Downstream new product development and upstream process innovation

Research and development (R&D) in upstream and downstream markets influence each other. This is because, in assembly industries, when upstream input prices are low, downstream firms can easily introduce or develop new products. The introduction of a new product creates a new final good market, creating an increased demand for inputs. This greater demand for inputs provides an incentive for upstream firms to reduce their costs through R&D. In this study, we consider both downstream R&D for new product introduction and upstream R&D for cost reduction. We show that if upstream R&D is efficient (inefficient), the results of the downstream new product introduction race are strategic complements (substitutes). Furthermore, in terms of timing, the upstream firm determines its input price after observing the downstream firm’s investment decision, with the upstream firm extracting benefits from downstream R&D by raising the input price. It is well-known that this behavior by upstream firms impedes downstream investment (the hold-up problem). Despite this timing structure, we show that the more downstream firms invest, the lower the input price.