Abstract
We examine a vertically differentiated duopoly where firms invest in process and product innovation and then compete in prices under full market coverage. We show that (i) process and product innovation are complements (substitutes) for the low-quality (high-quality) firm; (ii) the firm which is initially more efficient invests more than the rival in process innovation; (iii) if the initial differential between marginal costs is sufficiently high, the demand for the less efficient firm is nil and the duopoly equilibrium does not exist. Finally, we investigate the feasibility of R&D cooperation for process innovation.
Highlights
IntroductionThe analysis of vertically differentiated market conveys two main messages, that can be summarised by saying that (i) if quality improvements mainly hinge upon fixed costs, the number of firms that can survive at equilibrium with positive profits is finite, and (ii) there exists an incentive for earlier entrants to fill quality niches starting from the top
We show that (i) process and product innovation are complements for the low-quality firm; (ii) the firm which is initially more efficient invests more than the rival in process innovation; (iii) if the initial differential between marginal costs is sufficiently high, the demand for the less efficient firm is nil and the duopoly equilibrium does not exist
The analysis of vertically differentiated market conveys two main messages, that can be summarised by saying that (i) if quality improvements mainly hinge upon fixed costs, the number of firms that can survive at equilibrium with positive profits is finite, and (ii) there exists an incentive for earlier entrants to fill quality niches starting from the top
Summary
The analysis of vertically differentiated market conveys two main messages, that can be summarised by saying that (i) if quality improvements mainly hinge upon fixed costs, the number of firms that can survive at equilibrium with positive profits is finite, and (ii) there exists an incentive for earlier entrants to fill quality niches starting from the top. Notwithstanding the fact that, as casual observation suggests, product and process innovation very often coexist in firms’ R&D portfolios, the interplay between investments for quality improvement and marginal cost reduction has been rarely analysed so far, with the relevant exception of Bonanno and Haworth (1998) They examine a vertically differentiated duopoly where either the high- or the low-quality firm may choose whether to activate an R&D project for either process or product innovation. The present setup allows us to examine the presence of complementarity or substitutability between different activities in a firm’s R&D portfolio In this respect, quite unlike the current wisdom on this matter, we find out that product and process innovations are complements for the low-quality firm while they are substitutes for the high-quality firm.
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