Integration and Competition for Innovation in Science-Based Industries

Abstract

We develop a model for how innovation competition affects the organization of research activity and property-rights allocation in science-based industries. We consider a vertical production process with division of labor between research and commercialization. We analyze firms' incentive for integration in the presence of upstream innovation competition. Integration adversely affects integrated firms' R&D investment and creates positive externality for independent firms. For a sufficiently strong externality, a semi-integrated structure appears in equilibrium. Thus, the model can explain the coexistence of integrated and independent research firms and conforms to evidence of R&D competition in science-based industries. A non-integrated arrangement can sometimes appear in equilibrium although a semi-integrated arrangement has higher innovation probability and aggregate industry payoff, because parties that gain from integration cannot commit to compensate losing parties at the contracting stage. We analyze the effects of resource constraints and inter-customer licensing on industry structure and their implications for innovation competition.