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Julio C. Saavedra – Setting Standards

12. Oktober 2007

Remember the old story of the battle between the Sony’s Betamax video-cassette system and its rival, JVC’s VHS? It was all about setting an industry standard. Betamax, despite being technically superior, lost. Nowadays you’d need to be a greying baby-boomer to even remember the word.Would Sony have been better off cooperating with JVC in making their standards compatible, instead of trying to erase the competition off the map? And would have consumers profited from such cooperation? A paper by Jan Philipp Bender and Klaus M. Schmidt, both from the University of Munich, sheds some light on the cooperation vs. competition issue in standards setting.
Having your standard adopted throughout an industry is no minor coup—as long as you reap the royalties accruing from it. Just think of Microsoft’s Windows, a virtual standard for PC operating systems. Thus, firms have a strong incentive to try their best to see rival formats off.
Bender and Schmidt show that when firms merely make their products compatible, price competition is reduced and market structure is affected, but the incentives to invest on improvements remains. If, however, they agree ex ante on technology and royalty sharing, investment incentives suffer as a result. Firms, in other words, will use these instruments to jointly reduce their incentives to invest and to increase the market price. Imposing a zero-royalty rate on this institutional structure makes the problem worse.
Unsurprisingly, the authors found that firms always prefer an ex ante agreement of this kind to ex post licensing. Using the Microsoft-Linux tiff and later rapport as an example, they illustrate the workings, effects and risks such a strategy can have, as well as the antitrust issues it raises.
When you think of the standards war now going on between Blu-Ray high definition video disc (Sony again) and the HD DVD one from Toshiba, it is clear that the issue has lost no relevance over the years. Both the warring factions and antitrust watchdogs would do well to read the paper in question.

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