Exploration and Exploitation in the Presence of Network Externalities

Abstract

T his paper examines the conditions under which exploration of a new, incompatible technology is conducive to firm growth in the presence of network externalities. In particular, this study is motivated by the divergent evolutions of the PC and the workstation markets in response to a new technology: reduced instruction set computing (RISC). In the PC market, Intel has developed new microprocessors by maintaining compatibility with the established architecture, whereas it was radically replaced by RISC in the workstation market. History indicates that unlike the PC market, the workstation market consisted of a large number of power users, who are less sensitive to compatibility than ordinary users. Our numerical analysis indicates that the exploration of a new, incompatible technology is more likely to increase the chance of firm growth when there are a substantial number of power users or when a new technology is introduced before an established technology takes off.

Market Leadership Through Technology – Backward Compatibility in the U.S. Handheld Video Game Industry

“…Waldman (1993) and Choi (1994) find that price discrimination increases compatibility incentives, while Kende (1994) argues that backward compatibility is more likely as valuations for old and new technologies are similar and building an installed base of complementary products is expensive. These results are confirmed in a simulation model by Lee et al (2003), who find that low valuation for backward compatibility and a small installed base advantage of the old generation render backward compatibility less likely. Nahm (2008) finds that profits for the incumbent are higher with backward compatibility, which may increase its incentives to upgrade beyond the social optimum (Ellison and Fudenberg 2000).…”

Investigating the Determinants of Innovation According to Radical and Incremental Attributes

“…As competition intensifies and the pace of change accelerates, firms need to exploit existing competences or exploring new opportunities [5]. The concept of exploration and exploitation in innovation emerged from Danneels [6], Lee et al [7] and Rothaermel and Deeds [8] to investigate the capacity of firms to develop both types of innovation converting them in an ambidextrous organizations [9] [10]. There is little evidence of the study of exploratory and exploitative development.…”

“…In contrast to a radical innovation, an incremental innovation usually involves less cost and less impact on company profit, regardless of the importance of the continual incremental innovation to the firm's competitiveness. Thus, incremental innovation represents the addition of services attributes to an existing service in the same sense that exploitation and exploration innovation in Danneels [6], Lee et al [7], and Rothaermel and Deeds [8].…”

Winners Take Some: The Impact of Conversion Technologies on Network Effects in Digital Goods Markets

“…However, standardization can be difficult to achieve. The dominant firms may prefer not to be compatible with other products so that they can enjoy a number of strategic advantages such as a higher price premium (Brynjolfsson and Kemerer, 1996, Gandal, 1994, Gallaugher and Wang, 2002, a faster rate of market penetration (Kauffman et al, 2000, Zhu et al, 2006, the ability to deter potential entrants (Lee et al, 2003) and the possibility to control the design interface (Conner, 1995). Such allegations have been directed, for instance, at…”