VERTICAL PRODUCT INNOVATION AND PARALLEL IMPORTS

In this paper, we develop a model of endogenous R&D in vertical product innovation by an original manufacturer facing Bertrand competition from parallel importer(s). We show that if parallel imports are prohibited among the distributors' countries and there is at least one country other than the manufacturer's homeland in which there is only one distributor, then allowing reimports reduces the manufacturer's incentive to innovate. Otherwise, permitting reimports has no effect on the manufacturer's incentive to invest in R&D. Moreover under the assumption of Bertrand competition, either delegating more than one distributor in each country outside the manufacturer's homeland or allowing parallel imports among the distributors' countries enables the manufacturer to maximize his total profit regardless of whether innovation is successful.