Supporting Services and the Choice of Compatibility

This paper investigates the incentives of firms to produce compatible products in a market where consumers’ choice among brands depends on the availability of complementary services supporting the individual brands. We analyze a computer industry in which consumers treat computers and computer specific software as complementary products. Our main result shows that, despite the fact that a computer firm can increase the variety of its supporting software by making its machine compatible with other machines’ software, a firm may end up losing part of its market share and profit by investing in compatibility. This paper also underlines the importance of distinguishing between hardware compatibility and economic compatibility.