How Much to Integrate? - Firms’ Profit-Maximizing R&D Allocations in Emerging Standard Settings

We formalize firms’ research and development (R&D) diversification decisions during the pre-market phase of an emerging standards setting. Capturing transaction costs, resource-based considerations, and network effects in a two-player model, in which both agents are fully diversifiable and must trade-off the expected benefits from co-operating on a joint standard vs establishing their own, we can show that transactional hazards and knowledge-based complementarities from in-house production lead to expected increases in diversification. Contrary to established wisdom, however, increasing network effects also reduce firms’ co-specialization. We motivate our study and elaborate on our findings from two related perspectives: a corporate strategy perspective on the optimal degree of specialization and the technology scholar’s viewpoint on firms’ anticipation of standard-related bargaining considerations to the pre-market phase