FS IV 99 - 2 Compatibility Investments in Duopoly with Demand Side Spillovers under Different Degrees of Cooperation

Compatibility Investments in Duopoly With Demand Side Spillovers Under Different Degrees of Cooperation by Christian Wey This paper examines the effects of different degrees of cooperation on firms’ incentives to undertake interbrand compatibility investments ex post, which benefit the competitor indirectly via an increase of its mass market demand. We find that cooperation in compatibility investments while preserving competition on the product market gives second-best welfare for all positive values of the spillover parameter. For large spillover effects cartelization in compatibility investments and on the product market is welfare improving compared to pure competitive behavior. Hence, the paper gives strong efficiency reasons for forming horizontal organizations such as standardization committees, which help to achieve joint-profit maximization in compatibility investments. Furthermore, we examine the effects of an “open standardization policy” which increases the level of the spillover parameter, and show that an asymmetric outcome might dominate the symmetric solution under a regime, where firms cooperatively determine investment levels and noncooperatively choose production quantities. ∗ I wish to thank Jan Brueckner, Heidrun Hoppe, Joachim Keller, and Willy Spanjers, for their suggestions and especially Paul Heidhues, for extensive discussions of the underlying issues and for detailed editorial suggestions. Of course, any errors remain the author's sole responsibility. This paper also benefited from presentations at the Humboldt University and at the 3rd Helsinki Workshop on Standardization and Transportation. The usual disclaimer applies. This paper has been partly supported by the Graduiertenförderungsstipendium of the state of Saarland, which is gratefully acknowledged.