MERIT-Infonomics Research Memorandum series Structural change in the presence of network externalities: a co-evolutionary model of technological successions

The paper examines the conditions under which technological successions can occur in the presence of network externalities. A two-stage, multi-agent simulation model is presented in which product designs co-evolve with consumer preferences. It provides a rich framework in which to study the complex phenomenon of quality. Following an initial period, in which old technology firms develop their designs and externalities accrue, a technological shock occurs. New technology firms and new consumer classes enter the market. Data from the simulation model is analysed by identifying a robust econometric model of the probability of succession, given the immediate state of the post-shock market. 4 factors affecting the probability of a succession are identified. First, succession can occur if gains in direct utility from higher quality new technology goods outweigh the network utility of old technology goods. Second, sailing ship effects are possible. Old firms can innovate in order to see off the new entrants. Hence, a better initial (new technology) design does not guarantee succession. Third, a trade-off exists between quality and price. A succession will not occur if cost (price) differentials favour the old technology. Consequently, increasing returns in production enjoyed by established firms are an important barrier to successful entry. The fourth factor is time: the relative length of time old firms have to develop their products, and that which new firms have to develop their products.