Complements ?

This paper revises the interdependence between flexible technology and product innovation in the context of a monopolistic firm. Previous literature argued that flexible machinery reduces the cost of incremental innovation. To take interactions beyond the fixed cost into account, we introduce a 2-period optimization model where technology, innovation and price are chosen first, then stochastic demand realizes and, finally, production is carried out. We find that flexibility increases the expected second period gain from incremental innovation in some but not all cases. Thus, the overall profit function need not be supermodular although fixed cost complementarity might be substantial. Empirical evidence from the German mechanical engineering industry suggests that fixed costs complementarity indeed does not outweigh potential adverse effects in expected operational profits. Effekte aus den erwarteten operativen Gewinnen zu kompensieren. Zhentang Zhang. I would also like to thank Jos Jansen, Rainer Schulz and workshop participants at the Humboldt University Berlin and the Free University Berlin for their useful comments. Funding from the Deutsche Forschungsgesellschaft (DFG) and the GAAC project " Impediments to Innovation: A Complementarities Approach " of the RTN program of the European Commission (HPRN-CT-2000-00061) is greatfully acknowledged. Remaining errors are mine.