How Strong Buyers Spur Upstream Innovation

38 Pages Posted: 13 Feb 2006

See all articles by Roman Inderst

Roman Inderst

Goethe University Frankfurt

Christian Wey

University of Düsseldorf - Düsseldorf Institute for Competition Economics (DICE)

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Date Written: December 2005

Abstract

We challenge the view that the presence of powerful buyers stifles suppliers' incentives to innovate. Following Katz (1987), we model buyer power as buyers' ability to substitute away from a given supplier and isolate several effects that support the opposite view, namely that the presence of powerful buyers induces a supplier to invest more in cost reduction. In contrast to negotiations with smaller buyers, the outcome of negotiations with large buyers is fully determined by their more valuable alternative supply option. This increases the supplier's incentives to reduce marginal costs, both as the supplier receives a larger fraction of the thereby generated incremental profits and as this makes buyers' alternative supply option less valuable. The latter effect is due to downstream competition between buyers and, as we show, is also stronger the larger and thus the more powerful buyers are.

Keywords: Buyer power, merger, investment incentives

JEL Classification: D43, L12, L41

Suggested Citation

Inderst, Roman and Wey, Christian, How Strong Buyers Spur Upstream Innovation (December 2005). CEPR Discussion Paper No. 5365, Available at SSRN: https://ssrn.com/abstract=883702

Roman Inderst (Contact Author)

Goethe University Frankfurt ( email )

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Frankfurt am Main, Hessen 60629
Germany
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+49 (69) 798-35000 (Fax)

HOME PAGE: http://www.wiwi.uni-frankfurt.de/en/departments/finance/lehrstuhl/prof-dr-roman-inderst/team

Christian Wey

University of Düsseldorf - Düsseldorf Institute for Competition Economics (DICE) ( email )

Universitaetsstr. 1
Duesseldorf, NRW 40225
Germany
+49-211-81-15009 (Phone)
+49-211-81-15499 (Fax)

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