Diversification: A Road to Inefficiency in Product Innovations?

Motivated by recent empirical observations made in industries like the automobile industry, this paper employs an agent-based industry simulation model to examine the strategic relationship between product diversification strategies in an industry and some aspects of the product innovation strategy of a single producer. In particular, it is established that an increase in the average degree of product diversification in an industry increases the incentive for a producer to reduce the time to market for innovations at the expense of product quality. However, if all firms adapt their strategies according to these incentives, this results in a severe loss of average firm profits in the industry and also to a reduction in consumer surplus. It is then studied how the strength of this dilemma depends on several parameters describing the market structure and patent policy.