ZEW Discussion Papers
Buyer Power and Suppliers' Incentives to Innovate
Köhler, Christian and Christian Rammer (2012), Buyer Power and Suppliers' Incentives to Innovate, ZEW Discussion Paper No. 12-058, Mannheim. Download
With many industries experiencing significant concentration processes during the last years,
suppliers are increasingly confronted with powerful buyers. The common belief is that exertion
of buyer power negatively affects the innovation decisions of suppliers. The rationale
behind this view is that buyer power leads to decreasing profits of suppliers, which at the
same time lowers their investment incentives.
This explanation may be too narrow as competition in the buyer market may spur suppliers'
innovation incentives. We consider both the price and the technology dimension of buyer
market competition. A powerful buyer confronted with strong price competition might have
the incentive to demand lower prices or higher quality in order to gain a cost advantage or to
differentiate away from competitors. Moreover, for suppliers exposed to powerful technologically
competing buyers it may be a precondition to be innovative and to utilize knowledge
spillovers from the buyer side. Then supplier and buyer need cooperation and collaboration
which requires considerable investments into their relationship. In turn this leads to a stronger
bargaining position for the supplier and thus increases innovation incentives.
A few empirical studies are dedicated to the analysis of buyer power and suppliers' incentives
to innovate and they frequently find a negative relationship. However these studies lack an
objective measure for buyer power or merely use industry measures. Furthermore the focus is
by now on particular industries which are perceived to be heavily affected by concentration
processes among buyers. Besides, all these studies tend to neglect the dimensions of competition
in the buyer market.
We analyse the relationship between buyer power and suppliers' innovation incentives empirically
in different stages of the innovation process. That includes the innovation decision and
the decision on the intensity of innovation activity. We apply firm level data provided by the
Mannheim Innovation Panel (MIP). Our dataset comprises 1,129 observations from German
firms across manufacturing and service sectors and allows us to apply objective measures for
buyer power taking account of a supplier’s economic dependency from the largest three customers
and the buyers’ opportunities to switch to competing suppliers.
We find a negative effect of buyer power on a supplier’s likelihood to invest in R&D. This
negative effect is mitigated by the intensity of price competition in the downstream market. In
contrast, we find no evidence of buyer power to affect a supplier’s decision how much to invest
in R&D directly. Instead, there is weak evidence that the effect of buyer power depends
on the intensity of technology competition in the downstream market. The stronger the technology
competition downstream, the lower R&D investments of a supplier confronted with a
Keywords: Innovation, Buyer Power