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Exclusive Licensing in Complementary Network Industries

Explore factors driving exclusivity in complementary network industries and the impact on industry outcomes, platform differentiation, and consumer behavior. Research investigates conditions for exclusive supply of complements and the consequences on market dynamics.

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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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