Channel Structure with Knowledge Spillovers

We study two main questions in this paper: 1) How do spillovers of knowledge created by manufacturers' investments in process innovation affect channel structure and effort investment incentives? 2) What are the interactions between organizational incentives to form joint ventures and strategic alliances with competitors, and coordinate decisions vertically with downstream channel members? We focus on situations where spillovers are involuntary, firms' innovative activities are non-overlapping, and firms benefit directly from the results of competitors' innovations. Under these conditions, we find that spillovers in process knowledge increase the likelihood of observing decentralized channel structures. Surprisingly, decentralized manufacturers invest more in process innovation than perfectly coordinated manufacturers do when spillovers are large. Moreover, in industries where large spillovers exist, horizontal cooperation among manufacturers induces higher levels of process innovation investments than channel coordination does. From a public policy perspective, however, the desirability of such cooperative arrangements among competitors depends on channel structure: joint ventures among decentralized manufacturers are more likely to meet the regulators' criteria of raising effort investments than cooperation among integrated manufacturers would be. Investment incentives are best provided when firms share their process knowledge and are buffered from subsequent price competition by independent retailers