The information products dramatically reduce the production costs of vertically differentiated products. Information products are also more likely to be affected by network externalities. Thus the proliferation of digital products is increasing the interests in network externality and vertical product differentiation. In step with this trend, the impact of network externalities on price competition in vertically differentiated markets has been continuously studied. Existing studies related to this topic have assumed that network externalities increase consumers' willingness to pay per unit quality. The results show that higher quality products are affected more by network externality. However, network externality is essentially a concept affected by the size of the consumer, not a concept associated with quality. In this work, unlike previous studies, we present a new market model that reflects the essential definition of network externality. Based on the proposed market model, we derive both simultaneous and sequential Nash equilibria and analyze them numerically. The main results obtained from the analysis can be summarized as follows. First, network externalities primarily increase the demand for low-quality products and have a secondary impact on the demand for high-quality products. Second, the larger the quality difference between products, the more profitable they are. It also has been shown that sequential pricing methods are more advantageous in terms of revenue than simultaneous pricing method.

It is a general phenomenon for manufacturers to provide vertically differentiated product line for more profit through improved market coverage. For such manufacturers, the compatibility between vertically differentiated products is an important decision issue. Some manufacturers provide full compatibility between high and low version products, whereas some provide only downward compatibility for the purpose of recommending high version product. In this study, the two representative compatibility strategies, full or downward, between vertically differentiated products produced by a single manufacturer are analyzed, especially under network externality and in the viewpoint of profit maximization. To do this we used a market model which captures the basic essence of vertical differentiation and network externality. Based on the proposed market model, the profit maximizing solutions are derived and numerically analyzed. The results can be summarized as follows : (1) Regardless of compatibility strategy, under network externality, vertical differentiation is always advantageous in terms of profit. (2) The full compatibility strategy is shown to be the most advantageous in terms of profit. In addition, it is necessary to make quality difference between differentiated products as wide as possible to maximize profit. (3) To gradually drive low version product out of the market and shift the weight pendulum of market to high version product, it is shown that the downward compatibility strategy is essential. Unlike intuition, however, it is also shown that in order to drive low version product out of market, it is necessary to raise the quality of the low version product rather than to lower it.

Network externalities are essentially dynamic in that the value consumers feel about a product is affected by the size of the existing customer base that uses that product. However, existing studies on network externalities analyzed the effects of network externalities in a static way, not dynamic. In this study, unlike previous studies, the impact of network externalities on price competition in a vertically differentiated market is dynamically analyzed. To this end, a two-period duopoly game model was used to reflect the dynamic aspects of network externalities. Based on the game model, the Nash equilibria for price, sales volume, and revenue were derived and numerically analyzed. The results can be summarized as follows. First, if high-end product has strong market power, the high-end product vendor takes almost all benefits of the network externality. Second, when high-end product has strong market power, the low-end product will take over most of the initial sales volume increase. Third, when market power of high-end product is not strong, it can be seen that the effects of network externalities on the high and low-end products are generally proportional to the difference in quality. Lastly, if there exists a strong network externality, it is shown that the presence of low-end product can be more profitable for high-end product vendor. In other words, high-end product vendor has incentive to disclose some technologies for the market entrance of low-end product, even if it has exclusive rights to the technologies. In that case, however, it is shown that the difference in quality should be maintained significantly.

The proliferation of information technologies made it possible to produce information products of different versions at much lower cost comparing to traditional physical products. Thus it is common for information product manufacturers to consider vertically differentiated product line for more profit through improved market coverage. Another salient characteristic of most information product is network externality. Existing researches dealing with vertical differentiation and network externality usually assumed oligopolistic market where vertically differentiated products are provided by competing companies, respectively. Moreover, they analyzed the essentially dynamic characteristic of network externality statically. In this study, different from the previous researches, the vertical differentiation strategy of a monopolistic company under network externality is dynamically analyzed. We used a two-period model to accommodate the dynamic feature of network externality. Based on the two-period model, the profit maximizing solutions are analyzed. The results showed that a monopolistic company has no incentive to differentiate products vertically when the network externality is absent. On the contrary, when the network externality exists, the monopolistic company can derive more profit by vertically differentiating the product line. It is also shown that, for more profit, the monopolistic company should keep the quality difference between the high quality product and the low quality product as greater as possible.

Network externality can be defined as the effect that one user of a good or service has on the value of that product to other people. When a network externality is present, the value of a product or service is dependent on the number of others using it. There exist asymmetries in network externalities between the online and traditional offline marketing channels. Technological capabilities such as interactivity and real-time communications enable the creation of virtual communities. These user communities generate significant direct as well as indirect network externalities by creating added value through user ratings, reviews and feedback, which contributes to eliminate consumers’ concern for buying products without the experience of ‘touch and feel’. The offline channel offers much less scope for such community building, and consequently, almost no possibility for the creation of network externality. In this study, we analyze the effect of network externality on the competition between online and conventional offline marketing channels using game theory. To do this, we first set up a two-period game model to represent the competition between online and offline marketing channels under network externalities. Numerical analysis of the Nash equilibrium solutions of the game showed that the pricing strategies of online and offline channels heavily depend not only on the strength of network externality but on the relative efficiency of online channel. When the relative efficiency of online channel is high, the online channel can greatly benefit by the network externality. On the other hand, if the relative efficiency of online channel is low, the online channel may not benefit at all by the network externality.