Intensity of competition and the choice between product and process innovation

Abstract

Two questions are examined within a model of vertical differentiation. The first is whether cost-reducing innovations are more likely to be observed in regimes of more intense (Bertrand) or less intense (Cournot) competition. We find that there are cost-reducing innovations that are pursued under Cournot but not under Bertrand competition. The second is whether the regime of competition affects a firm’s choice between product and process innovation. We show that for the high quality firm, whenever there is a difference between the choice made by a Bertrand competitor and the choice made by a Cournot competitor, the former opts for product innovation, while the latter prefers process innovation. For the low-quality firm the result is reversed.