Backward Compatibility in Two-Sided Markets

Often new hardware is backward compatible with software designed for previous generations of hardware. For example, PlayStation 2 can play games designed for PlayStation. Our study contributes to the growing literature on dynamic discrete choice- demand estimation for consumer durables by incorporating backward compatibility into a framework with heterogeneous forward looking consumer who can multi-home (purchase more than one piece of hardware). We apply it using data from the home video game industry on seven consoles and their games spanning two product generations from 1995 - 2005. We use our estimates to obtain the marginal value of console backward compatibility on hardware share. Our results suggest backward compatibility oers hardware rms a signicant advantage over non-backward compatible competitors. However, backward compatibility increases the cannibalization of the associated previous generation hardware - an important factor for managers considering protability throughout the hardware lifespan. Also, we assess the eect of backward compatibility on hardware adoption for dierent consumer inventories. Interestingly, we nd backward compatibility has the greatest eect on non-adopters of the previous generation hardware.