Creating Economic Advantage By Setting Compatibility Standards: Can ‘Physical Tie-Ins’ Extend Monopoly Power?

Abstract

The paper deals with the micro-economics of interface manipulation, i.e. the design of the interface between two products to enhance the profits accruing to the firm controlling the design. Taking several alleged instances of ‘physical tie-ins’ as a reference point, it argues that economist's usual treatment of ‘tie-ins’ and bundling is inappropriate for these cases, and it proposes an alternative model. The model identifies the circumstances under which interface manipulation will yield competitive advantages to an integrated system designer. It also focuses on the limits placed on such behavior by the demand for ‘backward compatible’ components. The model's implications are then examined for the light they shed on arguments about the plausibility of ‘leveraging’–i.e. the use of monopoly power in one component market to gain monopoly power in a complementary component market. The paper concludes that the notion of leveraging can be given analytical substance, but emphasizes that the concept should be used with some care.