Effects of Acquisitions on Product and Process Innovation. and R&D Performance

Transcription

1 Effects of Acqustons on Product and Process Innovaton and R&D Performance Elena Cefs Stephane Rosenkranz Utz Wetzel 1 Utrecht School of Economcs Unversty Utrecht Vredenburg BG Utrecht The Netherlands 1st prelmnary draft verson, June 15th nd prelmnary draft verson, Jan 10th 2005 Comments are very welcome. Please do not cte wthout permsson of authors. The usual dsclamers apply. Abstract The startng pont of our analyss s that acqustons nternalze dfferent externaltes for product and process nnovatons, whch evoke a respectve change n R&D nvestments and dynamc effcency. On the bass of a game theoretcal model where frms smultaneously nvest n product and process nnovaton we deduct and emprcally test hypotheses about the optmal R&D portfolo n acqustons and n ndependently competng frms. The model also allows us to formulate and test hypotheses about the aggregate nvestment, performance, and dynamc effcency of acqustons. For emprcal testng we use cross sectonal data from the Italan part of the frst Communty Innovaton Survey, whch cover frms across all manufacturng ndustres and sze groups n The emprcal fndngs support the results of the formal analyss n varous aspects. Frms nvolved n acqustons do nvest n dfferent R&D portfolos than ndependent frms,.e. more n product and less n process nnovaton. Furthermore, they nvest at least an equal amount n aggregate R&D. However, the emprcal results also show that our hypotheses do not hold wth regard to dynamc effcency, snce acqustons lead to a comparatvely worse overall R&D performance. Keywords: Merger & Acquston; Dynamc Effcency; Process Innovaton, Product Innovaton JEL: L1, L22, O31 1 correspondng author: u.wetzel@econ.uu.nl ; tel ; fax

2 1. Introducton An ntensvely debated queston n U.S. and European anttrust regulaton s whether merger polcy should move beyond ts tradtonal statc focus on market power (allocatve effcency) and producton effcency (X-effcency) to ncorporate nnovaton and dynamc effcency. 2 The body of lterature n ths area s stll very lmted and most studes that analyze the effects of mergers and acqustons on dynamc effcency refer to nnovatve actvtes n general, regardless whether they are focused on processes or products. We argue that exactly ths dstncton between product and process nnovaton s mportant to fully understand the effects of acqustons on dynamc effcency. 3 If product and process nnovatons have dfferent externaltes, changes n dynamc effcency through an acquston also depend on the magntude of nternalzaton of these effects. An overpowerng nfluence of only one dmenson, ether product or process nnovaton, could then determne aggregate nnovatve nvestment and performance. In ths paper, we adapt an exstng theoretcal model and deduct testable hypotheses. We then emprcally show that acqustons do have dfferent effects on product and process nnovaton, both, wth regard to R&D nvestment, performance and dynamc effcency. Generally, we can dstngush between three strands of prevous research n ths area: () studes on product and process nnovaton n ndependently competng frms; () studes on aggregate R&D (.e. wthout the dstncton between product and process) and dynamc effcency n acqustons; and () studes on product and process nnovaton n jont ventures. () From an ndvdual frm s perspectve, nnovaton strateges often focus ether on process nnovaton or on product nnovaton. Mchael Porter (1980) argued that a frm's strategc poston wthn a broad-scope market s determned by one of two fundamental optons s: offer the lowest prce or dfferentate your products. Frms that attempt to pursue both strateges smultaneously, he clams, become stuck n the mddle between conflctng demand and cost parameters. Hs reasonng s based on the smple economc trade-off that hgher qualty or better performng products often 2 For a comprehensve examnaton of the developng role of nnovaton n U.S. merger polcy see Katz and Shelansk (2004). 3 Throughout ths paper we wll use the term acquston synonymous for mergers and acqustons or any other knd of shared fundng or equty-based nterest wth (shared) decson control or coordnaton. 2

3 cost more to develop and produce. Although Porter (1980) consdered the two strateges of cost reducton and dfferentaton to be bascally ncompatble, several emprcal studes provde evdence that the trade-off may not be as strong as orgnally suggested (e.g. Mller and Fresen, 1986a, 1986b). In fact, they make a strong case that a frm's advantage s rarely based entrely on costs or product dfferentaton and that both dmensons ought to be modelled and studed jontly. Such a less polarzed world suggests that there exsts an optmal level of nvestment n process R&D (cost reducton) and n product R&D (product dfferentaton). Ths noton s also wdely accepted n nnovaton research, whch stresses the general mportance of an optmal mx n frms R&D portfolo. A promnent research path n ndustral dynamcs can be traced back to the semnal work of Abernathy and Utterback (1982), who ntroduced a technologcal lfe-cycle model of ndustres. It depcts the development of an ndustry from an ntal flud stage, where market needs for a new technology are ll-defned and product nnovaton prolferates, to a fnal mature stage where there s a domnant desgn and cost advantages as well as process nnovaton become the new crtcal factors to success. A number of theoretcal and emprcal studes usefully elaborate on ths concept (Agarwal and Audretsch, 2001; Duranton, 2000; Klepper, 1996; Yn and Zuskovtch, 1998; Tushman and Anderson, 1986; Anderson and Tushman, 1990; Klepper and Graddy, 1990; and Suarez and Utterback, 1991), but wthout specfc focus on the strategc nterdependence of frms decsons or the role of acqustons. () When we depart from the dstncton between product and process nnovatons, we fnd a growng debate whether acqustons lead to hgher or lower aggregate levels of nnovaton and dynamc effcency. Unfortunately, despte the mportance of the subject, the number of emprcal studes s stll very lmted. Ths mght be connected to the fact that, apart from ndustral organzatonal models on jont ventures (see below), the theoretcal lterature largely remans mute on ths ssue. 4 Some emprcal studes on the fnancal and economc performance of acqustons consder the consequences on frms technologcal actvtes. However, aggregate results wth regard to the nfluence of acqustons on nnovaton levels turn out to be heterogeneous and dffcult to compare: Emprcal analyses n ndustral organzaton reach no consensus, but tentatvely pont towards a more postve relatonshp (Röller et al, 2001; also see Cohen and Levn, 1989; and Scherer, 1992, for useful revews). Larger studes n the feld of fnancal economcs and corporate control are rather undecded, but tend to support the noton of a neutral or negatve mpact of acqustons on 4 For a comprehensve survey please see Cassman et al (2003). 3

