The Impact of Start-up Acquisitions on the Entrant’s and Incumbent’s Innovation Portfolios

Title:The Impact of Start-up Acquisitions on the Entrant’s and Incumbent’s Innovation Portfolios

Abstract: We study the interaction between a start-up and an incumbent firm which can invest in rival and non-rival research projects. First, the start-up chooses how to allocate its research budget across a “rival” project, which threatens the dominant position of an existing incumbent, and a “non-rival” project. If successful, the start-up enters the market of the incumbent with a high-quality product; if not, the start-up stays out of the rival market. Then, the incumbent chooses how much to invest to “defend” its dominant position and how much to invest in other markets. Finally, the entrant and the incumbent compete in the rival market. We show that, in the absence of acquisitions, the entrant’s and incumbent’s investments in the rival project are strategic substitutes. However, if acquisitions are allowed, there exist parameters under which the entrant’s and incumbent’s investments in the rival project become strategic complements. We characterize start-up acquisitions for which the direction of innovation improves and, despite the detrimental price effects associated to monopolization of the product market, consumer surplus increases.