Interoperability in Digital Markets: Boon or Bane for Market Contestability?

Interoperability in Digital Markets: Boon or Bane for Market Contestability?

Marc Bourreau

Telecom ParisTech

Jan Kraemer

University of Passau; Center on Regulation in Europe (CERRE)

Date Written: July 25, 2022

Abstract

Policymakers worldwide discuss whether interoperability obligations are an appropriate regulatory tool to promote contestability and competition in digital markets where network effects are strong. In the EU, the Digital Markets Act imposes horizontal interoperability obligations on dominant messaging services, requiring them to allow rival services to connect to their network. The standard economic wisdom is that interoperability is pro-competitive in the presence of an incumbent with a large user base, because interoperability lowers the entry barriers constituted by network effects. However, we show that this logic is incomplete in the dynamic context of digital services, where only partial interoperability can be achieved and multihoming is economically feasible. Absent full interoperability some proprietary network effects remain and consumers still gravitate to the larger network in order to take advantage of the full richness of features. At the same time, horizontal interoperability lowers the incentives of consumers to multihome services, which is a powerful driver for contestability. We develop a dynamic multi-period model, which formalizes the trade-off between the (imperfect) sharing of network effects through interoperability and reduced incentives to multihome. We highlight that mandated interoperability can impede the ability of a more efficient entrant platform to contest the less efficient dominant platform. Hence, our results have immediate implications for the ongoing policy debate by demonstrating that horizontal interoperability obligations do not only have pro-competitive, but also anti-competitive effects and may thus not be an appropriate remedy for regulating dominant online platforms.