On Vertical Relations and Technology Adoption Timing

On Vertical Relations and Technology Adoption Timing

This paper explores how vertical relations influence the timing of new technology adop- tion. It shows that both the bargaining power distribution among the vertically related firms and the contract type through which vertical trading is conducted affect crucially the speed of adoption: the downstream firms can adopt later a new technology when the upstream bargaining power increases as well as when wholesale price contracts, instead of two-part tariffs, are employed.

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The speed with which new technologies are adopted and diffused constitutes a fundamental determinant of economic growth (e.g., Lucas, 1993; Krugman, 1994). However, extensive empirical observations indicate that new technologies often display both long time lags between their invention and their adoption and a slow adoption rate (e.g., Griliches, 1957; Mansfield, 1968, 1985; Jovanovic and Lach, 1997; Genesove, 1999; Asterbo, 2002). In addition, they indicate that there are significant differences in the adoption timing of new technologies not only across different firms in the same market, but also across different markets (e.g., Griliches, 1957; Mansfield, 1968, 1985; Rogers, 1995).

In response to these observations, an extensive theoretical literature (see e.g., Reinganum, 1981a&b, 1983 a&b; Fudenberg and Tirole, 1985; Quirmbach, 1986; Riordan, 1992; Riordan and Salant, 1994) studying the timing of technology adoption has been developed. This literature has stressed the significant impact of the strategic interactions between the potential adopters on the timing of adoption. Moreover, a number of papers within this literature have argued that the variation in the adoption timing across different markets could be due to differences in the markets’ features. For instance, it could be due to the presence of network externalities (Cabral, 1990; Choi and Thum, 1998), the existence of informational externalities (Chamley and Gale, 1994), the strategic managerial delegation (Mahathi and Rupayan, 2013), and the mode and the intensity of market competition (Milliou and Petrakis, 2011).

Although the existing literature has significantly increased our understanding regarding the timing of technology adoption, it has done so focusing exclusively on one-tier markets. That is, on markets in which the production process consists of only one stage or all the production stages are fully internalized within a firm. In reality though, most markets are vertically related, i.e., most markets consist of various production stages - the stages of the so- called vertical production chain - and have distinct firms operating at the different production stages. Vertically related markets have a number of important features which are absent in one-tier markets. Their main diverse feature is the presence of trading among the vertically related firms - the upstream firms and the downstream firms. Two additional distinct features of vertically related markets are, first, the way through which trading is conducted (i.e., the contract type employed), and second, the distribution of bargaining power among the trading partners.3 Since one-tier markets differ significantly from vertically related markets, it follows that in order to understand the timing of technology adoption in the latter, one has to take into account the role of their distinct features, i.e., to model explicitly the vertical structure and vertical trading.

In this paper, we study the timing of adoption of a new cost-reducing technology in ver- tically related markets. In particular, we explore how a number of features of such markets, along with the presence of vertical relations itself, affect the speed of technology adoption. We address a number of questions, such as: When is a new technology adopted in a vertically related market? How does the bargaining power distribution among the vertically related firms affect the speed of technology adoption? Whether and how the contract type employed (two-part tariffs vs. wholesale prices) affects the adoption timing? How the vertical relations influence the timing of technology adoption, i.e., how the adoption dates differ among vertically related markets and one-tier markets? Or equivalently, how do they differ among different or- ganization structures of production, and in particular, among input outsourcing and in-house input production? 

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