Are Product Innovation and Flexible Technology Complements?

REVISED ABSTRACT: This paper analyzes the interdependence between the firms’ technology choice and innovation. Previous literature argues that product flexibility and product innovation are complements, because flexible machines handle a large variety of product designs with low changeover times. In a model where technology is chosen before uncertain demand is realized, we show that long-run technology, by imposing constraints on short-run production, does not only affect the cost of innovating but also its payoff. The results coincide with the literature in that the cost of product innovation is always reduced by flexibility, but we find that the operational profits from product innovation might be decreasing in flexibility. Consequently, flexibility does not necessarily complement product innovation. Empirical evidence from the German mechanical engineering industry supports the complementarity conjecture, since random shocks tend to trigger adjustments of both decision variables in the same direction. ORIGINAL ABSTRACT: This paper revises the interdependence between flexible technology and product innovation in the context of a monopolistic firm. Previous literature argued that flexible machinery reduces the cost of incremental innovation. To take interactions beyond the fixed cost into account, we introduce a 2-period optimization model where technology, innovation and price are chosen first, then stochastic demand realizes and, finally, production is carried out. We find that flexibility increases the expected second period gain from incremental innovation in some but not all cases. Thus, the overall profit function need not be supermodular although fixed cost complementarity might be substantial. Empirical evidence from the German mechanical engineering industry suggests that fixed costs complementarity indeed does not outweigh potential adverse effects in expected operational profits. ZUSAMMENFASSUNG - (Sind Produktinnovation und flexible Technologien komplementär?) Der vorliegende Beitrag überprüft den Zusammenhang zwischen flexibler Technologie und Produktinnovation im Kontext des Monopols. Die bisherige Forschungsliteratur betonte die Eigenschaft flexibler Produktionstechnologie die Kosten für zusätzliche Innovation zu senken. Um Interaktionen über die Fixkosten hinaus zu berücksichtigen, analysieren wir ein Optimierungsmodell über zwei Perioden, in welchem zuerst die Technologie, Innovation und Preis gewählt werden, danach die stochastische Nachfrage eintritt und schließlich die Produktion stattfindet. Es zeigt sich, dass Flexibilität den erwarteten Gewinn der zweiten Periode aus zusätzlicher Innovation nicht immer steigert. Daher muss die Profitfunktion nicht notwendigerweise supermodular sein, selbst wenn die Komplementarität in den Fixkosten erheblich ist. Empirische Belege aus dem deutschen Maschinenbausektor weisen darauf hin, dass die Fixkostenkomplementarität tatsächlich nicht ausreicht um potentiell gegenläufige Effekte aus den erwarteten operativen Gewinnen zu kompensieren.]