context of digital services. The main reason for this assessment is that in the context of digital markets only partial interoperability can be achieved, because innovation is faced-paced and efforts to standardize a common set of interoperable features will always lag behind. Interoperability, by contrast, requires standardization and a relatively steady environment. Absent full interoperability some proprietary network effects remain and consumers still gravitate to the larger network in order to take advantage of the full richness of features. At the same time, horizontal interoperability lowers the incentives of consumers to multihome services, which is a powerful driver for contestability. We develop a dynamic multi-period model, which formalizes the trade-off between the (imperfect) sharing of network effects through interoperability and reduced incentives to multihome, and show that mandated interoperability can impede the ability of a more efficient entrant platform to contest the less efficient dominant platform. Our results have immediate implications for the ongoing policy debate and suggest that horizontal interoperability obligations may not be an appropriate remedy for regulating dominant online platforms