Abstract
This paper analyzes implications of network compatibility and competition on process innovation in differentiated network goods duopoly. It shows that firms’ R&D investments are strategic substitutes (complements) if effective network compatibility is less (more) than product substitutability, regardless of the nature of product market competition. If R&D investments are strategic complements, firms always invest in process innovation and they invest more under Bertrand competition than under Cournot competition. If R&D investments are strategic substitutes, unlike Cournot firms, Bertrand firms do not always undertake process innovation; but when Bertrand firms also undertake process innovation, Cournot–Bertrand R&D ranking depends on the strength of network externalities. Presence of R&D spillover improves the case of strategic complementarity of R&D levels under both Bertrand and Cournot competition.
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