By modifying a vertical-differentiation model, the relationship between the vertical product innovation and process innovation is investigated in duopoly markets with network externalities. The purpose of vertical product innovation (resp. process innovation) is to improve product quality (resp. lower marginal cost). When firms decide product quality first and then perform process innovation, the following conclusions are found: (i) the vertical product innovation may lower (or increase) process innovation efforts; (ii) the network externality may change the relationship between vertical product innovation and process innovation.
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