Abstract
We explore the impact of downstream competition on upstream innovation in a supply chain consisting of an upstream supplier who invests in innovation and downstream manufacturers who sell to consumers. We show that the impact of downstream competition between manufacturers on innovation depends on the contract form linking the manufacturers and the supplier. If it is the supplier who sets the wholesale price, downstream competition does not affect upstream innovation. However, if it is the manufacturers who set wholesale prices, downstream competition can induce more innovation in a supply chain. If the manufacturers and the supplier bargain, downstream competition can either increase or decrease upstream innovation. Moreover, these results are robust under the presence of a complementary component supplier. We also compare the effects of contract forms in motivating upstream innovation and demonstrate that all firms within a supply chain can be better off by giving the supplier more channel power, i.e., letting the supplier set the wholesale price rather than bargaining.
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