Incompatibility, Product Attributes and Consumer Welfare: Evidence from ATMs, NET Institute Working Paper #04-06, www.NETinst.org

Incompatibility in markets with network effects can either benefit or harm consumers. Incompatibility reduces consumers’ ability to “mix and match” components offered by different sellers, but can also be associated with changes in product attributes that might benefit consumers. In this paper, we estimate the effects of incompatibility in a classic hardware/software market: ATM cards and machines. Our empirical model allows us to measure the indirect network effect relating the value of ATM cards to ATM availability. It also allows us to measure the effects of incompatibility as measured by ATM fees. Our sample contains a relatively discrete move toward incompatibility after 1996, when banks began to impose surcharges on non-customers using their ATM machines. We provide estimates of the partial equilibrium effects of increased incompatibility on consumer welfare, finding that ATM fees ceteris paribus reduce the indirect network effect associated with other banks’ ATMs. However, a surge in ATM deployment accompanies the shift to surcharging and in many cases completely offsets the reduction in welfare associated with higher fees. This suggests that welfare analyses should consider the interaction between incompatibility and changes in product attributes. ∗Knittel: Department of Economics, University of California, Davis and NBER. Email: [email protected]. Stango: Tuck School of Business, Dartmouth College. Email: [email protected]. Carrie Jankowski and Kaushik Murali provided excellent research assistance. We thank Andrew Bernard, Jeff Campbell, Ed Green, Tim Hannan, Tom Hubbard, Robert Pindyck and Catherine Wolfram for helpful comments. Seminar participants at Berkeley (Haas), Dartmouth (Tuck), the Federal Reserve Bank of Chicago, the 2004 AEA Meetings and the 2004 NBER Summer Institute also provided constructive comments. The authors gratefully acknowledge the financial support of the NET Institute.