Innovation and Transfer of Technology Decomposing the Benefits of Cost Reducing Innovation

This paper analyzes interaction of two identical firms in a price reciprocating competition and introduces value of unpredictability in a mixed strategy game. Further, it examines the sensitivity of firm values to different idiosyncratic shocks in preinnovation stage. In the post innovation stage, the study finds that the price and quantity effect of cost reducing innovation are linear in cost reduction and depends only on price elasticities of demand. The study also finds that proprietary benefits of innovation induces switching effect and demand innovation premium. At the end of this paper we suggest a simple license pricing scheme for sharing the benefits of innovation both for complete and partial transfer of technology. In our analysis, shared benefits of nondrastic innovation provide a win-win situation for both firms.