Strategic compatibility choice, network alliance, and welfare

Based on a simple model of compatibility choice under differentiated Cournot duopoly with network externalities, we consider how the levels of a network externality and product substitutability affect the choice of compatibility. In particular, if the level of network externality is larger than that of product substitutability, there are multiple equilibria involving imperfect and perfect compatibility. Furthermore, we demonstrate the conditions for constructing such a network alliance so that firms provide perfectly compatible products. The network alliance is stable and socially optimal.