How Strong Buyers Spur Upstream Innovation

Christian Wey and Roman Inderst

No 5365, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We challenge the view that the presence of powerful buyers stifles suppliers' incentives to innovate. Following Katz (1987), we model buyer power as buyers' ability to substitute away from a given supplier and isolate several effects that support the opposite view, namely that the presence of powerful buyers induces a supplier to invest more in cost reduction. In contrast to negotiations with smaller buyers, the outcome of negotiations with large buyers is fully determined by their more valuable alternative supply option. This increases the supplier's incentives to reduce marginal costs, both as the supplier receives a larger fraction of the thereby generated incremental profits and as this makes buyers' alternative supply option less valuable. The latter effect is due to downstream competition between buyers and, as we show, is also stronger the larger and thus the more powerful buyers are.

Keywords: Buyer power; Merger; Investment incentives (search for similar items in EconPapers)
JEL-codes: D43 L12 L41 (search for similar items in EconPapers)
Date: 2005-11
New Economics Papers: this item is included in nep-com and nep-mic
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Citations: View citations in EconPapers (7)

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