Vertical Integration and Disruptive Cross‐Market R&D

Vertical Integration and Disruptive Cross‐Market R&D

 

Ping Lin

Lingnan University - Department of Economics

Tianle Zhang

Lingnan University

Wen Zhou

The University of Hong Kong - School of Business

Abstract

We study how vertical market structure affects the incentives of suppliers and customers to develop a new input that will enable the innovator to replace the incumbent supplier. In a vertical setting with an incumbent monopoly upstream supplier and two downstream firms, we show that vertical integration reduces the R&D incentives of the integrated parties, but increases that of the nonintegrated downstream rival. Strategic vertical integration may occur whereby the upstream incumbent integrates with a downstream firm to discourage or even preempt downstream disruptive R&D. Depending on the R&D costs, vertical integration may lower the social rate of innovation.