Upgrading or Replacing: A Decision for Innovation Products with Network Externalities

Upgrading or replacing is an important choice for products innovation, especially for the products with network externalities. This paper develops a two-period duopoly model to describe the influence of compatibility with the established industry standard, by using the method of undercut-proof equilibrium in game theory. Two factors, including product quality and expected market share, are added in the model to analyze profits from the decisions of upgrading or replacing in products innovation. The results show that there is no unique optimal strategy for the firms, and firms have to make their decisions according to the qualities and the expected market share of upgrade or replacement products, as well as the install base of the original product.