INTERGENERATIONAL PRODUCT COMPATIBILITY AND PRICE COMPETITION

This paper considers firms’ incentive to preserve compatibility between product generations in a duopoly setting. A firm may or may not maintain backward compatibility depending on its first period market share. Firms’ compatibility choices consequently will affect their pricing behaviors. Specifically, it is shown that under certain conditions both firms will preserve compatibility and act as local monopolist in the second period. Hence, backward compatibility becomes a tool for firms to relax second period price competition.