How Does Vertical Integration Affect Incentives to Innovate?

How Does Vertical Integration Affect Incentives to Innovate?

Gaoyang Cai

Northwestern University, Kellogg School of Management

Daniel F. Spulber

Northwestern University - Kellogg School of Management

Abstract

We introduce a model of product innovation to examine how vertical mergers affect incentives to innovate. Incentives to innovate are the same for a vertically integrated platform that innovates in house and a product market gatekeeper that organizes an innovation tournament. A vertically integrated platform, however, has lower incentives to innovate than independent innovators. Competition between two vertically integrated platforms generates more innovation than a vertically integrated platform and less innovation than competing independent innovators. A monopoly upstream innovator with competing downstream sellers has lower incentives to innovate than a vertically integrated platform.