R&D Expenditure and Entry Deterrence in Presence of Network Externality

The existing literature suggests that an incumbent monopolist supplier of a network good can successfully deter entry by increasing its installed base, which plays a role similar to that of the commitment value of investment in capacity. In this paper, we consider a market with network externality, where the consumers' utility not only depends on the network size but also on the technological quality of the product. We show that when the installed base of the incumbent fails to play its preemptive role to deter entry, the monopolist can deter entry, strategically by revealing its R&D expenditure on upgrading the product. The result is independent of whether the R&D project is, ex-post, successful or not. Such entry deterrence is welfare reducing