Strategic R&D and Network Compatibility

We analyse the effects of network externalities in strategic R&D competition. We present a model of two firms competing with R&D investments and prices in a differentiated consumer market. Buyers form firm-specific networks which can be compatible. A high degree of compatibility and large spillovers moderate price competition due to weak strategic value of firm-specific networks and R&D investments, respectively. Asymmetry in product qualities brings out network effects that cancel out in conventional symmetric settings. The lower quality firm increases R&D and decreases its price as spillovers or network compatibility is increased. This happens when R&D and firm-specific network size have high strategic value