Many wearable device products come into the market recently. As a specific application of mobile health, wearable device has garnered attentions form both practitioners and scholars. In this paper, we investigate the impact of network externality and optimal product design of wearable device in a two-dimensional product differentiation model considering a market that has a broad product variety (horizontal differentiation) and various possible quality levels (vertical differentiation). Our model shows that in the presence of product variety competition and quality competition, firms will obtain the similar benefits when they supply differentiated and undifferentiated products without considering the network externality. In addition, we find that firms’ profits will be decreased in the presence of network externality in horizontal dominance differentiation, but increased in vertical dominance differentiation. Network externality has positive impact on higher-quality product’s profit, and also has positive impact on lower-quality product’s profit only when network externality is large. Furthermore, we also find that firms should let their products incompatible when network externality is large, and they should release compatible products when network externality is small.