4 R&D (Hall, 1990, 1999; Ravenscraft and Scherer, 1987; Htt et al, 1991, 1996; Blongen and Taylor, 2000). In contrast to that, several smaller n depth studes on acqustons and jont ventures convey a more postve outlook on nnovatve nvestment and performance (Gugler and Sebert, 2004; Ahuja and Katla, 2001; Cassman et al, 2003; Adams and Marcu, 2004). One reason why the emprcal results are so mxed may be that many studes focus ether on nnovaton nput (e.g. R&D spendng) or on nnovaton performance (e.g. patents). Any concluson for nnovatve behavor n general then mplctly assumes a constant R&D effcency. However, changes n statc or dynamc effcency e.g. created through the elmnaton of R&D duplcaton or scale/scope economes can have opposng effects on the two varables: whle R&D nvestment may be cut, jont R&D performance or output can stll be unchanged or even hgher. 5 For a thorough understandng of dynamc effcency, we therefore have to take both sdes nto account. Another reason why emprcal results are mxed may be that effcency gans n acqustons are often mplctly nterpreted as cost synerges and thus expected to reduce nvestment n R&D. However, the nternalzaton of technologcal spllover or other postve externaltes ncreases margnal returns to nnovaton and therefore provdes an ncentve to nvest more n R&D after an acquston, even under effcency gans. As dscussed below, we therefore nclude such externaltes n our analyss. () A survey of the lterature that studes the nfluence of acqustons (or other forms of coordnaton) on product and process nnovatons quckly reveals that next to a lack of emprcal studes most theoretcal work s done n the feld of ndustral organzaton. Intated by the work of D Aspremont and Jacquemn (1988) these studes manly focus on the nternalzaton of postve or negatve externaltes through research jont ventures (RJVs) and ther comparatve statc effects wth regard to process and product R&D spendng (de Bondt and Veugelers, 1991, de Bondt, 1997; Bonanno and Haworth, 1998). Process nnovatons can be seen as negatve externaltes, snce lower prces force compettors to ether wastefully nvest n correspondng cost reductons or accept lower profts due to the busness stealng effect. However, by formng an RJV or acqurng a frm, ths negatve externalty can be nternalzed and avoded. Technologcal spllovers, on the other hand, can be seen as postve externaltes, snce compettors proft from the know-how of others wthout own nvestment. Wth acqustons the returns lost to the nnovator due to unprotected spllovers are 5 Especally when nnovaton measures are ll defned ths can lead to some addtonal confuson whether terms lke nnovaton and nnovaton level refer to R&D nvestment/spendng (nput) or performance (output). 4

5 (partally) captured and, dependng on the magntude of nternalzaton, lead to hgher ncentves to nnovate. Most of the RJV lterature focuses on spllovers when t addresses postve externaltes. However, horzontal product dfferentaton can have the same effect when t reduces the substtutablty of compettors products and ncreases consumers wllngness to pay. 6 Ths leads to less drect competton and hgher profts. An nternalzaton of horzontal dfferentaton captures the postve externaltes of consumers ncreased wllngness to pay, whch would otherwse be lost to competton. By modelng horzontal and vertcal dfferentaton efforts n a strategc settng, Rosenkranz (2003) shows n a formal model that the formaton of RJVs change the optmal combnaton of product and process R&D. On the bass of past research we can thus assume for our analyss: Provded that product and process R&D have dfferent externaltes, an acquston should lead to an adjustment of the optmal mx of nnovaton nvestments snce t nternalzes dfferent degrees of postve and negatve external effects. The analyss of these effects would not only explan changes n R&D portfolos when frms coordnate formerly ndependent nnovaton decsons, but also llumnate an acquston s mpact on overall dynamc effcency. In ths paper we adapt the model of Rosenkranz (2003) to our purposes and deduct testable hypothess wth whch we can then emprcally analyze the relatve mportance of process and product R&D n acqustons and n ndependently competng frms. The model also allows us to formulate and test hypotheses about the aggregate nvestment, performance, and dynamc effcency of acqustons. In summary, the central questons addressed n our analyss are: Do frms nvolved n acqustons nvest more n cost reducton or more n product dfferentaton than ndependent frms? Do frms that are nvolved n acqustons generally nvest more or less n product and process 6 Much n lne wth Eswaran and Galln (1996) ths refers to horzontal nnovatons where no new product s automatcally superor n the absolute sense. They smply have more dstnctve characterstcs, whch generally ncrease consumers valuaton. An extreme example for such horzontal nnovatons n allances s a mult purpose vehcle (MPV) dubbed Eurovan, whch s produced by a jont venture of PSA Peugeot/Ctroën and Fat/Lanca. For each of the companes nvolved a techncally dentcal van wth slghtly dfferentated bodes s produced and then sold under the brand names Peugeot 806, Ctroën Evason, Fat Ulysse, and Lanca Zeta. (These are the brand names used for the frst generaton of Eurovans produced snce For the second generaton, whch s produced snce 2002, the names were partally changed to Peugeot 807, Ctroën C8, Fat Ulysse, and Lanca Phedra.) Other examples can be frequently found wthn automotve groups. In the Volkswagen group, for nstance, Seat, Aud, Škoda, and Volkswagen buld some of ther cars on dentcal chasss platforms and wth nearly dentcal techncal characterstcs, but these cars are nevertheless dfferentated by nteror and exteror desgn, brandng and postonng. 5

