Acquisitions, Entry, and Innovation in Network Industries

In industries with network effects, incumbents’ installed bases create barriers to entry that discourage entrepreneurs from developing new innovations. Yet, entry is not the only commercialization route for entrepreneurs. We show that the option of selling to an incumbent increases innovation incentives for entrepreneurs when network effects are strong and incumbents compete to preemptively acquire innovations. We thus establish that network effects and installed bases do not necessarily restrict innovation incentives. We also show that network effects promote acquisitions over entry and that the entrepreneur has strong incentives to invest in the initial user base of the innovation.