Standards Coalitions Formation and Market Structure

We discuss the formation of technical standards platforms in industries with network externalities where firms are free to choose their degree of technical compatibility with competitors. In our model, firms choose affiliation to a technical standards coalition in the first stage of a game, and play an oligopoly game in the second stage. In adding itself to a technical standards coalition, a firm benefits from the network effects of the whole coalition, but also faces increased competition in the output market from other firms in the coalition. Also, the increase of the size of the coalition changes the competitive position of members of that coalition relative to other firms. We find that the extent and size of coalitions at equilibrium depends crucially on the degree of the intensity of network effects. When network effects are very strong, full compatibility prevails. When externalities are slightly weaker, two standards coalitions are formed, a singleton, and one with all remaining firms. On the other extreme, for very weak network effects, the equilibrium is total incompatibility, and for slightly more intense network effects, coalitions are of small size. We characterize a number of other equilibria for intermediate strengths of network externalities.