Market leadership through technology – Backward compatibility in the U.S. Handheld Video Game Industry

Claussen, Jörg ; Kretschmer, Tobias and Spengler, Thomas (May 2010): Market leadership through technology – Backward compatibility in the U.S. Handheld Video Game Industry. Discussion Papers in Business Administration 2010-5

Abstract

The introduction of a new product generation forces incumbents in network industries to rebuild their installed base to maintain an advantage over potential entrants. We study if backward compatibility moderates this process of rebuilding an installed base. Using a structural model of the U.S. market for handheld game consoles, we show that backward compatibility lets incumbents transfer network effects from the old generation to the new to some extent but that it also reduces supply of new software. We examine the tradeoff between technological progress and backward compatibility and find that backward compatibility matters less if there is a large technological leap between two generations. We subsequently use our results to assess the role of backward compatibility as a strategy to sustain market leadership.

• Item Type: Paper
• Form of publication: Preprint
• Keywords: backward compatibility market leadership network effects two-sided markets
• Faculties: Munich School of Management; Munich School of Management > Discussion Papers; Munich School of Management > Discussion Papers > Communication Economics
• Subjects: 300 Social sciences > 330 Economics
• JEL Classification: L15, L82, O33
• Language: English

References

ARTHUR, W. 1989. Competing technologies, increasing returns and lock-in by historical events. Economic Journal, 99, 116-131. BERRY, S. 1994. Estimating Discrete-Choice Models of Product Differentiation. RAND Journal of Economics, 25, 242-262. BERRY, S., LEVINSOHN, J. & PAKES, A. 1995. Automobile prices in market equilibrium. Econometrica, 63, 841-890. CHEN, P.-L., WILLIAMS, C. & AGARWAL, R. 2012. Growing pains: Pre-entry experience and the challenge of transition to incumbency. Strategic Management Journal, 33, 252-276. CHOI, J. 1994. Network externality, compatibility choice, and planned obsolescence. Journal of Industrial Economics, 42, 167-182. CHURCH, J. & GANDAL, N. 1996. Strategic entry deterrence: Complementary products as installed base. European Journal of Political Economy, 12, 331-354. CLARK, B. & MONTGOMERY, D. 1998. Deterrence, reputations, and competitive cognition. Management Science, 44, 62-82. CLEMENTS, M. & OHASHI, H. 2005. Indirect network effects and the product cycle: video games in the U.S., 1994-2002. Journal of Industrial Economics, 53, 515-542. CORTS, K. S. & LEDERMAN, M. 2009. Software exclusivity and the scope of indirect network effects in the U.S. home video game market. International Journal of Industrial Organization, 27, 121-136. DANNEELS, E. 2002. The dynamics of product innovation and firm competences. Strategic Management Journal, 23, 1095-1121. DE FIGUEIREDO, J. M. & SILVERMAN, B. S. 2007. Churn, baby, churn: Strategic dynamics among dominant and fringe firms in a segmented industry. Management Science, 53, 632-650. DIXIT, A. 1980. The role of investment in entry-deterrence. The Economic Journal, 90, 95-106. EGGERS, J. P. 2012. All experience is not created equal: learning, adapting, and focusing in product portfolio management. Strategic Management Journal, 33. ELLISON, G. & FUDENBERG, D. 2000. The neo-Luddite's lament: Excessive upgrades in the software industry. Rand Journal of Economics, 31, 253-272. FARRELL, J. & SALONER, G. 1985. Standardization, compatibility, and innovation. Rand Journal of Economics, 16, 70-83. FORSTER, W. 2005. The Encyclopedia of game-machines: consoles, handhelds and home computers 1972-2005, Gameplan. GANDAL, N., KENDE, M. & ROB, R. 2000. The dynamics of technological adoption in hardware/software systems: The case of compact disc players. Rand Journal of Economics, 31, 43-61. GENAKOS, C. 2001. Game Wars - The Home Video Game Industry. London Business School Case Study. GREENSTEIN, S. 1993. Did Installed Base Give an Incumbent any (Measureable) Advantages in Federal Computer Procurement? Rand Journal of Economics, 24, 19-39. GRUCA, T. & SUDHARSHAN, D. 1995. A framework for entry deterrence strategy: the competitive environment, choices, and consequences. Journal of Marketing, 59, 44-55. GUPTA, S., JAIN, D. C. & SAWHNEY, M. S. 1999. Modeling the evolution of markets with indirect network externalities: An application to digital television. Marketing Science, 18, 396-416. HAAN, M. 2003. Vaporware as a means of entry deterrence. Journal of Industrial Economics, 51, 345-358. HARRIGAN, K. 1981. Barriers to entry and competitive strategies. Strategic Management Journal, 2, 395-412. HILL, C. W. L. & ROTHAERMEL, F. T. 2003. The Performance of Incumbent Firms in the Face of Radical Technological Innovation. Academy of Management Review, 28, 