Competition favors the prepared firm: Firms’ R&D responses to competitive market pressure☆
Introduction
Market competition (or rivalry), and market structure in general, has been a central theme in the areas of strategic management and industrial organization, since it affects various aspects of firm behavior and market performance. In particular, the relationship between market structure and research and development (R&D) has been drawing a considerable amount of attention from both researchers and policy-makers. There is now a large body of literature on the relationship between market concentration and industry R&D (e.g., Lee, 2005, Aghion et al., 2005, Gottschalk and Janz, 2001, Van Cayseele, 1998, Symeonidis, 1996, Scherer and Ross, 1990, Geroski, 1990, Cohen and Levin, 1989, Angelmar, 1985, Kamien and Schwartz, 1982).
Unlike the abundance of studies on the effect of market competition, measured at the industry level by seller concentration ratios, on industry R&D, there are only a few studies that have examined R&D responses to competitive market pressure at the firm level. This is largely due to the difficulty of capturing the notion of competitive market pressure empirically. Furthermore, many studies (e.g., Cohen and Levin, 1989, Boone, 2000, Pereira, 2001, Tang, 2006) have pointed out that the predictions and findings of the existing studies on the effect of various forms of market competition on firm R&D behavior are diverse and often conflicting, mostly because of differences in theoretical models, ad hoc empirical specifications or data limitations.1 For example, Lee and Wilde (1980), Bertschek (1995), Blundell et al. (1995), and Nickell (1996) support the idea that competition favors innovation,2 while Loury (1979), using a patent-race model, and Martin (1993), using a Cournot principal-agent model, have shown that market competition has a negative effect on firms’ incentives to increase their R&D efforts.3 Meanwhile, after analyzing the R&D reactions of 308 U.S. corporations to high-tech import penetration in the U.S. markets during the years 1971–1987, Scherer (1992) and Scherer and Huh (1992) found that reactions varied widely from industry to industry, without any homogeneous behavioral pattern.
Several recent studies based on (production) cost asymmetry have predicted differential effects of competitive market pressure on firms’ incentives to invest in lowering production costs. Boone (2000) and Aghion and Schankerman, 1999, Aghion and Schankerman, 2000, for example, predict that the effect of market competition, variously defined, on a firm's incentive to invest in R&D depends on its level of cost efficiency relative to the efficiency levels of its rivals.4 Even though the predictions of these studies are quite intuitive, they are somewhat limited, particularly in the sense that they are based on horizontal differentiation (i.e., cost asymmetry in either production or transportation) and that none of these studies provide empirical evidence for their predictions, probably because of the difficulty of measuring firm heterogeneity in cost efficiency and of empirically capturing the level of competitive market pressure perceived by individual firms.5
The purpose of this paper is to contribute to the existing literature by investigating the effect of competitive market pressure on firm R&D behavior. First, based on a demand-pull, technological-competence-push model of firm R&D, this study analyzes the effect of increased market competition, as perceived by a firm, on its profit-maximizing level of R&D expenditure and R&D intensity (i.e., R&D-to-sales ratio). The approach taken in this analysis is different from those in previous studies in two respects: it employs a discrete-choice market-share model to identify an appropriate term that closely represents competitive market pressure faced by each individual firm, and, unlike previous studies (e.g., Boone, 2000, Boone, 2001, Aghion and Schankerman, 1999, Aghion and Schankerman, 2000), it explicitly considers firm heterogeneity in technological competence (or R&D productivity).
Second, this study uses unique firm-level data constructed by the World Bank to empirically test the predictions drawn from the analysis. The data set is unique, particularly in the sense that it provides a self-evaluated measure of the degree of competitive market pressure perceived by each individual firm in both the domestic and global markets. As such, it is more sophisticated than the survey-based dummy variables employed in existing studies (e.g., Stewart, 1990, Nickell, 1996) and the frequently used measures of overall market concentration (e.g., seller–concentration ratios and the Herfindahl-Hirschman Index).6 Furthermore, as described by Tang (2006), the self-evaluated perception-based measure of market competition has several merits and is particularly suitable for analyzing individual firms’ R&D responses to competitive market pressure.
Our analysis predicts that the effect of competitive market pressure on a firm's incentive to invest in R&D depends primarily on its level of technological competence: firms with high levels of technological competence are more likely to respond aggressively (i.e., increase R&D) to intensifying competitive market pressure, whereas firms with low levels of technological competence tend to react submissively (i.e., reduce R&D).7 Empirical analysis of the World Bank data supports the differential effect of competitive market pressure, conditioned by firm-specific technological competence, on firm R&D. This finding is consistent with the selection and adaptation effects of market competition (e.g., Boone, 2000), and implies that competitive market pressure separates more technologically competent firms from those that are less technologically competent and drives them to be more R&D-intensive.
The paper is organized as follows. Section 2 derives a model of firm R&D and a measure of competitive market pressure perceived by individual firms. Section 3 analyzes the effect of competitive market pressure on firm R&D expenditure and R&D intensity. Section 4 empirically tests the predictions of the analysis, and Section 5 concludes the study.
Section snippets
A model of firm R&D and competitive market pressure
This section develops a model of firm R&D and a measure of market competition that reflects the degree of competitive market pressure faced (or perceived) by each individual firm. Consider a monopolistically competitive industry with N firms, each producing a vertically differentiated product. The setup of the model is as follows.
