Vertical Control Change and Platform Organization under Network Externalities

In this paper, we examine how the introduction of network externalities impact an open and vertically integrated platform's post-merger contractual relationship with third-party sellers distributing through its marketplace. Regardless of whether the platform uses linear contracts or two-part tariffs, we find that, provided these contracts are public, the platform has no incentive to exclude its nonintegrated rivals and that the latter's market share rises as network effects gain importance. Vertical integration serves as a commitment device that open platforms can use to convince potential users (e.g., consumers and developers) that their ecosystem will be large and compelling. Interestingly, when the open platform competes with a closed rival, i.e., with a fully integrated ecosystem, it may find it profitable to subsidize independent third-party sellers to steer demand away from the competing ecosystem strategically. These results have novel managerial implications on the incentives of a platform to open up its ecosystem to third-party sellers, as well as for the regulation of vertical integration in the presence of network effect and when different platforms operate alternative business models