Durable Goods Monopoly with Network Externalities with Application to the PC Operating Systems Market

Abstract

We analyze a model of multi-period monopoly in durable goods. Taking into consideration the special conditions of software markets, we assume that there are no used software markets and that manufacturers stop selling older software when they introduce a replacement model. We show that nominal as well as discounted (real) prices decrease over time but are above cost, thereby violating the Coase conjecture. In contrast, when “new” durable goods are introduced by the monopolist which are only partially compatible with “old” durable goods, prices may increase over time. This occurs when the intensity of network externalities arising from weak partial forward compatibility (influencing the demand of the old good from sales of the new one) is low compared to the intensity of network externalities arising from partial backward compatibility (influencing the demand of the new good from sales of the old one). A new product introduced by an entrant is successful only when it has strong externalities arising from forward compatibility. In this case, the entrant and the incumbent have opposite incentives regarding the degree of forward compatibility of the new product (that defines the extent of network externalities of the old product on consumers of the new one).