Product Compatibility as an Strategy to Hinder Entry Deterrence

In many markets, firms produce and sell complementary components that form a product system. This paper studies the effects of compatibility in product advertisement, and how the available information in the market affects the decision of a company to become active in the industry. While advertising enhances the ability of consumers to mix and match components closer to their preferences, more advertising does not always generate larger welfare. In my model, an incumbent uses advertising to increase the prospects of market competition with the objective to deter potential entry. However, under some parameters of the model, entry deterrence does not occur when products are made compatible. With compatible products, the incumbent either obtains large benefits from accommodation or equilibria when all consumers are aware of the existence of the available products emerge. In this latter case, the amount of advertising cannot be further expanded to protect the incumbent's monopolistic position. As a result, policies that encourage compatibility may generate higher advertisement levels and a more competitive market.