Over the last three decades, we have witnessed a substantial increase in the number of R&D alliances between firms. Consistent evidence across the United States (Rοller et al., 2007), Europe (Kaiser, 2002) and Japan (Branstetter and Sakakibara, 1998) further suggests that firms collaborate in order to share know-how and enhance their technological capabilities. The recent upsurge in R&D alliances shows that hi-tech sector firms increasingly prefer non-equity forms of collaboration, such as R&D networks, relative to traditional, equity forms, such as research joint ventures (RJVs hereafter). For example, Hagedoorn (2002) documents that in the major fields of technology, such as information technology and pharmaceuticals, the number of newly established R&D alliances grew steadily during the 1980s and 1990s, reaching an impressive total share of more than 90%, while the share of RJVs declined to less than 10%.
Further empirical evidence and stylized facts suggest that R&D alliances are often established in the context of vertically related industries. For example, Cloodt et al. (2006) find that, in the computer industry, a substantial number of R&D alliances are formed at the upstream market tier that is, among firms that do not trade directly with consumers but instead supply key inputs. The principal motivation behind this observation is that individual firms find it rather difficult to develop technological capabilities alone, so they prefer to collaborate with others and pool their know-how. In particular, we have observed the formation of R&D alliances between producers of micro chips, such as Intel, Motorola and Texas Instruments who are located upstream and supply their inputs to personal computer manufacturers, such as IBM, Hewlett Packard, Sony, Dell and Compaq who are located downstream.
These observations raise a number of questions. First, what R&D network architectures will emerge endogenously between upstream firms? Second, how do the incentives to form R&D collaboration links depend on whether upstream firms set prices or quantities? Third, what are the welfare effects of the equilibrium R&D networks? Finally, in light of the favorable treatment of R&D collaborations in the United States (Hagedoorn et al., 2000) and the European Union (Luukkonen, 2002), can our model yield an insight into issues relevant to policy-making?
To address these questions, we study an endogenous network formation model. We envisage an industry with three upstream and three downstream firms, which are locked in exclusive relations. The input produced by the upstream firms is used by their respective downstream customers to produce a final good. In line with the stylized facts above, the upstream firms seek to reduce their costs by pursuing both process R&D investment and the formation of collaborative links to pool R&D outputs with other firms In this environment, when upstream firms decide whether to establish an R&D link between them, they anticipate how this will ináuence the competitive strength of their respective downstream customers. In turn, a more aggressive downstream firm sells more output and thus can secure more profit for its upstream supplier. To put it slightly differently, upstream firms compete against each other indirectly, through their downstream customers.