Product innovation and firms’ ownership

Abstract

This paper explores (i) the incentives for an incumbent firm to acquire an entrant willing to sell a product innovation rather than openly competing with this entrant, and (ii) in case of acquisition, the incentives to sell simultaneously both the existing products and the new one rather than specializing on a single variant. We prove that, in some circumstances, an incumbent firm can find it profitable to make an acquisition proposal to the entrant. Nevertheless, in this acquisition scenario, a product proliferation strategy is never observed at equilibrium. Furthermore, while being available for sale, sometimes the innovation simply remains unexploited.

Keywords:

• innovation
• acquisition
• vertical differentiation

Acknowledgements

We have benefited from useful comments from Paul Belleflamme, Cristiano Antonelli and two anonymous referees. Any remaining errors are ours.

Notes

While invention can be intended as a stochastic activity, ‘a commercializable innovation is one in which all technological uncertainty has been resolved (e.g. a prototype exists) and so, with (known) investments, could be introduced into the market’ (Aghion and Tirole 1994).

Recently, an increase in this phenomenon of innovation by acquisition has been observed. Data and further comments on this practice can be found in Norbäck, Persson, and Svensson (2011).

As stated in the epigraph, there are numerous examples of such acquisitions of products originated, which were later gobbled up by one of the big players (Google, Microsoft, Yahoo, IBM, Oracle, etc.). To this respect, ‘There are plenty of other prominent examples. How about Postini (bought by Google), YouTube (bought by Google), Feedburner (bought by Google), Flickr (bought by Yahoo), Delicious.com (bought by Yahoo), and we could just keep going’. ‘Innovation by Acquisition’ Mind (Royal Pingdom 2010).

Similar results are given in Hsu (2006).

As in some circumstances, under acquisition, the buyer decides to leave the innovation unexploited, our work also resembles the ‘sleeping patents’ argument.

We refer the interested reader to Siebert (2003) for a detailed discussion of this issue.

This assumption guarantees that competition develops in a natural duopoly framework: exactly two firms, and no more, can make strictly positive profits at an interior price equilibrium.

See the appendix for details on these equilibrium values.

It can be easily found that this threshold value [fcirc] is equal to 3l/(2x−4). See Lemma A2 in the proof of Proposition 4 provided in the appendix.

Note that, with some minor changes, one could interpret the quality gap among variants as a technological gap, thereby stating the above conclusion in terms of process innovation rather than in terms of product innovation. Nevertheless, this would not be completely true to the Schumpeterian definition of a process innovation, which is rather intended as a new method of production. To embed this further dimension in the analysis, one could introduce some new elements and define firms’ efficiency in terms of cost function. However, such type of analysis goes far beyond the purpose of the present paper.

Thus, contrary to what we found in the current version of the game, under this new timing, the absolute innovation would be never left sleeping.

This would be only prevented when the entrant would be at the bottom of the quality ladder. Still, this case is not contemplated in our analysis.

Indeed, the larger the gap between the variants in the market, the higher the resulting profits for each competing firm. Furthermore, even in the case when both the variants u _F and u _L would be offered, the price of the low-quality variant at equilibrium would still be equal to zero.

See the appendix for details.

This result still holds if the timing of the game is reverted, thus allowing the low-quality incumbent at the first stage to make the acquisition proposal and postponing the high-quality incumbent's proposal at the second stage of the game.

This is observed whenever the innovation is left unexploited.

A recent analysis on this issue is provided by Bonnisseau and Lahmandi-Ayed (2006).