Product Positioning and Incentives to Innovate

ABSTRACT 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 Bertrand 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 markup. We finally show that the aggregate innovation incentives are larger the more clustered toward the center are the firms and the larger the preinnovation cost asymmetry. We also analyze the effects of mergers on innovation incentives, confirming that they tend to reduce the merged firms' incentives to innovate.