R&D Cooperation or Competition in the Presence of Cannibalization

R&D cooperation is reconsidered in situations where firms direct R&D activities towards a new product that cannibalizes the firms' existing products. For soft cannibalization, the welfare-maximizing arrangement between firms involves, for low R&D costs, the formation of a separate entity that independently chooses both the output level of the new good and the level of R&D expenditures and otherwise, joint decisions about R&D but independent decisions about production. Yet, as cannibalization increases, firms find it unprofitable to market the new good unless they collaborate more narrowly. Merger should then be permitted for the socially desirable introduction of the new good.