Obtaining Strategic Advantage from Being Imitated: When Can Encouraging "Clones" Pay?

An important business strategy research theme concerns finding ways to minimize competition faced by the firm. This paper, however, focuses on a different set of situations: the model developed suggests that an innovator's best strategy may be to encourage "clones" of its product when a network externality is present. Key factors to consider in assessing whether encouraging cloning is the innovator's best strategy are: (1) the benefit to be derived in terms of added user base "contributed" by the clone sales, traded-off against (2) the unit sales that will be lost to the clone(s). These factors in turn depend upon the strength of the network effect and the degree to which the innovator's product quality is perceived by consumers to be superior to the clone's. The model further suggests that both the innovator and clone earn their highest payoffs when the clone takes the lead in price-setting, i.e., when the clone establishes its own price by considering, for each price it might set, how the innovator will react to that price, and the innovator, as price-follower, responds to the price the clone chooses. The paper demonstrates that the clone-leader/innovator-follower situation represents the unique Nash equilibrium in price-setting strategies. A central implication is that when operating in a network externality environment, instead of a problem to be avoided, clones may be valuable assets to an innovating firm, building up the user base for the innovator's technology by bringing lower-valuing consumers into the market, which in turn makes the innovator's product more attractive to high- and medium-valuing purchasers. Thus when the above-described conditions hold, being cloned can be more profitable for an innovating firm than dominating the market alone.