6 R&D than ndependent frms? Do acqustons ncrease or decrease R&D performance and dynamc effcency? For emprcal testng we use cross sectonal data from the Italan part of the frst Communty Innovaton Survey (CIS), whch covers frms across all manufacturng ndustres and sze groups (over 20 employees) from 1989 to We construct two samples, one wth ndependent frms and one wth frms that are members of a group. Based on the questonnare of the CIS, membershp n a group can be nterpreted as a coordnaton of nnovaton strateges and decsons n acqustons, mergers, jont ventures, cross holdngs, or any other knd of shared fundng or equtybased nterest wth (shared) decson control or coordnaton. The emprcal results support the propostons of the formal analyss n varous aspects. Frms nvolved n acqustons do nvest dfferently n R&D than ndependent frms,.e. more n product and less n process nnovaton. Furthermore, they nvest at least an equal amount n aggregate R&D. However, the emprcal results also show that our hypotheses do not hold wth regard to dynamc effcency, snce acqustons lead to a comparatvely worse R&D performance. The contrbuton of ths paper to the current state of research s threefold: Frst, to our knowledge ths s the frst study that emprcally analyzes the relatonshp between product and process nnovaton n combnaton wth acqustons. Second, ths study provdes theoretcally motvated and emprcally tested results about the effect of acqustons on aggregate R&D nvestment, performance and dynamc effcency. Thrd, n an area wth relatvely sparse theoretcal and emprcal lterature, ths analyss also contrbutes to the fundamental understandng of relevant forces that determne the overall level of dynamc effcency n acqustons. The paper s organzed as follows: the followng secton 2 presents the game theoretc model used ncludng the formulaton of testable hypotheses. In secton 3 we descrbe the data, the varables, and the statstcal methods employed for the econometrc test. The emprcal results and ther mplcatons are then presented n secton 4 followed by concludng remarks n secton Formal Analyss and Hypotheses 6

7 2.1 The model We consder a duopolstc ndustry, consstng of two frms, j that produce quanttes x and x j. The two frms operate under constant returns to scale. Frms unt costs of producton are gven by c and c j wth c, cj [0, a], whch can be chosen through R&D nvestment before the market opens. The product characterstcs whch determne the degree of product substtutablty gven by δ := δ + δ j can also be nfluenced by the frms, j through R&D nvestment n δ, and 1 respectvely, wth δ, δ [0, ]. j 2 δ j The cost functon for R&D s the same for both frms and s descrbed by Kc ( ) + Gδ ( ) wth K < 0, G < 0 and K > 0, G > 0. The hgher the margnal costs and the lower product dfferentaton the lower s the needed research nvestment. We assume that there exsts an ntal level of costs o o c wth ( ) 0 Kc = for all c o c and lm o Kc ( ) 0 c c = and an ntal level of product o 1 o o dfferentaton δ wth G( δ ) = 0 for all δ δ and lm G( ) = 0. Further, (to guarantee 2 o δ δ δ nteror solutons) we mpose that lm 0 Kc ( ) = as well as lm δ 0 G( δ ) =, and we assume that no technologcal spllovers exst. c Frms play a non-cooperatve two-stage game under complete nformaton. In the frst stage, they decde on ther margnal costs by nvestng n a research project generatng a process nnovaton. Smultaneously, they decde on the optmal degree of product dfferentaton by nvestng n another research project generatng a product nnovaton. On the second stage, frms choose quanttes. Antcpatng the outcome of the stage-two game as x ( c, c, δ, δ ) and x ( c, c, δ, δ ), frms j j j j j choose optmal R&D portfolos. Possble R&D projects n such a portfolo are targeted at process nnovaton and at product nnovaton. Through the former they choose margnal costs of producton and through the latter they choose a degree of product dfferentaton. Frms strateges are ( c ) 2 o ν, δν R, wth cν [0 c ] o, and δ [0, δ ] wth ν =, j. ν 7

8 Now suppose that frms coordnate ther R&D actvtes through an acquston. For smplcty we assume that they reman compettors n the second stage of the game. 7 Assume that frms coordnate ther strateges as to maxmze jont proft but do not acheve effcency gans because they utlze research technologes (both, for new products as well as processes) wth decreasng returns. Ths rather unrealstc scenaro s ncluded n the analyss because t allows us to solate the strategc effects of cooperatve R&D nvestment and the nfluence of effcency gans. Frms jont proft s ( c c δ δ ) arg max { π,,, Π = ( c, δ, c, δ ) + π ( c, δ, c, δ ) K( c ) K( c ) G( δ ) G( δ )}. j j k j j j j j j j c, cj, δδ j Optmzaton wth respect to c leads to the followng frst order condton whch characterzes optmal nvestment nto process nnovaton under coordnated R&D decsons, for c = cj = ck : where Πk Π Π j = + = 0, c c c Π j c s the (negatve) externalty conferred by frm s cost reducton on the proft of ts rval j. Analogously, also the (postve) externalty nduced through product nnovaton by frm on the proft of frm j s added to the compettve advantage externalty that frm s R&D effort has on ts own proft through ncreasng the amount of dfferentaton of ts compettor. Maxmzng jont proft wth respect to the level of product dfferentaton δ yelds the mplct functon for optmal nvestment nto product nnovaton n acqustons, for δ = δ j = δk : Πk Π Π j = + = 0, δ δ δ Those externaltes, postve or negatve, are gnored when each frm chooses ts R&D expendture so as to maxmze ts own proft. They are nternalzed when the frms coordnate ther R&D strateges. Ths makes the ndvdual maxmzaton problems equvalent to the jont maxmzaton problem that would be solved e.g. by a sngle decson maker for two frms that are combned through an acquston. 7 Ths s a common assumpton n the IO lterature when frms coordnate research strateges. An more complex analyss wthout such an assumpton leads to not only qualtatve dentcal, but altogether stronger results. 8

