Product compatibility as a signal of quality in a market with network externalities

In this paper, I consider the compatibility decision as a signaling device of the quality of a newly introduced technology of which users are not informed. Provided that firms are located sufficiently far apart in Hotelling's [0,1] interval, I find separating equilibria where low compatibility signals high quality. This possible separation is due to the fact that low compatibility is more advantageous to the high-quality entrant than to the low-quality entrant, since it can prevent users of the established technology from enjoying network benefits from the new technology very much. (C) 2002 Elsevier Science B.V. All rights reserved.