- Coordination between firms through mergers or common ownership can impact competitors' incentives to innovate. If coordination reduces market competition, it increases competitors' profits and discourages their research and development efforts. - Coordination also affects firms' incentives to invest in their own innovation. By internalizing gains from coordination, firms' incremental profits from successful innovation decrease, reducing their R&D incentives. - Firms with monopsony power over suppliers can manipulate input purchases and prices to influence suppliers' R&D incentives, such as by decreasing current purchases and prices to pressure suppliers to invest in innovation. - Firms can also commit to high prices to soften competition and discourage competitors' innovation efforts, potentially allowing prices

1. Innovation and Market Power
Hearing on the Relationship between Competition
and Innovation — OECD
Álvaro Parra1
1Sauder School of Business, UBC
June 15, 2023

2. Background
Many merger proposals reviewed by competition policy agencies
involve R&D-efficiency claims
Gilbert (2006): 40% of mergers between 2003-05 in “R&D industries”
Analyzing these mergers is problematic!
Current merger guidelines are based on the Williamson trade-off
Are (p, q) the only relevant “welfare” objects in innovative industries?
The guidelines include some wording on “competition and
innovation”
Less competition may reduce incentives to perform R&D
Conflicts with evidence of a non-monotonic relationship between
competition and innovation
There is (was?) a lack of theoretical frameworks incorporating key
issues about innovation
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3. What is special about innovative industries?
Innovations may improve product quality and/or lower prices.
If a merger increases incentives to innovate, short-run price effects
may be compensated for in the long-run.
Some innovations have a large impact on market structure.
Today’s leader may not be tomorrow’s.
Britannica, Encarta, Wikipedia.
Symbian, Blackberry, iOS, Android.
Some mergers affect the development of products that have not
reached the market.
Recent examples: Merck–Idenix (2014), Harris Corporation–Exelis
(2015), DuPont–Danisco (2011).
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4. Goals
...and outline
I want to give you:
an overview on how market power affects innovation
connect it with ’traditional’ competition policy
how to incorporate these concerns in practice
We start: How competition affects innovation
A. Innovation and Arrow’s replacement effect
B. Ownership Structure and Competitors’ Innovation
C. Ownership Structure and own Innovation
D. Innovation and Monopsony Power
And, if we have time... two slides on: how innovation affects competition
E. Innovation and Oligopoly Pricing
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5. A. Arrow’s Replacement Effect
The main working horse of this talk. What determines the incentives to invest in R&D?
P
c
Q
c
c
q q
A
B C
f
l
i
i
Two firms: leader and follower
Marginal cost of production
cl < cf
Price is p = cf
Profits: πl = A and πf = 0
Cost-reducing innovation ci < cl
If leader succeeds:
p = cf and πi
l = A + B
Incremental rent πi
l − πl = B
If follower succeeds:
p = cl and πi
f = B + C
Incre. rent πi
f − πf = B + C
The follower has more incentives to develop the innovation! 4 / 16

