Network externalities, product compatibility and process innovation

This article augments d’Aspremont and Jacquemin’s (1988, 1990) cost-reducing R&D duopoly by introducing network externalities and product compatibility and then considers the investment decision stage. For standard non-network industries, the received literature has robustly shown that the non-cooperative R&D investment decision game is, without technological spill-over, a prisoner’s dilemma with investing firms (there is a conflict between self-interest and mutual benefit of investing in R&D), and a deadlock (there is no conflict between self-interest and mutual benefit of investing in R&D) only whether the extent of technological spill-over is sufficiently high. Network externalities and product compatibility challenge this result. In fact, outcomes antithetical to those emerging in a non-network industry do exist. Under symmetric full compatibility, the game is a deadlock also without spill-over effects. Under symmetric incompatibility, the game can be a prisoner’s dilemma irrespective of the extent of the technological spill-over. From a policy perspective, the article shows that R&D subsidies or taxes can be used as social welfare maximising tools depending on the extent of the network externality and the degree of product compatibility. The work focuses on Cournot rivalry, but results hold also for price-setting firms (Bertrand rivalry).