The Impact of Compatibility on Incentives to Innovate and Consumer Benefits in a Network Industry

Compatibility and connectivity are essential elements in a digital economy. We use the degree of network compatibility as a measure of market competitiveness. That is, an increase in network compatibility possibly reduces market competitive pressure. We consider the impact of compatibility on profit incentives to innovate and consumer benefits in a digital market. We mainly demonstrate that if the degree of network externalities is larger than a half, as compatibility increases, the profit incentives to innovate first decreases, then increases (i.e., a U-shaped function of compatibility); conversely, the consumer benefits first increase, then decrease (i.e., an inverse U-shaped function of compatibility). Otherwise, the profit incentives decrease while the consumer benefits increase, monotonically.