Network externalities, compatibility, and R&D strategies

This paper analyzes the effects of network externalities and compatibility on R&D incentives and R&D strategies. It finds that there exists a threshold endogenously generated by network externalities, compatibility and product differentiation. When innovator's R&D investment efficiency is higher (lower) than the threshold, R&D investment will increase (decrease) in network externalities. This conclusion effectively explains why firms in developed countries have stronger R&D incentives than that in developing countries within markets with network externalities. For innovators with lower R&D investment efficiency, improving R&D investment efficiency, increasing compatibility and enlarging differentiation are good approaches to contradict the negative effects of network externalities on it. At last, the effects of compatibility choices on social welfare are analyzed. This paper is of importance for strategic R&D competition within network industries in China.