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To Hunt Or to Scavenge: Optimal Investment Strategies in the Presence of Indirect Network Effects

Sarit Markovich

Northwestern University

Johannes Moenius

University of Redlands

February 2007

What determines optimal R&D investment in a market with indirect network effects? We analyze this question in a hardware-software framework, where software firms strategically invest in quality upgrades. We find that a firm's optimal investment depends predominantly on (1) its quality level relative to its competitors on the same hardware and on (2) the quality level of software firms on the same hardware relative to other hardware platforms. Using a dynamic model, we examine the effect of initial quality differences within and across platforms on firms' investment behavior. We show that small quality differences across platforms stimulate investment across firms on the same platform, regardless of their current quality level. However, large quality differences across platforms affect competition within platforms such that a firm's quality level relative to competitors on the same platform may increase or reduce its incentives to invest. In this case, responses to own and cross quality upgrades are determined by the overall market structure. The two different responses - increased or reduced investment, give rise to a taxonomy of optimal investment strategies. Since responses depend on market structure, we can then map a firm's position within the market into its optimal investment strategy.

Number of Pages in PDF File: 32

Keywords: Network Effects, Investment, Strategy, Computer Industry

JEL Classification: L11, L13, L63, M2

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Date posted: February 23, 2006  

Suggested Citation

Markovich, Sarit and Moenius, Johannes, To Hunt Or to Scavenge: Optimal Investment Strategies in the Presence of Indirect Network Effects (February 2007). Available at SSRN: https://ssrn.com/abstract=884324 or http://dx.doi.org/10.2139/ssrn.884324

Contact Information

Sarit Markovich
Northwestern University ( email )
2001 Sheridan Road
Evanston, IL 60208
United States
Johannes Moenius (Contact Author)
University of Redlands ( email )
PO Box 3080
Redlands, CA 92373-0999
United States
HOME PAGE: http://www.redlands.edu/Johannes_Moenius.xml
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