The Monetization of Innovation *

Abstract

We develop a dynamic model for digital service firms, which invest in monetization to generate revenues from services provided to customers for free. A key novelty of our model is that we separate customer acquisition by firms from the generation of revenues. Our model explains why such firms often build a large customer base and become highly valued while continuing to suffer losses-traditional models would struggle to explain this pattern. Counterfactual analysis reveals that monetization uncertainty slows technological advancement by diverting resources away from innovation. We show that regulation aimed at protecting user privacy has sizable adverse effect on firm size and service quality but, perhaps surprisingly, makes firms less unprofitable.

Keywords: Monetization, Innovation, Digital service firms, Data privacy, Regulation. JEL Classification Numbers: D21, G31, O31, O32

JEL Classification: D20; G31; O31; O32