APPLICATIONS BARRIER TO ENTRY AND EXCLUSIVE VERTICAL CONTRACTS IN PLATFORM MARKETS

Authors

  • JAMES E. PRIEGER,

    1. Prieger: Associate Professor of Public Policy, School of Public Policy, Pepperdine University, 24255 Pacific Coast Highway, Malibu, CA 90263-7490. Phone (310) 506-710, Fax (310) 506-7494, E-mail james.prieger@pepperdine.edu
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  • WEI-MIN HU

    1. Hu: Assistant Professor, School of Economics, Hanqing Advance Institute of Economic and Finance, Renmin University of China, No. 59, Zongguancun Street, Beijing 100872, China. Phone 86-10-62514921, Fax 86-10-62511343, E-mail weiminhu2006@gmail.com
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    • We gratefully acknowledge financial support from the NET Institute (www.NETinst.org) for this project. We are grateful to Matthew Clements and Hiroshi Ohashi for sharing their data, which we used in an earlier version of the paper. We also thank seminar participants at the 2007 NET Institute Conference on Network Economics, the Western Economic Association International 82nd Annual Conference, the 2007 International Industrial Organization Conference, and UT Arlington, and especially the editor, Tim Brennan, for helpful comments.


Abstract

Our study extends the empirical literature on whether vertical restraints are anticompetitive. We focus on exclusive contracting in platform markets, which feature indirect network effects and thus are susceptible to an applications barrier to entry. Exclusive contracts in vertical relationships between the platform provider and software supplier can heighten entry barriers. We test these theories in the home video game market. We find that indirect network effects from software on hardware demand are present, and that exclusivity takes market share from rivals, but only when most games are nonexclusive. The marginal exclusive game contributes virtually nothing to console demand. Thus, allowing exclusive vertical contracts in platform markets need not lead to domination 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. (JEL L42, L63, D12)

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