9 To determne the effect of those strategc terms, the frst-order condtons can be wrtten as 8 π c K + βπ = 0and, (1) jc π δ G + βπ = 0, (2) jδ respectvely, wth β = 1. By applyng comparatve statcs wth respect to β, the effects of addng these strategc terms to frms frst-order condtons of proft maxmzaton (and thus the effect of nternalzed externaltes on frms nvestment ncentves) can be analyzed. Takng all varables as functons of β, dfferentaton of (1) and (2) wth respect to β yelds: Cramer s rule leads to: ( π K + βπ ) dc + ( π + βπ ) d δ + π d β = 0, cc jcc cδ j cδ j c ( π + βπ ) dc + ( π G + βπ ) dδ + π dβ = 0. (3) δc j δc δδ j j δδ δ dc sgn ( ) d β = sgn( ( π G + βπ ) π + π ( π + βπ )), δδ j δδ j c j δ cδ j cδ d δ sgn ( ) dβ = sgn( ( π K + βπ ) π + π ( π + βπ )). cc jcc j δ j c δ c jδ c The sgn of the rght-hand sdes of both expressons s ambguous f we do not make any further assumptons about the underlyng demand functons. Obvously the slopes of the margnal R&D cost functons (together wth the sgn of the externaltes) determne whether R&D nvestment ncreases or decreases. Now, assume negatve externaltes for process nnovaton and postve externaltes for product nnovaton. Ths mples decreased nvestment n process nnovaton, e.g. c β > 0, f the rght-hand sde of the frst expresson s postve, whch s true n case: G > ( π (1 + β) π π (1 + β) π )/( π ):= Gˆ. jc j δδ j δ c j δ c Acqustons ncrease nvestment n product nnovaton, e.g. δ β < 0, whenever the rght-hand sde of the second expresson s negatve, or f: 8 Note that the equatons represent the ndvdual frst order condton for β = 0, whle they represent the jont proft maxmzaton problem for β = 1. 9

10 K > ( π (1 + β) π π (1 + β) π )/( π ):= Kˆ. jδ cc j c jδc j δ These condtons on the R&D-cost functons can only be met f they allow for the exstence of an equlbrum. To ensure that there exsts an equlbrum for all values of β, the second-order condton has to be satsfed: G 2 ( π + βπ ) cδ j cδ π + βπ δδ j. δδ π + βπ K Substtutng ˆK nto ths second-order condton of proft maxmzaton, reveals that whenever K K < Kˆ t s necessary for the equlbrum to exst that G Gˆ. Smlarly, G Gˆ < requres that Kˆ. Ths leads to the followng proposton: cc jcc Proposton 1. A coordnaton of strateges through acqustons nduces frms to nvest: () more n product dfferentaton and less n process nnovaton f K Kˆ > and G Gˆ >. () more n process nnovaton and more n product nnovaton f G Gˆ <, () or less n process nnovaton and less n product dfferentaton compared to the noncooperatve equlbrum f K Kˆ <. It can defntely be excluded that frms nvest more n process nnovaton, c β < 0, and less nto product dfferentaton, δ > 0, when they coordnate ther research strateges through an β acquston (as compared to the compettve equlbrum). Proof: See the arguments above. Keepng n mnd that ˆK as well as Ĝ are functons of R&D spendng one can smplfy the nterpretaton as follows: If both margnal R&D-cost functons are suffcently steep (such that K > Kˆ and G Gˆ > ) acqustons nduce frms to nvest more n product dfferentaton but less n process nnovaton. Ths fndng corresponds to the general economc nsght, that the nternalzaton of postve externaltes should ncrease ncentves to conduct R&D whle the opposte should hold for negatve externaltes. 9 On the other hand, f margnal R&D costs ncrease slowly for process 9 See DeBondt and Veugelers (1991) for a comprehensve dscusson of the effects of nvestment externaltes. 10

11 nnovaton, that s K < Kˆ, frms wll nvest less n both knds of nnovaton compared to frms wth ndependent R&D. If margnal costs for process nnovaton are low, negatve externaltes become strong for competng frms and the nternalzaton of those strong negatve externaltes overcompensates postve externaltes. If the slope of margnal R&D costs s low for product nnovaton, that s G < Gˆ, frms nvest more n both knds of nnovaton. If frms can easly dfferentate ther products, the nternalzaton of postve externaltes overcompensates negatve externaltes. It s worthwhle to nvestgate whether frms also change the proporton of optmal R&D nvestment as compared to R&D competton f they nvest ether more n both or less n both knds of nnovatons. Consder the rato of the frst-order condtons of proft maxmzaton (1) and (2) gven by: K G π + βπ c j c =, π + βπ and dfferentate t wth respect to β. Usng (3) ths yelds: δ K K ( π + βπ ) G ( π + βπ ) G =. β π + βπ jδ δ j δ c j c 2 ( j ) δ δ From ths we can see that frms proportonately nvest more nto product nnovaton whenever K ( π + βπ ) δ j δ > G. ( π + βπ ) c Consderng the condtons on the margnal R&D-cost functons from the proposton, ths condton s most lkely satsfed whenever frms nvest more nto both types of nnovaton. For the case that frms nvest less nto both knds of nnovaton t s more lkely that they shft ther nnovatons towards more process nnovaton. jc (4) 2.2 Deducton of hypotheses Based on proposton 1 of the formal analyss we can now deduct testable hypothess about () the optmal relaton between product and process R&D, and () the optmal level of aggregate R&D after an acquston. 11

