Effect of piracy on innovation in the presence of network externalities

This paper analyzes the impact of simultaneous increases in piracy (piracy effect) and network externalities (network effect) on R&D investment. A single firm's R&D investment increases (or decreases) if the network effect (or piracy effect) is dominant. With R&D competition, if the firms “significantly” differ with respect to their R&D efficiencies and if the piracy effect dominates the network effect then the less efficient firm's R&D investment increases and that of the more efficient firm's decreases. In this case, the overall probability of successful innovation increases. The reverse holds if the network effect dominates the piracy effect. If the firms are “less” asymmetric then their R&D investment either increases or decreases depending on the relative strengths of the piracy and network effects.