Competing in Markets with Digital Convergence: Product Differentiation, Platform Scope and Equilibrium Structure

Abstract

The incorporation of digital technologies into the products of diverse industries, accompanied by a shift to von-Neumann-like platform architectures, while resulting in substantially more valuable and flexible products, also leads to increased substitutability across previously distinct markets. This paper analyzes the economic implications of this trade-off in technology markets subject to digital convergence. We present a new model of imperfect competition that captures flexible platform scope, variability in consumer requirements, and multiple product purchases. We specify four types of equilibrium configurations - local monopoly, kinked, competitive and non-exclusive - that emerge as outcomes of the model, and describe how each equilibrium structure characterizes a distinct stage of digital convergence. Our analysis establishes that as markets converge, prices always rise initially even as competing products become less differentiated. However, when platform scope is largely dictated by exogenous factors, prices and profits eventually fall as the stage of convergence progresses, though consumer surplus and total surplus rise. Furthermore, while convergence has the expected effect of shifting consumption patterns from purchasing multiple specialized products to buying a single general-purpose product, we describe examples of equilibria in which consumers may buy multiple general-purpose products, using each for a specialized subset of their requirements. Pricing responses to changes in variable costs and consumer functionality needs are also discussed. When firms can make strategic choices of platform scope, we show that in any subgame perfect equilibrium, duopoly prices are always higher than monopoly prices, and industries may sustain high levels of profitability even when their boundaries blur. We also establish that as technological progress lowers fixed costs, a natural outcome is for unregulated firms to over-invest in platform scope relative to the social optimum, and that this outcome is true under both monopoly and duopoly market structures