Buyer-supplier interaction, asset specificity, and product choice

Firms often differentiate their products through the use of inputs that are differentiated or specialized. The goal of this paper is to explore how the demand for specific investments may affect product variety in a bilateral duopolistic industry. I develop a model where the degree of specificity of investments is endogenously determined through the product choices of both downstream buyers and upstream suppliers of inputs. The existence of non-contractible investments results in the emergence of a single supplier of a non-specialized input. However, as the importance of having specific inputs increases, fully specialized suppliers may emerge. The buyers choose to increase their own competition by producing more similar products only in cases when the inputs are non-specialized. They do so to increase the investment incentives of the suppliers.