Product positioning and incentives to innovate

This paper shows that product positioning affects the incentives to invest in process innovation. The result is found using a model of price competition with three firms under horizontal product differentiation - and then extended to a more general Bertarnd triopoly. The central firm may have a higher gain from a cost reduction than the peripheral firms, even if it reaps a lower profit or has a lower demand. By contrast, the peripheral firms have a larger gain if, and only if, they also have larger profits. Furthermore, we argue that the central firm exploits a reduction in the marginal cost mainly to expand its sales, whereas the peripheral ones to increase their mark-up. We finally show that the aggregate innovation incentives are larger the more clustered toward the center are the firms and the larger the pre-innovation cost asymmetry. We also analyze the effects of mergers on innovation incentives, confirming that they tend to reduce the merged firms’ incentives to innovate.