R&D investments and the persistence of monopoly

Original article (link) posted: 26/10/2005

R&D-intensive industries are natural context in which to address the following questions; “Do dominant firms tend to maintain, or even increase, their market dominance?” and “Is market power temporary or is it permanent?”
Gilbert and Newbery (1982) develop a strong argument in the view of persistence of incumbency. They claim that a monopolist has more to lose from letting competition in than a potential entrant has from challenging the monopolist. As a result, the tendency should be towards persistence, not alternation, of market dominance. Interestingly enough, they relate their model to a model of an auction market and state that preemption is a Nash equilibrium of the corresponding auction game. (A monopolist has higher willingness to pay than that of an entrant and hence bids higher amount. I think this result can be quoted in my license auctions paper.)
Reinganum (1982) makes the point that Gilbert and Newbery’s result depends on their assumptions on the deterministic process of R&D. She shows that with uncertainty, there are cases when the probability the monopolist is replaced by an entrant is greater than the probability of persistence, hence R&D would decrease the market dominance. Her logic is as follows. Under uncertainty, with positive probability, the potential entrant does not succeed in inventing a new product, even though it invests a positive amount. When this happens, a successful incumbent would only be replacing its monopoly product with another monopoly product. Because of this “replacement” effect, a monopolist has less incentive to engage in R&D that a competitive firm has.

References
Gilbert and Newbery (1982) “Preemptive Patenting and the Persistence of Monopoly” AER, 72
Reinganum (1982) “Uncertain Innovation and the Persistence of Monopoly” AER, 73