Integration and Competition for Innovation in Science-Based Industries

Abstract

We develop a model to understand how competition for innovation affects the organization of research activity and property-rights allocation in science-based industries. We consider a vertical production process with a division of labour between research and commercialization. We analyze firms’ incentive for integration in the presence of upstream competition for innovation. Integration adversely affects an integrated firm’s R&D investment and creates positive externality for the independent firms. For a sufficiently strong externality, a semiintegrated structure appears in equilibrium. The model can thus explain the coexistence of integrated and independent research firms and conforms to the evidence of R&D competition in science-based industries. Interestingly, a non-integrated arrangement can sometime appear in equilibrium even though a semi-integrated arrangement has higher innovation probability and aggregate industry payoff. This is because those who gain from integration cannot commit to compensate the losing parties at the contracting stage. We analyze the effects of resource constraints and inter-customer licensing on the industry structure and their implications for the competition for innovation.