Complementing Substitutes: Compatibility, Bundling and Entry

In this paper we study price competition, equilibrium market configurations and entry when firms compete in vertically-differentiated markets producing complementary goods. We consider two complements and start from a configuration where the market for one complement is a duopoly, whereas the other is a monopoly. In such framework, when products are highly differentiated, the low-quality duopolist is always pushed out. We then allow for competition between complements on both sides of the market: one of the duopolists starts to produce also the other complement and decides whether to offer its two products as a bundle or to allow consumers to combine them with complements from other producers. We prove that this strategy always allows the low-quality duopolist to stay in the market, no matter if the duopolist producing both complements is the high or the low-quality one. Moreover, this strategy always increases consumer surplus, even when the duopolist sells the two complements only as a bundle.