Growth Incentives to Invest in a Network Externality Environment

Firms that operate in the telecommunications industry often have to make large and risky investments in digital infrastructure. This paper examines how firm size affects the incentive to invest in infrastructure projects in industry environments that incur substantial network externalities. We suggest that, in the presence of network externalities, a firm's rate of growth first declines and then increases with the size of its user base. An implication of this result is that firms may benefit from making investments in emerging digital infrastructure early enough to achieve a substantial user base and to gain that user base before other firms' investments pre-empt them. The results mean that firms that undertake earlier successful investment may achieve pre-emption very quickly. The sources of network externalities contribute to the incidence of strategic alliances in network industries, particularly when coupled with the pressures of technical uncertainty.