R&D Investment and Technological Appropriability in a Preemption Model

Abstract

In a continuous time model with stochastic demand, two firms compete in R&D, with the lead patent affecting the probability of success of a second innovation competing in the same product market; the size and direction of this effect characterize the level of appropriability. From this characterisation, four representative mechanisms of R&D investment emerge. When appropriability is weak, investment in more challenging innovations (with low probability of success) is pulled by the demand, that is, low appropriability is supplemented by late R&D investment so that the market demand is sufficiently high to support both firms on the product market. Instead when innovations are more likely to succeed, early investment by the leader (at a low level of the demand) deters the rival from investing soon after; thus, weak appropriability is supplemented by early leadership, and hence an early and persistent monopoly can be the endogenous outcome of weak appropriability. The opposite scenarios emerge with strong appropriability and low/high probability of success in R&D. Understanding the interconnectedness between appropriability and technological opportunities and its role in identifying investment drivers is important as the response of R&D investments to adverse changes in the demand differs according to the investment mechanism in action. Also, unlike previous studies, we find that, with demand-pulled innovations, preemption delays investment above the non-strategic investment threshold of a single firm. Furthermore, as an early monopoly can emerge from weak appropriability, we find that the monopoly duration increases with respect to the innovation hazard rate the weaker the appropriability and the more volatile the demand.

Keywords: real options, geometric Brownian motion, Stackelberg games, intellectual property, R&D, appropriability, spillovers

JEL Classification: C7, D8, O3, K4