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How Strong Buyers Spur Upstream Innovation

  • Roman Inderst
  • Christian Wey

We challenge the view that the presence of powerful buyers stiffles 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.

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File URL: http://www.diw.de/documents/publikationen/73/diw_01.c.43803.de/dp524.pdf
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Paper provided by DIW Berlin, German Institute for Economic Research in its series Discussion Papers of DIW Berlin with number 524.

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Length: 36 p.
Date of creation: 2005
Date of revision:
Handle: RePEc:diw:diwwpp:dp524
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