Recently, as informatization of transactions and digitization of product itself progress, the influence of network externalities is increasing. The reason why network externalities receive so much attention is that they fundamentally lead to fierce price competition between products. Following this trend, in this paper, we study the effect of quality and compatibility on the price competition between products under network externalities. To do this, we first present a new market model incorporating quality, network externalities and compatibility. Based on the presented model, the Nash and Stackelberg equilibrium solutions are derived and analyzed numerically. The results can be summarized as follows: First, when the quality difference between products is small, the Nash method of pricing is optimal, whereas when the quality difference is large to some extent, the Stackelberg method of pricing is optimal. Second, in the case of the low quality product, it was shown that there are situations where it is necessary to intentionally lower its own quality for more profit. Third, it was also shown that compatibility mitigates the effects of network externalities.

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.