Competition and Innovation in Markets with Technology Leaders

Abstract

In this article, we consider technology leaders (which are innovators) and technology followers (which are non-innovators) to provide a new theoretical explanation for the well-cited empirical evidence of an inverted-U relationship between competition and aggregate innovation. We consider a two-stage game with a deterministic Research and Development (R&D) process, where the leaders first determine their R&D investments simultaneously and then all leaders and followers determine their outputs simultaneously. We show that the inverted-U relationship between competition and aggregate innovation occurs if competition is affected by the number of technology followers. However, the presence of more technology leaders decreases individual R&D investments while increasing aggregate R&D investments. If the total number of firms remains the same but the composition of technology leaders and followers changes in favor of leaders (followers), individual R&D investments decrease (increase) but aggregate R&D investments increase (decrease). The relationship between competition and R&D investments can be U-shaped if the intensity of competition is measured by product substitutability. Contrary to the standard expectation, the presence of more firms may reduce welfare.

What Drives Innovation within a Business

“…Competition also holds multiple variables regarding the aspect being competitive. Ku-Chu Tsao's research (Tsao et al, 2021) elaborates on the notion that an increase in the number of firms would lead to a decrease in quality investments if the number of firms correlated with competition. Their research theorizes that a larger density of firms could cause an increase in investment quality, and subsequently innovation, if the competitive intensity contributes to the symbiotic benefit of the cost of quality improvement for companies.…”