12 () Wth regard to the effects of acqustons on the optmal relaton between product and process R&D, the formal analyss predcts two clearly observable changes: Frst, t predcts that the relatonshp never changes towards less product R&D and more process R&D. Second, t predcts that there wll be relatvely more (less) nvestment n product (process) R&D f the margnal costs for both types of nnovaton are above a crtcal value. In other words, frms should not be rght at the begnnng of convex cost functons where R&D s cheap and margnal costs are extremely small, nether for product nor process nnovaton. Accordng to research n ndustral dynamcs, dscussed n the ntroducton, we would expect comparatvely low margnal costs n product and process R&D prmarly n the early (or flud ) stages of a technologcal lfe cycle, where frms experment wth varous frst desgns and producton technologes. Snce we wll test the hypotheses wth a broad sample of Italan data across all manufacturng ndustres and several stages of the lfe cycle, we expect the average frm to be nether n a very early (formatve) nor very late (declnng) technologcal stage. Ths mples that margnal costs for product and process R&D (and respectve nnovaton decsons) have reached a certan crtcal level of non-trvalty or mpact, snce the average cross sectonal frm s bound to operate n a rather mature ndustry where both types of nnovaton are more or less equally developed. Hence, we can formulate the followng hypothess. Hypothess I (nput related): Frms that are nvolved n acquston(s) nvest more n product R&D and less n process R&D than ndependently competng frms. If we assume that possble effcency gans (or losses) n acqustons are equally large for product and process nvestments we can restate the nput related hypothess I nto an output-related hypothess. Hypothess II (output related): Frms that are nvolved n acquston(s) have a better performance n product R&D and a worse performance n process R&D than ndependently competng frms. 12

13 Due to the ceters parbus assumpton any dfferences n the emprcal results of hypothess I and II should ndcate dsproportonate changes n the effcency of product and process R&D due to acqustons. () When we turn to the effect of acqustons on aggregate R&D the results of the formal model are a bt more complex and do not exclude certan possbltes. In prncple, low margnal costs for process (product) R&D can lead to a decrease (ncrease) n aggregate R&D whle at least moderate margnal costs for both types of R&D can lead to offsettng counter effects and thus to more or less unchanged aggregate nvestments. However, as the formal dscusson of proposton 1 shows, acqustons wth a hgher (lower) nvestment n product (process) R&D n relatve terms should make a hgher or at least equal nvestment n absolute and aggregate terms. Hence, f hypothess 1 and ts underlyng assumptons are supported, the followng hypotheses over the effects of acqustons on aggregate R&D can be formulated. Hypothess III (nput related): Frms that are nvolved n acquston(s) do not nvest less n R&D (product and process) than ndependently competng frms. Under the ceters parbus assumpton of unchanged effcency, we can transform the nput-related hypothess III on aggregate R&D nto an output-related hypothess. Hypothess IV (output related): Frms that are nvolved n acquston(s) have no worse performance n R&D (product and process) than ndependently competng frms. Wth regard to the dscusson of dynamc effcency n acqustons any dfferences n the emprcal results of hypothess III and IV should ndcate a change n total R&D effcency due to acqustons. 3. Data and Statstcal Methods 3.1 Descrpton of the data 13

14 Before the 1990s, publcly avalable and relable data on nnovaton have been extremely sparse. However, snce the frst Communty Innovaton Survey (CIS) coverng the years from 1989 to 1997 some frm-level data on nvestment n nnovaton (ncludng non-r&d costs) and nnovaton performance are avalable. In a comparatve analyss of nnovatve ndcators Klenknecht et al (1996, 2002) show that the CIS ndcators measure nnovaton nput and output more comprehensvely and more drectly than earler measures. For our emprcal test we use the cross-sectonal frm-level data on nnovatve nvestment and performance of the Italan part of the CIS for Altogether 18,467 frms n Italy have responded to the survey wth data for the year A survey among non-respondents ndcated that these dd not dffer systematcally from the respondent frms. Ths suggests that the survey s relatvely representatve for frms wth 20 and more employees n all manufacturng sectors of the country. One queston n the survey nqured, whether the frm was part of a group of companes. Out of the total of 18,467 frms 3302 respondents (17.9%) answered ths queston affrmatvely. We consder them to be part of an equty-based coordnaton of nnovaton decsons and label them GROUP respondents (82,1%) answered ths queston negatvely. We consder them to be ndependently competng frms and label them INDEP. Table 1 descrbes the complete sample and the two sub samples n more detal. Table 1 Descrptve Statstcs (Italan manufacturng frms, 1992) Total sample GROUP INDEP total sales employees total sales employees total sales employees (n ml Lre) (n ml Lre) (n ml Lre) N Mean Mn th pctl Medan As mentoned earler, ths defnton can nclude acqustons, mergers, jont ventures, cross holdngs, or any other knd of shared fundng or equty-based nterest wth (shared) decson control or coordnaton. 14

