Working Paper

The Monetization of Innovation

Abstract: We develop a dynamic model for digital service firms, which invest in monetization to generate revenues from services provided to customers for free. Our model captures and explains why such firms often build a large customer base and become highly valued while continuing to suffer losses—traditional models would struggle to explain this pattern. Counterfactual analysis reveals that monetization uncertainty slows technological advancement by diverting resources away from innovation. We also show that regulation aimed at protecting user privacy has sizable adverse effect on firm size and the quality of the offered service but, perhaps surprisingly, makes firms less unprofitable. On the other hand, regulation encouraging competition supports innovation.

Keywords: monetization; data privacy; digital service firms; innovation; regulation;

JEL Classification: D21; G31; O31; O32;

https://doi.org/10.17016/FEDS.2022.084

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Finance and Economics Discussion Series

Publication Date: 2022-12

Number: 2022-084