R&D subsidies in a duopoly market with outsourcing to the rival firm

This paper investigates the effects of a public R&D subsidy policy in a duopoly market of a firm outsourcing input supplies (VS) from its downstream integrated rival (VI). It is shown that a policy setting a R&D subsidy uniform for both downstream competitors has in this market structure relevant effects largely differentiated between competitors. This is because it may significantly modify the relative market shares and profitability of the competing firms. In particular the ultimate effect is to determine R&D investments relatively larger in the VI firm and to shift market shares in favour of the VI firms, with the possible consequence even of a transfer of profits from the VS to the VI firm. Therefore, these findings offer some testable implications and suggest that a subsidy policy in a market with outsourcing to a rival should take also into account of its differential effects on the "competitors".