| Abstract: |
We consider a software vendor selling both a monopoly platform (e.g. operating
system) and an application that runs on this platform. He may face competition
by an entrant in the applications market. Consumers are heterogeneous in their
preferences for both the platform and the applications. They first buy the
platform and then the applications. Their utility over the horizontally
differentiated applications is known only after they bought the platform. In
equilibrium the platform seller can be better off with a competitor in the
applications market for three reasons. First, the platform vendor makes more
profits with his platform. Second, the competitor’s entry serves as a credible
commitment to lower prices for applications. Third, higher ex ante
expectations of product diversity lead to a higher demand for his application.
Competition may be profit enhancing even if the first two effects are absent,
i.e. the product diversity effect can be sufficient. The model also gives an
answer to the much debated question why Microsoft prices MS Office
significantly higher than its operating system. |