How process innovation affects vertical product innovation in a part-coverage market with network externalities

Through an extended vertically differentiated model, how process innovation affects vertical product innovation is investigated in a partly covered duopoly market which exhibits network externality. The aim of vertical product innovation (resp. process innovation) is to improve product quality (resp. lower marginal cost). Assuming the cost of quality may be variable or fixed, the following conclusions are found: (i) process innovation lowers (resp. improves) vertical product innovation efforts for high-quality (resp. low-quality) firm and product differentiation increases with the intensity of network externality in both types of quality cost; (ii) how process innovation affects product differentiation may be different in two types of quality cost.