Innovation and pricing competition with absorptive capacity

We develop a game theoretical model of sequential entrance in which an entrant with absorptive capacity tries to enter a market where the incumbent exists. The incumbent decides on innovation and pricing strategies to prevent or allow market entry of the entrant with absorptive capacity. Our study concludes that the entrant’s absorptive capacity negatively affects the incumbent’s pricing strategy, which may even sell at a lower price than that of the entrant. However, the innovation efforts may increase to establish higher barriers to invasion. The incumbent may have to allow the market entry if the entrant has a stronger absorptive capacity or the competition between products is lower. Interestingly, the entrant has a second-mover advantage under certain conditions. Our main findings remain valid under different production costs. Moreover, in the face of an innovative entrant with absorptive capacity, the incumbent’s innovation decisions become more cautious. As for the entrant, it may invest more in innovation efforts than the incumbent in order to enter the market and achieve a high profit. By applying for patents or enhancing the technical difficulty, the incumbent can improve its defense capability. Findings reveal the effect of absorptive capacity and competition in operational decisions and provide practical recommendations for decision making by competing manufacturers.