Analysis On The Strategy Choice Of The Firms' Vertical Merger Under Indirect Network Externality

First, this paper introduces the concept and the sorts of the network externality. Then, it analyzes the important factors which can affect the intension of network externality. Following it, we explain the special motivation of vertical integration based on the indirect network externality.Second, we discuss the vertical integration in the context of indirect network externality under the hypothesis of fitting/assembled product and the industrial structure of upstream monopoly with downstream oligopoly. Our study shows that, under the assumption which has been presented the incumbent will surely integrate the upstream firm which produces the semi-finished product through the first-mover advantage, as a result, it can monopolize the whole marker. Furthermore, we prove that the monopoly profits will increase as the strength of network externality becoming larger. The outcome of consumer welfare that has been affected by the vertical integration is uncertain. When the strength of network externality is higher and lower, the integration is benefit for the consumer welfare, on the opposite, when the strength of network externality is moderate, it will be harmed by the integration.Finally, we model another integration game based under the context of hardware/software. The equilibrium indicates that: if the number of the software producers is enough, in another word, the software market is free entry, the hardware producer can not integrate too many software producers. So the hardware producer which integrates the software producer firstly will not get the first-mover advantage easily. Further more, the first-mover advantage may weaken as the intension of network externality lessens. Third, the equilibriums of the integration game doesn't always damage the consumer surplus, because the integrated firm has two choices to gain benefits: one is compatible, through this way the firm's output of hardware will reduce, but the output of software will increase; the other one is non-compatible, on the opposite, the firm's output of software will reduce and the output of hardware will increase. This tradeoff decides the strategic choice of hardware producers. In the end, when the intension of network externality and output-decided parameter satisfy some condition, the former way of gaining benefits is better, so the integrated firm will surely choose the strategic of integration-compatibility and the consumer surplus is optimal. But, as same as the result of the former model, the integration under the...