This paper examines how incumbent firms with different levels of market dominance respond to revenue model innovation, i.e. the process by which revenues are generated and captured, and investigates the relationship between market dominance and different incentives to innovate. The empirical context of my research is the strategic behavior of online game operators (i.e. the companies who operate online games) in the Chinese online game market — the most active market in the world with strong network effects.

Facing revenue model innovation, incumbents have to make some response so as to secure their revenue streams and try to sustain the company’s competition in the industry’s future growth. Three options are usually available to them: 1) Stop using the existing model and invest in the revolutionary model narrowly; 2) Still make the narrow investment in the existing model and merely make it more efficient; 3) Diversify the investment via combining the existing model with the revolutionary model in the company’s operation.

A widely held view is that dominance and profits maintain a static relationship and dominant incumbents are less innovative than non-dominant incumbents because of the need to protect their traditional business model. Velu from Cambridge University in his PhD thesis [17] shows that the dominant firm is more innovative and the power to influence the success of a new business model from the strong network effects of the installed customer base makes the dominant firms commit to a particular narrow investment. He further proposes that less dominant firms tend to diversify their investments due to the threat of lock-out as a result of their weaker ability to influence the success of the investment. All his propositions are supported by the investment strategies of the incumbent dealer banks in the US fixed income market, another industry with strong network effects.

In this research, the authors extend Velu’s research by challenging some of his propositions. By considering an undifferentiated market served by two firms, Velu develops his game theoretic model by only considering two players. During this study, we incorporate around 40 public and private Chinese online game operators with different market dominance to understand how dominant and non-dominant incumbent firms innovate their revenue model. There seems no scholarly research concerning how the middle and small Chinese online game operators react to the revolutionary innovation for surviving and future growth within the Chinese online gaming context. As a consequence, this research should provide insights into this academic blind spot and rationalize the diversity of strategic theory within the specific industry. In the Findings Part, this paper explains why acquisition is regarded by main dominant game operators as the most effective way to complement their revenue model evolution.