Non-linear impact of product and process innovations on market power: A theoretical and empirical investigation

An innovative firm enjoys market power either by creating differentiated products (through product innovations) or by increasing productivity (through process innovations). On the basis of theoretical model, we hypothesize that there exists an inverted U-shaped relationship between technological innovations and firms' market power. Creative destruction with respect to firms' own product innovation lessens market power after an optimal point of development and extensive costs of implementing new processes reduce firms' benefits beyond a certain level. Empirical findings based on Indian pharmaceutical firms affirm inverted U-shaped relationship between technological innovations and market power operationalized by Lerner index. The results are robust to alternative measure of market power namely profitability. The identification of such non-linear relationship between technological innovations and market power may help managers to restructure innovation investments to avoid reduction in benefits.