15 75 th pctl Max S.D Not surprsngly, the average sze of companes n GROUP and INDEP s notceably dfferent wth regard to most moments. Frms n acqustons (GROUP) have jont average sales that are almost 9.5 tmes larger than those of ndependent frms (INDEP) and the medan s 4 tmes larger. Furthermore the mean of the number of employees n GROUP s 6 tmes larger and the medan almost 3 tmes. In order to exclude sze bas we relate all varables n our analyss to total sales. The Communty Innovaton Survey s not only professonally generated by several European statstcal offces, but also frequently used n dverse economc studes. There are nevertheless some lmtatons wth regard to sample and varable selecton. Although the CIS was conducted n a number of European countres and over several years we only use the Italan part of the 1992 data snce we do not have access to other natonal databases. 11 However, snce the nnovatveness of the Italan economy s not exceptonally dfferent from other European economes we do not expect a sgnfcant samplng bas. Another lmtaton of the data s that we cannot trace the exact date or modaltes of the acquston that led to the formaton of a group. We therefore nether know the age of the assumed externaltes at work, nor the percentage of nterest acqured n another frm. Fortunately, although these detals would gve our analyss more substance, the formal model and deducton of hypotheses only requre a dfferentaton between coordnated and ndependent decsons n nnovaton, regardless of corporate control or age of relaton. Thus, even when only a mnorty nterest n another frms or jont venture should have been acqured, the fact that the respondent nevertheless consders hmself to be a part of a group ndcates hs wllngness to coordnate hs behavour and fulfls our defnton of acquston. 3.2 The varables The CIS questonnare had two parts. The frst part asked for general nformaton on the frm, lke total sales, number of employees, and ndustry afflaton. At the end of the frst part, frms were 11 Furthermore, the data may only be accessed and analyzed n the buldngs of the natonal statstcal offce n the respectve country. 15

16 asked to ndcate whether they have developed any technologcally changed products or processes n the last 2 years or planned to do ths n the followng 2 years. Only f ths was the case, the frm was asked to complete the second part of the questonnare. 12 The second part contaned questons on nnovatve actvtes and provdes detaled measures of nnovaton nput and output, whch we partally transformed nto the followng varables: Investment varables (nput-related): TOTRD-IN: total R&D expenses (n ml. Lre) dvded by total sales (n ml. Lre) TOTIN-IN: total nnovaton expenses (n ml. Lre) dvded by total sales (n ml. Lre). (next to R&D, total nnovaton expenses also nclude costs for patents and lcences, project engneerng, prototype testng, and market research.) PROD-IN: product R&D expenses as a percentage of total R&D expenses PROC-IN: process R&D expenses as a percentage of total R&D expenses (PROD-IN and PROC-IN complement to 100% of total R&D expenses) Performance varables (output-related): TOT-OUT: percentage of total sales realzed wth new products (ncremental and radcal) and nnovatve processes PROD-OUT: percentage of total sales realzed wth new products (ncremental and radcal) PROC-OUT: percentage of total sales realzed wth nnovatve processes 4. Emprcal Results 4.1 Effect of acqustons on product and process R&D In order to test the effect of acqustons on the nvestment n product and process R&D we statstcally compare the two samples GROUP (coordnated nnovaton decsons) and INDEP (ndependent nnovaton decsons) for those frms that report a formal (and postve) R&D budget. Table 2 descrbes ths sub sample contanng 3696 frms. Compared to the entre sample of frms (descrbed n table 1), 38.3% of the frms n GROUP and 16% of the frms n INDEP nvest n 12 Ths procedure was an attempt to mnmze selectve non-response on non-nnovators who otherwse would have been bothered wth a number of rrelevant questons. 16

17 R&D. Snce the medan (mean) of sales of all frms n GROUP s about 4 (9.5) tmes larger than the correspondng sze n INDEP (see table 1) t s not surprsng that formal R&D budgets are more frequently observed n larger frms. It s nterestng to note that the magntude of ths sze dfference perssts n the sub sample of frms nvestng n R&D: The medan (mean) of sales of all frms n GROUP s about 4.2 (11.2) tmes larger than the correspondng sze n INDEP (see table 2). Ths ndcates that wth respect to sze dstrbuton R&D actve frms represent a non-based sub sample out of the total populaton of frms. Table 2 Descrptve Statstcs (Frms nvestng n R&D) GROUP INDEP total sales (n ml Lre) total sales (n ml Lre) N Mean Medan Table 3 shows the results of two sample tests (GROUP vs. INDEP) for hypothess I and II. Wth regard to R&D nvestment, hypothess I states frms nvolved n acqustons (GROUP) nvest relatvely more n product and less on process R&D than ndependent frms (INDEP). Ths s supported wth a statstcal sgnfcance on the.01 level not only for the means (t-test), but also for the entre dstrbuton (Kolmogorov-Smrnov). In fact, frms nvolved n acqustons nvest on average 2.9 percentage ponts more (less) out of ther total R&D budget n new products (processes) than ndependent frms. 13 When we turn to the performance of R&D, hypothess II s only moderately supported: As predcted, the average performance n process R&D s lower for frms n GROUP, although t s only the Kolmogorov-Smrnov Z that ndcates a statstcally sgnfcant dfference between the two samples. However, wth regard to product R&D, the performance n acqustons does not ncrease (as predcted), but decreases wth a farly sgnfcant Kolmogorov- Smrnov Z (p=0.042) for the entre dstrbuton. Ths mples that the assumpton of constant 13 Snce the nvestments n product and process R&D (varables PROD-IN, PROC-IN) are related to the total R&D budget, they complement to 100%. Ths explans why the magntude of standard devaton, varance, skewness and kurtoss are dentcal. 17

