Interconnecting Differentiated Networks

I examine interconnection decisions of horizontally differentiated firms. I find that previous results that firms do not interconnect enough, based on the finding that consumers always benefit from interconnection, are only half right. In a Hotelling, as opposed to a Cournot, model consumers may suffer from interconnection, and the firms may interconnect when it is not socially optimal (interconnect too much). I also examine the case where two monopolists interconnect to create a post-interconnection duopoly. Counter intuitively, the stronger are the network effects, the less incentive the monopolists have to interconnect. I examine the effects of network externalities on product positioning, and conclude with a model of only some firms interconnecting.