In this paper, we study how a research and development cost structure that scales imperfectly with the number of customers impacts the strategic decisions of firms. It can explain why some markets encourage a small firm to behave submissively while it acts aggressively on other markets. Two firms compete in R&D efforts. Efforts attract customers from the competitor and increase the revenue per customer. The cost of efforts depends partially on the number of customers. We show how this cost structure can generate an inverse u-shaped reaction function of the firms’ efforts. We derive conditions under which both firms can increase their efforts in response to an intervention supporting the market leader and under which such an intervention can only encourage the leader or only the laggard. The outcome hinges on whether a laggard becomes more or less competitive as they lose market share. Using three exemplary markets - for hardware, software, and platform technology - we illustrate the importance of this effect to regulators interested in stimulating innovation.

We consider the problem of competing firms contributing to the development of a common standard by analyzing the two core functions of standards. First, standards are set, i.e. they harmonize product characteristics and make products more like each other. Second, standards are developed, i.e. they are a solution to a technical problem that firms jointly solve. To analyze this problem, we develop a model of standard setting, where firms are separated into standards. Within a standard, firms can share their research and development and thus avoid costly duplication. Additionally, firms within the standard also face a higher competition from each other relative to competition from firms outside of the standard. By differentiating between both roles of a standard we show that competition has an inverted U-shaped effect on standard investments. For high levels of competition, a reduction raises firms’ investment. For already low levels a further reduction lowers the incentives of firms. Furthermore, by disentangling competition within and outside of the standard we illustrate how both aspects of a standard conflict with each other. Thus, a standard that leads to a high degree of similarity reduces firms’ incentives to invest. Consequently, governmental interventions that impact the level of competition with the goal of raising R & D investments need to be carefully implemented in the presence of standards. This is even more so true if society has a preference for one of the two goals of a standard.