18 effcences, whch led to the deducton of hypothess II out of hypothess I, does not hold for product R&D. To the contrary, ths result seems to support the noton of post-merger neffcences or dseconomes of scale n product R&D that are strong enough to turn an ncrease n nvestment nto a decrease n performance. Table 3 Investment and Performance of Product and Process R&D R&D Investment (nput) R&D Performance (output) Product (PROD-IN) Process (PROC-IN) Product (PROD-OUT) Process (PROC-OUT) N Mean Medan GROUP S.D Varance Skewness Kurtoss N Mean Medan INDEP S.D Varance Skewness Kurtoss Levene s F test p-value t-test t p-value Kolmog.- Z Smr test p-value

19 For a robustness check we construct another sample of nnovatve frms: Some companes do not have formal R&D budgets but nevertheless ntroduce new products and processes nto the market. The CIS survey therefore provdes another varable for nnovatve nvestment, called total nnovaton expenses, whch ncludes non-r&d costs, lke costs for patents and lcences, project engneerng, prototype testng, and market research (TOTIN-IN). Table 4 shows the frequences of these types of nnovatve frms. Table 4 Sub Samples of Innovatve Frms Total sample GROUP INDEP N pct N pct N pct 1: nv R&D : nv nnov all frms * Sample 1 contans all frms wth TOTRD-IN>0 and sample 2 all frms wth TOTIN-IN>0 Unfortunately, the addtonal varable total nnovaton expenses (TOTIN-IN) s not splt up nto product and process nnovaton. We therefore cannot use t for robustness on the nput related hypothess I, but we can utlze sample 2 to check the output related results of hypothess II. Table 5 reports the results for sample 2, whch confrm the above fndngs wth regard to sample Wth regard to product R&D, hypothess II s stll not supported snce the percentage of sales generated through new products (PROD-OUT) does not rse. Wth regard to a hgher performance for acqustons n process R&D, hypothess II and the fndngs n connecton wth sample 1 are fully confrmed. Table 5 Performance of Product and Process R&D (2 Samples of Innovators) Performance Product R&D (PROD-OUT) Performance Process R&D (PROC-OUT) sample 1 sample 2 sample 1 sample 2 14 To enable a better overvew, table 5 once agan reports the output related results from sample 1, whch are also ncluded n table 3. 19

20 N Mean Medan GROUP S.D Varance Skewness Kurtoss N Mean Medan INDEP S.D Varance Skewness Kurtoss Levene s test F p-value t-test T p-value Kolmogorov- Z Smrnov test p-value The effects of acqustons on dynamc effcency are thus splt: Whle neffcences turn sgnfcantly hgher nvestments n product R&D nto a lower or at most equal nnovaton performance, acqustons enjoy effcency gans n process R&D, whch enable a comparatvely hgher performance wth less nvestment. However, the analyss of these ndvdual effects does not yet allow for conclusons about aggregate effcency. In the followng secton we therefore conduct separate tests for hypotheses III and IV. 4.2 Effect of acqustons on aggregate R&D nvestment and performance 20

21 Hypothess III predcts that aggregate nvestment n R&D wll not be lower after acqustons when compared to ndependent frms. Ths s fully supported by the results n table 5, not only for frms wth a postve formal R&D budget (sample 1), but also for frms wth postve total nnovaton expenses (sample 2). It thus seems that the hgher nvestments n product R&D and the lower nvestments n process R&D (see table 3) offset each other. For nnovaton performance, table 5 also shows that the assumpton of constant effcences n aggregate R&D, whch led to Hypothess IV, cannot be held up. Both samples n table 5 clearly show a decrease n aggregate nnovaton performance. Wth no sgnfcant dfference n aggregate R&D nvestment ths clearly ponts towards a dynamc neffcency n acqustons, whch seem to orgnate prmarly from product R&D (see table 5). Table 6 Investment and Performance of Aggregate R&D (2 Samples of Innovators) Investment (nput) Performance (output) sample 1 TOTRD-IN sample 2 TOTIN-IN sample 1 TOT-OUT sample 2 TOT-OUT N Mean Medan GROUP S.D Varance Skewness Kurtoss N Mean Medan INDEP S.D Varance Skewness Kurtoss

22 Levene s test F p-value t-test t p-value Kolmogorov- Z Smrnov test p-value Concludng Remarks Followng concepts n ndustral dynamcs the magntude of margnal returns to product and process nnovaton are lkely to change through the lfe cycle of a technology (e.g. Abernathy and Utterback, 1982). Based on the formal model n ths paper t can be argued that, especally at the begnnng of a technologcal lfe cycle, margnal returns to nnovaton are so hgh that there ncentve to expand generally overcompensates the opposng ncentve to reduce absolute nvestment n process nnovaton, whch an acquston creates through the nternalzaton of negatve externaltes. Followng ths lne of argument, exactly the opposte could be hypothessed for a very mature or even declnng phase of a technologcal lfe cycle n whch margnal returns to nnovaton (product as well as process) are sgnfcantly lower. Postve externaltes of product dfferentaton are then overcompensated by the generally decreasng absolute nvestments n nnovaton (although frms nvolved n acqustons wll stll employ relatvely more resources for product nnovaton than cost reducton). Between these two extremes there also s a stage of moderate margnal returns to nnovatons n the technologcal lfe cycle. Here, the absolute and relatve effects of product and process R&D should be algned. The fact that ths s only partally supported by our results can have two explanatons: From an ndustral dynamcs vew t may be argued that our data of the Italan manufacturng ndustry have a bas towards more mature technologes, whch generally reduces ncentves to nvest n R&D. However, ths would not completely explan our fndng of ncreasng nvestment and decreasng return n product R&D. We therefore take on a frm s perspectve n nterpretng the emprcal results and argue that acqustons lead to neffcences n product R&D, whch overcompensate possble effcency gans n process R&D. Followng ths lne of argument the mplcatons for aggregate dynamc effcency effects n acqustons hnge on the performance n product R&D. Whle externaltes seem to have a relatvely 22

