Network effects, compatibility decisions, and monopolization

This paper analyzes the compatibility decision of a dominant hardware supplier. There are two substitutive variants of the hardware component of a hardware-software system, they are horizontally differentiated, and one of the two has a quality advantage. Among other things, we show under what circumstances the dominant supplier monopolizes his market via maintaining incompatibility with the variant of the competitor. It turns out that, depending on the significance of the network effects, of the horizontal differentiation and of the quality advantage, not only the coexistence of compatible variants but also a monopolization and even the coexistence of incompatible variants can be welfare superior.