257-274. JONES, N. 2003. Competing after radical technological change: the significance of product line management strategy. Strategic Management Journal, 24, 1265-1287. KATZ, M. & SHAPIRO, C. 1994. Systems competition and network effects. Journal of Economic Perspectives, 8, 93-115. KENDE, M. 1994. A note on backward compatibility. Economic Letters, 45, 385-389. KENT, S. L. 2002. The ultimate history of video games: from Pong to Pokemon and beyond... Roseville (California), Prima Publishing. KLEMPERER, P. 1987. Entry deterrence in markets with consumer switching costs. The Economic Journal, 97, 99-117. KOSKI, H. & KRETSCHMER, T. 2005. Entry, standards and competition: Firm strategies and the diffusion of mobile telephony. Review of Industrial Organization, 26, 89-113. KOTHA, R., ZHENG, Y. & GEORGE, G. 2010. Entry into new niches: the effects of firm age and the expansion of technological capabilities on innovative output and impact. Strategic Management Journal, 32. KRETSCHMER, T. 2008. Splintering and inertia in network industries. Journal of Industrial Economics, 56, 685-706. LEE, C. H., VENKATRAMAN, N., TANRIVERDI, H. & IYER, B. 2010. Complementarity-based hypercompetition in the software industry: Theory and empirical test, 1990–2002. Strategic Management Journal, 31, 1431-1456. LEE, J., LEE, J. & LEE, H. 2003. Exploration and Exploitation in the Presence of Network Externalities. Management Science, 49, 553-570. LIEBERMAN, M. B. 1989. The learning curve, technology barriers to entry, and competitive survival in the chemical processing industries. Strategic Management Journal, 10, 431-447. LIIKANEN, J., STONEMAN, P. & TOIVANEN, O. 2004. Intergenerational effects in the diffusion of new technology: the case of mobile phones. International Journal of Industrial Organization, 22, 1137-1154. MASCARENHAS, B. 1992. Order of entry and performance in international markets. Strategic Management Journal, 13, 499-510. MILGROM, P. & ROBERTS, J. 1982. Limit pricing and entry under incomplete information: An equilibrium analysis. Econometrica, 50, 443-459. MOLLICK, E. 2012. People and process, suits and innovators: individuals and firm performance. Strategic Management Journal. NAHM, J. 2008. The effects of one-way compatibility on technology adoption in systems markets. Information Economics and Policy, 20, 269-278. NAIR, H., CHINTAGUNTA, P. & DUBE, J. 2004. Empirical analysis of indirect network effects in the market for personal digital assistants. Quantitative Marketing and Economics, 2, 23-58. ROTHAERMEL, F. T. & BOEKER, W. 2008. Old technology meets new technology: complementarities, similarities, and alliance formation. Strategic Management Journal, 29, 47-77. SALOP, S. 1979. Strategic entry deterrence. American Economic Review, 69, 335-338. SCHILLING, M. 2002. Technology success and failure in winner-take-all markets: The impact of learning orientation, timing, and network externalities. Academy of Management Journal, 45, 387-398. SCHMALENSEE, R. 1978. Entry deterrence in the ready-to-eat breakfast cereal industry. Bell Journal of Economics, 9, 305-327. SCHUMPETER, J. 1942. Capitalism, socialism, and democracy, New York, Harper. SHANKAR, V. & BAYUS, B. 2003. Network effects and competition: An empirical analysis of the home video game industry. Strategic Management Journal, 24, 375-384. SHAPIRO, C. 1996. Antitrust in Network Industries, Address Before the American Law Institute and American Bar Association, 25 January 1996 [Online]. Available: http://www.justice.gov/atr/public/speeches/0593.htm [Accessed 24 January 2012]. SHAPIRO, C. & VARIAN, H. 1999. Information rules: a strategic guide to the network economy, Harvard Business School Press. SHY, O. 1996. Technology revolutions in the presence of network externalities. International Journal of Industrial Organization, 14, 785-800. SMILEY, R. 1988. Empirical evidence on strategic entry deterrence. International Journal of Industrial Organization, 6, 167-180. SRINIVASAN, K. 1991. Multiple market entry, cost signalling and entry deterrence. Management Science, 37, 1539-1555. STREMERSCH, S. & BINKEN, J. 2009. The effect of superstar software on hardware sales in system markets. Journal of Marketing, 73, 88-104. SUAREZ, F. F. & UTTERBACK, J. M. 1995. Dominant designs and the survival of firms. Strategic Management Journal, 16, 415-430. SUTTON, J. 1998. Technology and market structure: theory and history, Cambridge, MIT Press. TRIPSAS, M. 1997. Unraveling the process of creative destruction: Complementary assets and incumbent survival in the typesetter industry. Strategic Management Journal, 18, 119-142. WADE, J. 1995. Dynamics of organizational communities and technological bandwagons: An empirical investigation of community evolution in the microprocessor market. Strategic Management Journal, 16, 111-133. WALDMAN, M. 1993. A new perspective on planned obsolescence. Quarterly Journal of Economics, 108, 273-283.