Quality choice of a new product development and network externality

Abstract

In a framework of hardware–software paradigm with network externality, this study analyses the resource allocation problem of a hardware firm, which is developing a new hardware system. By formulating a dynamic model of quality choice, this study shows that firm's long-run profit is sensitive to the network effect, especially to the provision of software varieties at the initial stage of development. The insights from this study can be applicable to the investment decision and resource allocation problems in rapidly developing network industries such as video console market or computer technology.