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Exclusive Licensing in Complementary Network Industries

Exclusive Licensing in Complementary Network Industries. Ravi Mantena – U. Rochester Ramesh Sankaranarayanan – U. Connecticut Siva Viswanathan – U. Maryland. Motivation for exclusivity. Industries with indirect network effects Platforms and complements/content

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Exclusive Licensing in Complementary Network Industries

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  1. Exclusive Licensing in Complementary Network Industries Ravi Mantena – U. Rochester Ramesh Sankaranarayanan – U. Connecticut Siva Viswanathan – U. Maryland

  2. Motivation for exclusivity • Industries with indirect network effects • Platforms and complements/content • E.g. Video game consoles and games; DVD formats and DVDs; Cable / satellite and program channels; etc. • Complement exclusivity is often important to • Acquire new customers • GTA III (Rockstar) – released October 2001 for PlayStation 2 “totally blew away gamers around the world and almost single-handedly made the PS2 a must-buy.” – NY Times: Oct, ’05 • “Sony's PlayStation 2 dominates the videogame industry, largely because many of the most popular games work only on the Sony console.” – Wall St. Journal: May, ‘05 • Differentiate from competing platforms

  3. Salient Characteristics of the Context • Customers in this industry • Mainly interested in complements • Prefer variety – more is better! • Join one platform, buy multiple complements • Platforms • Are typically incompatible • Control access to their members by complements • Complements usually have • High fixed costs, some porting costs • Negligible marginal costs • Availability on multiple platforms – desired, efficient

  4. Research questions • Under what conditions are complements supplied exclusively, and for which platform? • Impact of permitting exclusivity on industry outcomes – compared to when exclusivity is not permitted.

  5. Set-up: Players • Platforms • Two platforms A and B with members nA, nB. (nA > nB) • New customers (nN) • Complements • Many available for each platform • Number depends on size of membership network (indirect network effects) • Only a single developer behaves strategically • Consumers • New customers buy a platform and some associated complements • Current members of platforms buy only complements

  6. Platforms A and B simultaneously offer contracts to the strategic product developer S t a g e 1 The strategic product developer chooses the set of contracts to accept Outcomes: An exclusivity regime (Excl.A, Excl.B or Common) and an associated set of license contracts Platforms choose prices pA and pB S t a g e 2 • Current members of A buy strategic / non-strategic products for A • Current members of B buy strategic/ non-strategic products for B • New customers join one of the two platforms and buy strategic/non-strategic products for it.. Set-up: Game Structure

  7. Set up: A few more details • Each customer segment has a representative consumer with utility U(xg, xh) • G – Strategic complement developer • Pays license fee lkrto platforms per copy of complement sold • H – Composite commodity representing set of non-strategic complements • Whose quality is increasing in number of varieties available • Pay a fixed license fee L per copy • U(xg, xh) is increasing in quantity and displays some desire for variety

  8. Complement: Trade-offs • Strategic complement • Increases consumer spending on complements • However, some cannibalization • Trade-off for complement developer • Smaller platform has higher incremental value, provides higher demand • Larger platform has more customers, but is more competitive • Overall: Unclear which way to go

  9. Factors Driving Outcomes • Additional benefit to a platform from complement exclusivity as compared to a situation where the complement is exclusive to the other platforms (A, B) • This depends on • Impact of complement on platform sales to new customers • Impact on profits from complement sales • Impact on platform prices via differentiation

  10. Exclusive & Non-exclusive Outcomes

  11. COMMON EQ. REGIME EXCLUSIVE EQUILIBRIUM REGIME Exclusive contracting possible Exclusive contracting not possible Share of Profits as Market Matures

  12. COMMON EQ. REGIME EXCLUSIVE EQUILIBRIUM REGIME A G G A B B Share of Profits as Market Matures

  13. Summing Up… • Larger platform generally has an “upper hand” • But may be caught in a prisoner’s dilemma • Smaller platform can garner exclusivity in later stages. • Complements are much more likely to be exclusive in the early stages of a platform adoption • Complement’s Profitability decreases with market maturity • More competition from existing bundle of complements • Complement ceases to be a “strategic necessity” • Quality of Complements • Later complements would need to be of higher quality. • However, higher quality complements are more valuable in the early stages of platform competition.

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