23 drect mpact on process R&D, whch leads to a decrease n nvestment and performance, n our analyss organzatonal neffcences n product nnovaton represent the crtcal factor that prevents acqustons to ncrease or at least mantan aggregate dynamc effcency. Bblography Abernathy, W.J. and J.M. Utterback, 1979, Patterns of Industral Innovaton, Technology Revew, 80, Abernathy, W.J. and J.M. Utterback, 1982, Patterns of Industral Innovaton, n Tushman, M.L. and Moore, W.L. (eds.), Readngs n the management of nnovaton, Ptman, Boston, Adams, J.D. and M. Marcu, 2004, R&D sourcng, jont venturesand nnovaton: a multple ndcators approach, NBER, Agarwal R. and D.B. Audretsch, 2001, Does entry Sze Matter? The Impact of the Lfe Cycle and Technology on Frm Survval, The Journal of Industral Economcs, 1, Ahuja G. and R. Katla, 2001, Technologcal acqustons and the nnovaton performance of acqurng frms: A longtudnal study, Strategc Management Journal, 22, Anderson, P. and M. Tushman, 1990, Technologcal dscontnutes and domnant desgns: A cyclcal model of technologcal change, Admnstratve Scence Quarterly, 35, Blongen, B. and C. Taylor, 2000, R&D actvty and acqustons n Hgh Technology Industres: evdence from the US Electroncs Industry, Journal of Industral Economcs, 47, 1, Bonnano, G. and B. Haworth, 1998, Intensty of competton and the choce between product and process nnovaton, Internatonal Journal of Industral Organzaton, 16, Cassman, B., Colombo, M., Garrone, P. and R. Veugelers, 2003, The mpact of M&A on the R&D process. An emprcal analyss of the role of technologcal and market relatedness, mmeo. Cohen, W. and R. Levn, 1989, Emprcal Studes of Innovaton and Market Structure, n Schmalensee R; and R. Wllg (Eds.) Handbook of Industral Organsaton, North-Holland, chapter 18, D Aspremont, C. and A. Jacquemn, 1988, Cooperatve and noncooperatve R&D n duoploy wth spllovers. Amercan Economc Revew, 78, De Bondt, R., 1996, Spllovers and nnovatve actvtes, Internatonal Journal of Industral Organsaton, 15,

24 De Bondt, R. and R. Veugelers, R., 1991, Strategc nvestment wth spllovers, European Journal of Poltcal Economy, 7, Duranton, G., 2000, Cumulatve Investment and Spllovers n the Formaton of Technologcal Landscapes, The Journal of Industral Economcs, 2, Eswaran, M. and N. Galln, 1996, Patent polcy and the drecton of technologcal change, RAND Journal of Economcs, 27, Gugler, P. and R. Sebert, 2004, Market power versus effcency effects of mergers and research jont ventures: evdence from the semconductor ndustry, NBER Workng Paper Hall, B. 1990, The Impact of Corporate Restructurng on Industral Research and Development, Brookngs Papers on Economc Actvty. Hall, B. 1999, Mergers and R&D revsted, mmeo. Htt, M.A., R.E. Hosksson, R.D. Ireland and J.S. Harrson, Effects of acqustons on R&D nputs and outputs, Academy of Management Journal, 34(3), Htt, M., R. Hosksson, R. Johnson and D. Moesel, 1996, The Market for Corporate Control and Frm Innovaton, Academy of Management Journal, 39, Ravenscraft D.J. and F. M. Scherer, Mergers, sell-offs, and economc effcency. The Brookngs Insttuton, Washngton DC, US. Röller, L-H, Stennek, J; & F. Verboven, 2001, Effcency gans from mergers, European Economy, 5. Katz, M.L. and H.A. Shelansk, 2004, Merger Polcy and Innovaton: Must Enforcement Change to Account for Technologcal Change?, NBER Workng Paper Klepper, S., 1996, Entry, ext, and nnovaton over the product lfe-cycle, Amercan Economc Revew, 86, Klepper, S. and E. Graddy, 1990, The evoluton of new ndustres and the determnants of market structure, Rand Journal of Economcs, 2. Tushman, M. and P. Anderson, 1986, Technologcal dscontnutes and organzaton envronments, Admnstratve Scence Quarterly, 31, Suarez, F. and Utterback, J. 1991, Domnant desgns and the survval of frms, Sloan School of Management, MIT, Workng Paper, Klenknecht, A., K. van Montfort and E. Brouwer, 2002, The non-trval choce between nnovaton ndcators, Economc Journal of Innovaton and New Technology, 11, 2, Klenknecht, A. (Ed.), 1996, Determnants of Innovaton: The Message from New Indcators. Macmllan, London. 24

25 Mller, D. and P. Fresen, 1986a, Porter s (1980) Generc Strateges and Performance: An Emprcal Examnaton wth Amercan Data. Part I: Testng Porter, Organzaton Studes, 1986a, 7, Mller, D. and P. Fresen, 1986b, Porter s (1980) Generc Strateges and Performance. Part II: Performance Implcatons, Organzaton Studes, 1986b, 7, Porter, M.E., 1980, Compettve Strategy, 1980, The Free Press, New York. Rosenkranz, S., 2003, Smultaneous Choce of Process and Product Innovaton when Consumers have a Preference for Product Varety, Journal of Economc Behavor & Organzaton 50, 2003, Scherer, F. M., 1992, Schumpeter and plausble captalsm, Journal of Economc Lterature, 30. Yn, X. and E. Zuscovtch, 1998, Is frm sze conducve to R&D choce? A strategc analyss of product and process nnovatons, Journal of Economc Behavor and Organzaton, 35,