Innovation strategy and entry deterrence

Official URL: http://www.kellogg.northwestern.edu/research/journals/jems/jems.htm

We model an incumbent's decision to pursue radical or incremental innovation when facing a rival entrant. The radical innovation may yield lucrative financial returns but entails significant technological and market-related uncertainties. It is also particularly attractive to the rival entrant: if the market for it pans out, such an innovation obsoletes the existing technology and any incremental improvements to it. Each firm has its own assessment of the market potential for the radical innovation, and the reliability of these market forecasts can differ. We show that when the entrant's market-assessment capability is weak, the incumbent will pursue incremental innovation and postpone its plans to develop radical innovation even when it thinks highly of the market potential for the radical innovation. The incumbent does so to avoid validating the high market potential to the entrant, who may otherwise be encouraged to invest aggressively. The incumbent thus prefers to look 'soft' with respect to its innovation strategy in order to discourage entry. Even if its innovation strategy is not observable, we show that an incumbent that assesses the commercial potential for a radical innovation favorably may pursue an incremental path and communicate its plans publicly; this strategy serves to reduce entry by affecting the entrant's beliefs about the market potential of the innovation. Finally, we extend the model to investigate the entrant's decision to communicate its innovation intentions. We find that the entrant communicates its plans to aggressively pursue radical innovation only if the incumbent's market-assessment capabilities are strong. In doing so, the entrant acts preemptively to discourage the incumbent from pursuing the radical innovation, and is less concerned with validating market potential.