Revealing Incentives for Compatibility Provision in Vertically Differentiated Network Industries

We determine the incentives for compatibility provision of firms that produce network goods with different intrinsic qualities when firms do not have veto power over compatibility. When network effects are strong, there are multiple equilibria in pricing and consumer decisions. We show that in some equilibria, it is the high‐quality firm that invests in compatibility, whereas in others, the low‐quality firm triggers compatibility. The socially optimal compatibility degree is zero, except under very strong network effects, where one of the equilibria has all consumers buying the low‐quality good. In this case, a partial degree of compatibility is optimal.