6. A. Generalizing Arrow
Arrow’s ideas are more general
Arrow’s insight: Firms incentive to invest in R&D is driven by the
incremental rent they derive from an innovation.
∆π = πi
− π
Let’s generalize Arrow’s insight. We don’t need...
Homogeneous good, price competition, two firms, cost-reducing
innovation
What determines the pre innovation profit π
Number of firms (product-market competition)
Equilibrium prices
Degree of product differentiation
Ownership structure, vertical structure, and contracts in place
What determines the post-innovation profit πi
Size and type of innovation (degree of product differentiation)
Everything listed above...!
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7. B. Ownership Structure and Competitors’ Innovation: I
What happens when competitors coordinate activities?
Question: What is the impact of coordinating activities (e.g.,
consolidating ownership structure) on the competitors R&D?
Coordination of activities can come from a merger or the rise of
common/cross ownership.
Two types of innovation:
Incremental: Innovator gains a market advantage
Radical: Innovator monopolizes the market
Firms A and B coordinate activities. How does this affect C’s R&D?
Recall R&D incentives: ∆πC = πi
C − πC
I am going to focus on Radical innovation first, then discuss how things
change with incremental innovation.
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8. B. Ownership Structure and Competitors’ Innovation: II
The Radical Innovation Case
Firms A and B coordinate activities. How does this affect C’s R&D?
Recall R&D incentives: ∆πC = πi
C − πC
Under radical innovation, C becomes monopolist after the innovation:
post-innovation profits πi
C do not change with the coordination of
activities. A and B are out of the market after the breakthrough.
What happens to pre-innovation rents, πC?
Depends on the effect of coordination
Coordination leads to A, B to save costs and increase market power
Ultimately {pA, pB} is what matters
Do the new prices {pA, pB} increase or decrease πC?
If new {pA, pB} decrease market competition, πC increases, and
discourages R&D (∆πC ↓)
There is a link between short-run efficiency and R&D outcomes
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9. B. Ownership Structure and Competitors’ Innovation: III
The Incremental Innovation Case
Firms A and B coordinate activities. How does this affect C’s R&D?
Recall R&D incentives: ∆πC = πi
C − πC
Under incremental innovation, C still competes with A + B :
The pre-innovation innovation effects are the same:
if coordination is anticompetitive (πC ↑), R&D decreases (∆πC ↓)
If coordination is anti-competitive, softens post-merger competition
If coordination is anticompetitive, post-innovation rents πi
C ↑
Effect on R&D incentives is now ambiguous, an empirical question
However, it may be answered with standard empirical tools
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10. C. Ownership Structure and Own Innovation: I
What happens when innovator coordinate activities?
Question: What is the impact of coordinating activities (e.g.,
consolidating ownership structure) on own R&D?
Firms A and B coordinate activities. How does this affect A’s R&D?
before: ∆πA = πi
A − πA after: ∆πA = πi
A − πA + φ(πi
B − πB)
where φ represents the degree of coordination
φ = 0 independent firms
φ ∈ (0, 1) partial ownership
φ = 1 full control/merger
Firm B may or may not benefit directly from the innovation:
It depends on the degree of coordination φ
If on whether B adopts the innovation!
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11. C. Ownership Structure and Own Innovation: II
The Radical Innovation Case
Firms A and B coordinate activities. How does this affect A’s R&D?
before: ∆πA = πi
A − πA after: ∆πA = πi
A − πA + φ(0 − πB)
Under radical innovation, A becomes monopolist after the innovation:
post-innovation profits πi
A do not change with coordination
post-innovation profits πi
B = 0
What happens to pre-innovation rents, πA and πB?
Coordination should increase both firms profits!
R&D decreases throw three channels
A’s incremental rent decreases ∆πA ↓
Internalization of B loss −φπB
B loss −φπB becomes larger with coordination
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12. D. Innovation and Monopsony Power: I
Firms in innovative industries rely on global supply chains to create and
manufacture products
Some of the production and R&D is kept outside of the boundaries
of the firm
Example: Boeing 787 Dreamliner
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13. D. Innovation and Monopsony Power: II
News reports suggest that companies like Tesla, Apple, Boeing, and
other firms in innovative industries “squeeze” their suppliers:
“Squeezing” happens even though suppliers play a crucial role along
the innovation front
12 / 16

14. D. Innovation and Monopsony Power: III
How exactly are they squeezing suppliers?
Apple (source: WSJ):
Ford (source: WSJ):
Pressure suppliers to invest in R&D by decreasing current purchases and
prices
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15. D. Innovation and Monopsony Power: IV
How does a monopsonist incentivize R&D that takes
place outside of its boundaries?
By manipulating input purchases, the monopsonist can impact R&D
incentives: Recall Arrow’s replacement effect
Supplier’s incentives: ∆πs = πi
s − πs(pm, qm)
The monopsonist can affect πs today by manipulating contract
terms (pm, qm).
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16. E. Innovation and Oligopoly Pricing: I
How does innovation affects competition?
Can market power in innovative industries have an impact on other
dimensions of competition?
Yes! When firms can commit to the price posted, can charge higher
prices to discourage competitors from innovating. 15 / 16

17. E. Innovation and Oligopoly Pricing: II
How does innovation affects competition?
Can firms A discourage firm B from performing R&D?
Firm B incentives: ∆πB = πi
B − πB(pA, pB)
By increasing its price (pA ↑), firm A softens competition today (πB ↑),
discouraging firm B from performing R&D (∆πB ↓)
If both firms A and B can announce prices, equilibrium prices are higher
for both firms! Approaching and potentially surpassing monopoly pricing.
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