Product improvement and technological tying in a winner-take-all market

In a winner-take-all duopoly market for systems in which firms invest to improve their products, a monopoly supplier of an essential system component may have an incentive to advantage itself by technological tying; that is, by designing the component to work better in its own system. If the vertically integrated firm is prevented from technologically tying, then there is a pure strategy equilibrium in which the more efficient firm invests and serves the entire market. However other equilibria may exist, including a pure strategy equilibrium in which the less efficient firm invests and captures the market and mixed strategy equilibria in which each firm captures the market with positive probability. In contrast, if the vertically integrated firm is able to degrade the quality of its rival's system with a technological tie, and if the wholesale price of the essential component is insufficiently remunerative, then there is a unique equilibrium outcome in which the supplier of the essential component invests alone and forecloses a more efficient rival with an actual, or merely threatened, technological tie. A comparison of these equilibria for the two game forms demonstrates that a prohibition of technological tying can either increase or decrease social welfare depending on equilibrium selection