By Jerome Pouyet & Thomas Trégouët –
We analyze a vertical merger between a platform providing an operating system and a device manufacturer in the presence of indirect network effects between buyers of devices and developers of applications. Indirect network effects generate a form of demand complementarity at the manufacturer level. Vertical integration creates market power over nonintegrated manufacturers and application developers. It also allows the integrated firm to coordinate the pricing decisions across both sides of the market, thereby leading to a better internalization of network effects. The impact on competition depends on the strength and the structure of indirect network effects. Our analysis shows that indirect network effects qualitatively change the traditional competitive analysis of vertical integration in platform markets.