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Abstract

In recent years, we have witnessed an unprecedented growth in the security software market. This market is now fiercely competitive with hundreds of nearly identical products; yet, the price is high and coverage low. Although recent research has examined such idiosyncrasies and found the existence of a negative network effect as a possible explanation, several important questions still remain: (1) What possibly discourages product differentiation in such a competitive market? (2)  Why is versioning absent here? (3) How does the presence of free alternatives in this market impact its structure? We develop a comprehensive oligopoly model, with endogenous quality and versioning decisions, to address these issues. Our analyses reveal that, although the presence of numerous competitors leads to a greater need to differentiate, the network effect in this market works as a counterweight, incentivizing vendors to sacrifice differentiation in favor of collocating in the top end of the quality spectrum. We explain the reasons and implications of this important finding. We further show that this result is robust and applicable even when versioning by competing vendors or the presence of free software is taken into consideration. Furthermore, given that the presence of free software actually intensifies competitive pressure and heightens the need to differentiate, the role of the network effect in abating differentiation becomes even more discernible.

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