Limiting Compatibility in Two-sided Markets

Abstract

In two-sided markets where the platform is composed of a set of components, a monopolist may have an incentive to foreclose competition in the complementary market. By introducing incompatibility, the monopolist can exclude its complementors, thereby capturing surplus from both sides of customers. This type of behavior lowers social welfare. Private contracts such as a payment for compatibility can help restore efficiency, but its effectiveness depends on the form of the contract. The model's relevance to Microsoft's controversial practice of extending industry standards with proprietary capabilities is discussed.