Technological Tying and the Intensity of Competition: An Empirical Analysis of the Video Game Industry

Using data from the 128 bit video game industry this paper evaluates the incentives for hardware firms to technologically tie their produced software to their own hardware as well as analyze the impact such an action has on the intensity of console price competition. Tying occurs when a console hardware manufacturer produces software which is incompatible with rival hardware. There are two important trade-offs an integrated firm faces when implementing a technological tie. The first is an effect that increases console market power and forces prices higher. The second, an effect due to the integration of the firm, drives prices lower. A counterfactual exercise determines technological tying of hardware and software increases console price competition and is due to console makers subsidizing consumer hardware purchases in order to increase video games sales, in particular their tied games, where the greatest proportion of industry profits are made. Moreover, I determine technological tying to be a dominant strategy for hardware manufacturers when software development costs are low.