Volume 18, Issue 7:

Morten I. Kamien and Israel Zang

"Meet me halfway: Research joint ventures and absorptive capacity"
JEL codes: L1; O3
Keywords: Joint ventures; Absorptive capacity; Subgame perfect Nash equilibrium

Abstract: We propose a formulation of a firm's "effective" R&D investment level that reflects how both its R&D approach and spending level influences its ability to realize spillovers from other firms' R&D activity, i.e., its "absorptive capacity." This formulation reduces to the one commonly employed to represent a firm's effective R&D investment level, when the firm takes a general R&D approach. The ability to choose an R&D approach is accommodated by positing a three stage game in which the choice of an R&D approach is made in its first stage. The firm's R&D spending levels and output levels are chosen in the game's second and third stages. It is found that, in the presence of impediments to the firms' cooperating in the setting of R&D spending levels, that they choose less general, more firm specific R&D approaches, while in the absence of such impediments they choose the R&D approaches that favor cooperation in the setting of R&D expenditure levels. Thus, cooperation in R&D spending not only increases total spending but also facilitates the undertaking of more basic R&D. The analysis also suggests that the commonly employed representation of firms' R&D investment levels implicitly presupposes that the firms have chosen R&D approaches that facilitate cooperation in their R&D spending level decisions.

Rabah Amir

"Modelling imperfectly appropriable R&D via spillovers"

JEL codes: C72, D43, L13
Keywords: R&D spillovers, R&D cooperation, returns to scale in R&D, model validity

Abstract: We provide an extensive comparison of the R&D models of d'Aspremont-Jacquemin (1988) and Kamien-Muller-Zang (1992), exposing full or partial conflict in key conclusions and policy prescriptions. Using three separate formal and/or intuitive criteria, we argue that the first model is of questionable validity for large spillover values, the latter being characterized by jointly increasing returns to scale in the R&D process. An argument leading to equivalence between the two R&D processes, but not to agreement on some key conclusions, is exposited. In conclusion, the models emerge as fundamentally different, although a unilateral shift in the cost function of the first leads to agreement in all equilibrium outcomes.

Luis M. B. Cabral

"R&D Cooperation and Product Market Competition"

JEL codes: L1
Keywords: R&D cooperation; collusion; supergames

Abstract: I derive equilibria (that is, self-enforcing agreements) for firms that cooperate in improving their product and compete in marketing it. I am particularly interested in the interaction between R&D and product market decisions along optimal equilibria (that is, equilibria that maximize firm value). I assume that (i) the product is homogenous and any product improvement is a public good (in other words, spillovers are complete); (ii) product improvement is a function of the effort by each firm; (iii) firms cannot observe each other's effort; (iv) firms market the product by simultaneously setting prices. The analysis reveals some surprising results. I find that, in some cases, although monopoly prices can be sustained in equilibrium, optimal equibria call for firms to set lower-than-monopoly prices in the short run, thus providing the right incentives for investment in R&D. Under a different set of assumptions, I find that it is optimal to reduce R&D effort below the efficient level as a mean to sustain short-run collusion in prices, even though efficient R&D effort could be achieved in equilibrium.

J. Jude Kline

"Research Joint Ventures and the Cost Paradox"

JEL codes: L13; O31
Keywords: Research Joint Venture; Cost Paradox

Abstract:  We consider the impact of the cost paradox on the likelihood of cooperative firms to use a cost reducing Research Joint Venture (RJV) to increase research levels when spillovers are large. The cost paradox (CP) occurs whenever industry-wide cost reductions would lead to such intense competition that profits would fall. We give a restriction on cost reducing research which guarantees that an RJV   will prefer marginal reductions in research to the noncooperative levels whenever CP would  arise and spillovers are less than perfect. In such cases, firms use an RJV to lessen competition rather than to lower costs.

Lambson, Val E.

"Sunk costs, entry and the timing of cost-reducing investment"

JEL codes: L12
Keywords: Sunk costs; Entry

Abstract: The traditional IO literature asserts that firms with monopoly power produce less efficiently than competitive firms and that they often reduce costs only after entry delivers a "wake-up call". A model with sunk costs and uncertaintly can explain this phenomenon. If becoming more efficient entails sunk costs, imcumbents have an incentive to wait until a competitor´s efficiency is revealed by actual entry before deciding whether to make the investment. This "uncertainty resolution" incentive can outweigh incumbents´ incentives to attempt entry preemption.

Fiona M. Scott Morton

"Barriers to entry, brand advertising, and generic entry in the US pharmaceutical industry"

JEL codesL12; L13
Keywords: Quality competition; Vertical product differentiation; R&D

Abstract: This paper examines the entry decisions of generic pharmaceutical manufacturers into markets opened by patent expiration. In particular, I examine the role of pre-expiration brand advertising to see if it deters generic entry. Other drug characteristics affect the number of entrants; the most important of these is pre-expiration brand revenue. Drugs that treat chronic conditions and drugs that are oral solids attract more entry. The previous literature has assumed advertising is exogenous to the entry decision when analyzing the role of advertising. The results under this hypothesis indicate that brands may affect generic entry very slightly by advertising before patent expiration, but two opposing effects render the result nearly insignificant. When instrumented, the coefficient on advertising is completely insignificant. I conclude that brand advertising is not a barrier to entry by generic firms into the US pharmaceutical market.

Kanniainen, Vesa & Takalo, Tuomas

"Do Patent Slow Down Technological Process?"

JEL codes: D92; L10; O31
Keywords: Patents; Real options; Sequential investments

Abstract: This paper challenges the widely held view in the industrial organization literature that patents always speed up technological progress. We introduce a model of an innovating firm with uncertain property rights to its innovation. The impact of a commitment to an R&D project is to create future options for patenting and market introduction. Each decision undertaken will change the conditions in which the innovator is operating. It is shown that an increase in patent width or in expected life of patent reduces the elasticity of the option value of the program with respect to the value of the project raising the threshold value of market introduction and enhancing the ability of the innovator to wait. Thus, while the effect of patent is to raise the rents on and thereby the potential amount of innovations, it also tends to slow down market introduction.

Fosfuri, A.
"Patent protection, imitation and the mode of technology transfer"
JEL codes: O34, F23; D45
Keywords: International technology transfers; imitation; patent protection

Abstract: This paper analyzes a model in which a firm endowed with a new technology can choose between exports, licensing and direct investment as entry modes in a foreign market. I endogenize the vintage of the transferred technology and allow for imitation by the licensee. Subsidiary production and exports circumvent imitation by involve higher costs for the innovating firm. The firm can strategically use the vintage of the technology to deter imitation by the licensee. As a result, transfers to affiliates might be of later vintage than technologies sold to outsiders. Through modification of the imitation costs, the host country´s system of patent protection influences the mode of technology transfers which in turn affects the welfare of the recipient economy.