Applications Barriers to Entry and Exclusive Vertical Contracts in Platform Markets

Abstract

Our study extends the empirical literature on whether vertical restraints are anticompeti-tive. We focus on exclusive contracting in platform markets, which feature indirect net-work effects and thus are susceptible to applications barriers to entry. Theory suggests that exclusive contracts in vertical relationships between the platform provider and soft-ware supplier can heighten the entry barriers. We test these theories in the home video game market. We measure the impact on hardware demand of the indirect network ef-fects from software. We find that although network effects are present, the marginal ex-clusive game contributes virtually nothing to console demand. Thus, allowing exclusive vertical contracts in platform markets need not lead to a market structure dominated by one system protected by a hedge of complementary software. Our investigation suggests that bargaining power enjoyed by the best software providers and the skewed distribution of game revenue prevents the foreclosure of rivals through exclusive contracting.