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Published by Core Research

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Published by: Core Research on Jan 09, 2009
Copyright:Attribution Non-commercial


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Preliminary - Comments Welcome
Incumbency and Competition in Innovation Markets**
First Draft: 3 June, 1997
This Version: 27 June, 1997

Economic analyses of the impact that concentration in product markets has on innovation in those markets has not, to date, generated clear predictions as to how such concentration influences the pace of innovation. We argue that economic theory has neglected the possibility, and indeed likelihood, of licensing by or acquisition of entrants by incumbents. By considering this more complete picture of reality, we argue that regulatory uncertainty over licensing and acquisition of entrants has an direct effect on innovation incentives of entrants and through this a strategic effect on incumbents. These effects are particularly telling if entrants are more productive than incumbents for organisational or incentive reasons. Second, there is no reason to suppose that rapid opportunities for innovation will reduce market power in downstream product markets. Instead, the critical conditions rely on the relationship between innovation and the creation of information asymmetries between incumbents and entrants.

Third, the possibility of cannabilisation of incumbent assets can potentially create greater disincentives for entrants than for incumbents. Finally, the pre- emption effects that have raised anti-trust concerns do not matter when licensing is possible.

** This paper was prepared for the Australian Law and Economics Association Annual Conference,
University of Melbourne, 4-5 July, 1997. We thank Peter Cebon for helpful comments on an earlier draft
of this paper.
* University of Melbourne and MIT, respectively. All correspondence to: A/Prof. Joshua Gans, Melbourne
Business School, 200 Leicester Street, Carlton,

Australia; E-mail: J.Gans@mbs.unimelb.edu.au; Fax: +61-03-9349-8133. The latest version of this paper is available at: htt


There is a long standing concern in economics regarding the interaction between innovation and market structure. To this end two key, related classic questions have been posed:

\u2022 What are the relative incentives of incumbents and entrants to generate innovations?
\u2022 How does successful innovation itself influence market structure?

Since Schumpeter these questions have been seen as intimately related. That is, an answer to the first question determined the answer to the second. If it was argued that incumbents were more likely to generate innovations than entrants, then it could be equally argued that monopolies would persist in the post-innovation market. On the other hand, it was predicted that markets would become more competitive over time if entrants had greater innovation incentives than incumbents.

The close relationship between these questions comes from an implicit assumption about the link between successful innovation and product market entry. In particular, as depicted in Figure One, it was assumed that successful innovation by an entrant led to entry into the product market and that no entry would otherwise occur. In effect, this amounts to two assumptions: (1) that innovation is the springboard of entry; and (2) that entrants with innovations must enter product markets to realise the returns from their innovation.

Figure One: Traditional Conception
Product Market

The starting premise of this paper is to challenge this view of the relationship between innovation and product markets. In so doing, we argue that the tight linkage between the two classic Schumpeterian questions is misplaced. Our challenge rests on the notion that successful independent researchers have options other than product market entry that can assist them in deriving commericial value from innovations (see Teece, 1987). In particular, patentable innovations can be licensed to product market incumbents or, alternatively, independent research teams can themselves be acquired by incumbents. When independent research teams lack the complementary assets to become product market entrants, prima facie, this integration with incumbents will not have anti-competitive effects. Given the availability of these options, the appropriate framework for addressing the Schumpeterian questions is as in Figure Two, where licensing and acquisition as well as product market competition is an option for independent researchers.

Figure Two: Our Conception
Product Market
Licensing or
Bargaining and

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