Vertical Integration and Exclusivity in Two-Sided Markets

1. Vertical Integration and Exclusivity in Two-Sided Markets Robin Lee Discussant: Ignacio Esponda

2. Important question: Are exclusive contracts/vertical integration anti or pro-competitive in two-sided markets? • Sixth generation US Videogame industry (2000-2005)

3. Joint estimation of consumer demand for both hardware & software • Consumer heterogeneity in price sensitivity & taste for gaming • Dynamics • Selection problem • Across platforms: those onboard a platform have already exhibited preference for affiliated titles • Across time: early adopters of hardware differ from late adopters • Software “demand” for platforms • Estimate porting/development costs from observed allocation of 3rd party software titles assuming profit maximization • Equilibrium of dynamic network formation game • Counterfactual: banning exclusivity & vertical integration • 1st party titles enter the market, but as 3rd party titles • 1st party titles no longer produced Main Finding: exclusivity benefited smaller entrant platforms and not dominant incumbent

4. Comments: Consumer demand • Dynamics are important…but challenging • How do consumers form expectations in these markets? • Inclusive values in hardware & software utility are Markov, but these should be related to each other • Simpler model? • E.g. Installed base as a proxy for future titles • Incorporate heterogeneity in preferences for type of software • Feeling that lots of structure given the data • Better micro panel data • More clear about key identification: # of titles that would be sold in an alternative platform • E.g. case where most consumers that own a platform buy an exclusive hit for that platform

5. Comments: Equilibrium Industry Structure • No data on which 3rd party titles are exclusive • Assumes large, hit 3rd party titles are exclusive and therefore do not use these titles to back up porting/development costs • Potential problem: suppose these titles were not exclusive, but rather had high porting costs • In the counterfactuals, many of these titles sell on multiple platforms: overestimate how banning exclusivity would have helped incumbent • Evidence on porting costs for these titles may help • More general selection problem: exclusive titles may be different (e.g. have different porting costs) than non-exclusive titles • Model prediction • Since you fix decisions of 1st party titles, compare model predictions and observed data on those dimensions on which you allow them to differ

6. Comments: Counterfactuals • As acknowledged, it is a partial counterfactual • If exclusivity is banned, entrants & incumbents could change “strategies” • Firms can increase porting costs (?) • Specialize hardware to particular niches of the market • Incentives to develop software may change (how?) • Maybe incumbent does not benefit the most from exclusivity because it is not fully taking advantage of exclusivity • Early 90s: anti-trust case against market leader Nintendo for exclusive arrangements

7. Comments: Counterfactual (cont.) • Begs the question: why isn’t incumbent better able than entrants to take advantage of exclusivity? • Need a model of why exclusivity arises in the first place • Use framework to predict value of exclusivity to incumbents and entrants

8. Final comments • Very nice paper • Excellent knowledge of the industry • Great job at tackling very challenging setting • Very interesting question