Product Adoption and Profitability in an Industry with Malicious Market Players

Abstract:     
The development of the World Wide Web has created opportunities for malicious agents to attack information assets on an unprecedented scale. Harmful applications such as viruses and spyware can cause significant financial loss as well as other negative consequences. Software products with larger installed bases, and therefore more potential computers to attack, present more appealing targets for malicious agents. More appealing targets attract more attacks, and this increased vulnerability creates a negative externality for users of the product. This negative externality, and its impact on market share and profits, is the focus of this paper. We model a competitive environment in which software products are not only differentiated horizontally and vertically, but are also subject to a negative network effect driven by the presence of malicious market players. We find that the threat to consumers of malicious attacks can create perverse incentives for software firms, and can actually result in a preference on the part of these firms for malicious activity, as it enables increased profits. We also describe situations in which malicious activity allows a firm with an inferior product, which would otherwise not be a viable competitor, to operate profitably.

Keywords: information system security, network externalities, pricing of information

JEL Classifications: L1, D43, L86, D62, M21

Working Paper Series