Exploration and exploitation in the presence of network externalities

Abstract

This thesis 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). Throughout the 1990s, the workstation market and the PC market followed divergent evolutionary paths in response to RISC. In the workstation market, RISC replaced CISC. Sun prospered by effectively shifting its technology base from CISC to RISC, while Digital Equipment lost its market share quickly by delaying the adoption of RISC. In contrast, Intel in the PC market has continued to prosper by making its new products compatible with the CISC architecture. Apparently, ensuring network benefits turned out to be more important than enhancing performance in the PC market. These contrasting cases raise a question: Under what circumstances should incumbents explore a new, incompatible technology? This study is to address this question by modeling the situation of two competing technologies in the presence of network externalities. The main distinctions arise in two primary aspects. First, we evaluate the viability of exploring alternative possibilities by modeling the evolution of the whole system. The supply-side dynamics matter in the discussion of the lock-in problem. Yet, little attention has been paid to this in the literature, where much of the discussion is comprised of the demand-side factor focusing mainly on network externalities. The methodological stance here is close in spirit to Nelson and Winter (1977, 1982). A benefit of this approach is that one need not assume that buyers and sellers know the future consequences of their choices. Thus far, standard economic analysis with this assumption has not been able to address how new, incompatible technologies are successfully introduced under uncertainty. Second, we clas...