PUB - Publikationen an der Universität Bielefeld

This paper deals with the strategic reaction of firms to competitive threats stemming from newly developed products of actual competitors. Product innovation projects go through multiple time consuming stages with several continuation/termination decisions. Hence. competitors can react to the threat before the new product is introduced and thereby may prevent or facilitate the product's introduction. We consider a duopoly model where Firm 1 can start a two-stage product innovation project for obtaining a horizontally and vertically differentiated product. In-between the two stages Firm 2 can react by making an investment that improves the competitive position of the current product. We find that under weak vertical differentiation Firm 2 wants Firm 1 to innovate. Horizontal differentiation softens competition and Firm 2 over-invests to induce Firm 1 to launch the new product. Second, under strong vertical differentiation Firm 1 starts the product innovation project - triggering under-investment by Firm 2 - but never finishes it. The under-investment makes Firm 2 a weaker competitor, which induces Firm 1 not to innovate. Third, under very strong vertical differentiation Firm 2 prevents a launch of the new product by over-investing. This results in a strong competitive position of Firm 2. It therefore captures such a big market share that Firm 1 will not introduce the new product. The situation of Firm 1 in the old market has worsened. The option to complete the innovation, created by initiating the first stage of the innovation project, has a negative value for Firm 1. (C) 2010 Published by Elsevier B.V.