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Driving Technology Innovation Down a Competitive Supply Chain

Major suppliers in innovative industries, such as internet services, telecommunications, and electronics, rely on their downstream industrial customers' innovation and investment e orts for their own success and growth. Motivated by major industrial partner in the online content delivery industry, we investigate the following questions: How and when can an upstream technology leader encourage its customers to invest in their products, while still being able to recoup the benefits of doing so? Under what conditions is there a competitive advantage from an early technology leadership? We investigate these questions in a two-tier supply chain with a duopoly in the upper tier, and a set of downstream rms whose products are limited by the upstream technology. We establish the optimal pricing policy for a leader, and the equilibrium investments of its downstream customers. We de ne a new measure, \vertical potential" for downstream industries, which summarizes downstream demand and technological opportunity conditions. We show that high-potential downstream industries form the technological frontier, which plays a crucial role in the diffusion of upstream technology into nal goods, and solving the problem of under-investment in innovation. We also demonstrate that the same measure determines if early upstream technology leadership translates into competitive advantage.

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