Vertical Differentiation in the Market for Security Software

The market for security software has witnessed an unprecedented growth in recent years. A closer examination of this market reveals that, unlike a traditional software market, the use of vertical differentiation strategy is quite limited in this market. In this paper, we develop a quantitative model to explore the possible reason. Our model identifies a negative network externality effect as the primary reason for this divergence. Using our model, we show that, in this market, the vertical differentiation strategy would never be employed by a monopolist. We then extend our analysis to a duopoly competition and find that, although vertical differentiation may be adopted if the cost of development is sufficiently high, due to the presence of the negative network externality, the feasible region for differentiation is much more restricted when compared to a traditional market.