First, using a discrete-choice model of demand (e.g., Anderson et al., 1992), firm i's market share (mi) is represented as the probability that a representative
Firm R&D responses to competitive market pressure
One of the most important questions in the study of firm R&D behavior is whether competitive market pressure increases or decreases individual firms’ incentives to invest in R&D. The answer to this question has important implications for business strategies and competition policies in areas such as antitrust, economic deregulation and trade liberalization policies. However, as was briefly mentioned in Section 1, existing studies provide diverse and often conflicting results, predicting that
Empirical implications, data and variables
Using unique firm-level data from the World Bank on R&D intensity, firm-specific technological competence and the degree of competitive market pressure evaluated by each individual firm, this section tests empirically the predictions drawn from the analysis of the relationship between firm R&D and competitive market pressure and, in particular, the role of technological competence in conditioning the R&D–competition relationship. The key empirical implications to be tested in this section are
Concluding remarks
This paper has examined the effect of competitive market pressure on firms’ incentives to invest in R&D using a simple model of firm R&D and a multi-country firm-level data set constructed by the World Bank. In doing so, the study explicitly considers firm heterogeneity in technological competence and employs a unique measure of competitive market pressure perceived and self-evaluated by individual firms, which seems more appropriate than the conventional, indirect, measures of market
Acknowledgements
The author thanks his dissertation advisor at Harvard, Frederic M. Scherer, and other seminar participants at Harvard and KAIST Business School for their invaluable comments and advice on the early version of this paper. The author also thanks Editor Stefan Kuhlman and two anonymous referees for their encouragement and invaluable comments.
References (56)
- et al.
Corporate governance, competition policy, and industrial policy
European Economic Review
(1997) Intensity of competition and the incentive to innovate
International Journal of Industrial Organization
(2001)- et al.
Empirical studies of innovation and market structure
Technological paradigms and technological trajectories
Research Policy
(1982)- et al.
On the sources and significance of interindustry differences in technological opportunities
Research Policy
(1995) Endogenous firm efficiency in a cournot principal-agent model
Journal of Economic Theory
(1993)Technological paradigms and complex technical systems
Research Policy
(2008)Market power, cost reduction and consumer search
International Journal of Industrial Organization
(2001)Inter-industry studies of structure and performance
Competition and innovation behavior
Research Policy
(2006)
Competition and innovation: an inverted-u relationship
Quarterly Journal of Economics
Competition, Entry and the Social Returns to Infrastructure in Transition Economies
A Model of Market-enhancing Infrastructure
Discrete Choice Theory and Product Differentiation
Market structure and research intensity in high-technological-opportunity-industries
Journal of Industrial Economics
Product and process innovation as a response to increasing imports and foreign direct investment
Journal of Industrial Economics
Dynamic count data models of technological innovation
Economic Journal
Competitive pressure: the effects on investments in product and process innovation
RAND Journal of Economics
Innovation and learning: the two faces of R&D
Economic Journal
The theory of technological competition
Industrial structure and the nature of innovative activity
Economic Journal
Optimal advertising and optimal quality
American Economic Review
Sources, procedures, and microeconomic effects of innovation
Journal of Economic Literature
Schumpeterian competition
Quarterly Journal of Economics
Innovation, technological opportunity, and market structure
Oxford Economic Papers
Innovation Dynamics and Endogenous Market Structure: Econometric Results from Aggregated Survey Data
Cited by (56)
The impact of government support and market competition on China's high-tech industry innovation efficiency as an emerging market
2023, Technological Forecasting and Social ChangeInformal competition and firm level innovation in South Asia: The moderating role of innovation time off and R&D intensity
2022, Technological Forecasting and Social ChangeCitation Excerpt :Our second moderating variable, R&D intensity, shows the same moderating behaviour as employees’ innovation time off, where multinomial logit model explains that it is more effective for only highly innovating firms. Lee (2009) states that only those firms that have a strong research and development focus can bear the competitive pressure. In line with this research, our study specifically identifies the problem of informal competition for formal firms in developing countries and empirically shows that R&D intensity is most effective for formal firms that are innovating in both product and process domains.
High-tech acquisitions: How acquisition pace, venture maturity, and founder retention influence firm innovation
2022, Journal of Business ResearchGender diversity in R&D teams and innovation efficiency: Role of the innovation context<sup>✰</sup>
2020, Research PolicyCitation Excerpt :Market competition tends to increase when industry concentration decreases (Keats and Hitt, 1988) or when the number of competitors increases (Palmer and Wiserman, 1999). Firms in a competitive market often face a great need to innovate quickly to stand out in the market (Lee, 2009). Under such a situation, firms exhibit great dependence on their R&D team members.
The impact of competition strength and density on performance: The technological competition networks in the wind energy industry
2019, Industrial Marketing ManagementCitation Excerpt :On the one hand, when organizations face intense competition, they might feel more pressurized for maintaining their efficiency (Dess, 1987). Such pressures might enhance the organizational innovation performance, mainly by enhancing the organizational awareness related to new technological developments, increasing an organization's motivation to engage in technological activities (Boone, 2000; Lee, 2009) and, consequently, seek effective ways to heighten organizational efforts and enhance organizational growth (Gnyawali & Srivastava, 2013; Park et al., 2014b). On the other hand, high levels of competitive strength might imply that organizations develop their technology in the promising or prominent domains.
- ☆
This paper was completed during the author's sabbatical leave at Harvard's John F. Kennedy School of Government.