2014 - Working Papers: Strategy, Innovation and Entrepreneurship

This paper considers dynamic platform competition in a market with network externalities. A platform that dominated the market in the previous period becomes “focal” in the current period, in that agents play the equilibrium in which they join the focal platform whenever such equilibrium exists. We ask whether a low-quality but focal platform can maintain its focal position along time, when it faces a higher quality competitor. We find that the high-quality platform can win the market only when firms are patient enough. At intermediate levels of discounting there is a unique equilibrium, with the high-quality platform winning. However, with high discount factor and infinite horizon, there are multiple equilibria in which either the low or the high quality platform dominates. If qualities are stochastic, the firm with better average quality wins more often than the other. An increase in the discount factor makes it easier for this platform to win in periods when its quality is lower than the rival's. As a result, with stochastic qualities social welfare can decrease when firms become more forward-looking.