Imitation and R&D Incentives

7 Aug

innovation and profits
   We know that product and process innovation can explain us how technological advance can maximize firm’s profit, but it also it may state a potential problem in economics called imitation problem, situation in which firm’s rivals may imitate newly invented product or process, so that profit gained by firm that initiated R&D process is greatly reduced. An example can be, a firm buys a high-quality notebook from other one that has a great success in market sales and study it piece by piece and then reproduce entire new model in a computer that is an imitation of original one. This technique was used many times in our world’s market. This type of imitation is actually a legitimate one, so it is often the main path to widespread of innovation and diffusion.
   However, the dominant firm in an industry that is making big profits may let other small firms to spend great quantity of money on product and process of innovation and analyze their success and losses. This firm then quickly can become the second firm that uses these innovations if they are successful. This is called fast-second strategy, strategy by which a second firm uses innovation and R&D results of another firm, so that latter one incurs all cost of innovation and R&D expenditures.

Benefit of being first
   Fast-second strategy and imitation may raise an important question: is there any incentive to be the first firm that incurs all cost and expenditures if the competitors may imitate innovated product? Why not imitate others successful innovations and let them bear the cost of R&D and innovation process? Even this idea is a plausible there are some advantages and protections for the firms that take the lead in this innovation competition. Let’s describe some of them:

Patents
   Some technological innovations and breakthroughs may be patented. If a product or production process in patented it can’t be imitated for about two decades. The purpose of patents is to reduce imitation and to help other firm to engage in R&D with possibility of gaining of high profits. And if for example one firm clones the new innovated products of another firm then the latter one might be included in a patent-infringement lawsuit and pay back all revenues lost by the firm which patented its product.

Copyright and trademarks
   Copyrights protect publishers of books, various articles, movies, musical compositions from having their works copied. Trademarks give the exclusive opportunity to innovators to use a specific product name (Nokia, Ferrari, McDonald’s). These legal protections help innovators to increase their incentive for product innovation.

Brand Recognition
   Brand-name recognition gives innovator a major marketing advantage for several years. Consumers identify a product with the firm that first introduced and popularized it in the world’s market, for example Kellogg’s Corn Flakes, Sony’s Walkman).

Trade secrets
   Some innovations however include some trade secrets, without which imitation isn’t possible. A very popular example is Coca-Cola which has a secret formula for its drinks. Other firms have some special production technique that is known only to them. A relative advantage is learning-by doing, kind of specialization that allows them to achieve cost reductions. The innovator’s low cost may enable to continue its profits even after imitations are spread in the market.

  Time Lags
   Time lags between innovation and imitation often help innovating firms to realize high economic profits, since the firm that imitates needs some time to learn properties of new innovated good. Once imitators have learnt all these particularities of that good, it needs to design a substitute good and construct a factory that will produce it. Different entry barriers like big amount of funding, economies of scale, and price-cutting may increase the time between innovation and imitation. That’s why it may take several years before rival firms can successful imitate new product and earn some innovator’s market share. That’s why innovator will continue its profits.

Buyouts
   Another advantage of being first may be a buyout, purchase of innovating firm by a larger firm. In this case innovative entrepreneurs will get their rewards immediately in form of cash or shares from the purchasing firm, rather than waiting for uncertain future profits from their own production and efforts.

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3 Responses to “Imitation and R&D Incentives”

  1. theothersideofthelight August 7, 2012 at 9:14 PM #

    You see that process everywhere, even in the arts. For example, publishers saw how much money was to be made with vampire books, so publishing house started cranking out truckloads of them. All of these books, including the originals, were badly written. But you get the idea. It seems the only way a business survives in the wake of this will be customer service. If another company is going to reverse engineer your ideas, you have to differentiate yourself in some way to stand out. And a strong way to do this is your relationship with your customers.

  2. wordmatchmaker August 7, 2012 at 9:50 PM #

    Thank you very much for this clear description! I have never understood this issue very well.

    One thing that has always confused me is copyright law: as you say, it helps the creators of certain material to not be copied, and it encourages innovation. However, I do not understand why, when an author or composer (or any other individual person who has copyrighted material) dies, their work doesn’t always become public domain. Instead, a family or a company can sometimes own that copyrighted work after the creator’s death. To me, that doesn’t suit the original intent of the copyright: to protect the innovator him/herself.

    • justdan93 August 7, 2012 at 11:14 PM #

      As i know copyright and patent are just for some years… But i may be wrong :/

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