Strategic subsidization in the presence of indirect network externality: implications for the Microsoft case

This paper highlights a situation in which there exist an integrated (incumbent) hardware/software firm and an independent (entering) hardware firm in the presence of indirect network externality. Both firms can subsidize independent software producers for the provision of more software products. The integration of the hardware product division and the software product division may facilitate the integrated firm to coordinate for the development of available software. Hence, this integration will be considered to give the integrated firm the first-mover advantage in subsidizing the development of software products. With this first-mover advantage, the incumbent can choose either to accommodate or to deter the entry by enhancing the applications barrier to entry. It is shown that the accommodation equilibrium is always socially more beneficial (in terms of consumer surplus) than the duopoly equilibrium with the breakup of the incumbent. Furthermore, the deterrence equilibrium can be socially more beneficial as well if the entrant´s fixed start-up cost is sufficiently low