The process of standard formation and its strategic implications.

Abstract

This dissertation is motivated by the recent increase in formation of product standards in many high technology markets. These markets are characterized by a high degree of technological uncertainty and high levels of R&D expenditures by incumbent firms. In this dissertation we examine how how rapid technological change in the environment affects firms incentive to standardize. We also examine how product standards affect R&D investment levels and how firms' competence in different types of innovation affects their preferences for compatibility. We developed a game theoretical model in which firms make both compatibility and R&D investment decisions. We first studied how rapid technological change in high technology markets affects firms' incentive to standardize. We find that the inherent technological uncertainty in high technology environments promotes the formation of standards. This result is in contrast to the popular view that in technologically uncertain environments standards are less likely to be formed. Our results suggest that incumbent firms can use standards to protect themselves from the threat of displacement by exogenously developed superior technology. In other words, incumbent firms can use compatibility as a competitive tool to deter entry. We also find that compatibility generally leads to higher investments in minor R&D. In contrast, compatibility decreases investment in breakthrough R&D. This result suggests that standards affect the nature of R&D competition. Before products are standardized, firms are more likely to invest in developing new breakthrough technologies. In contrast, when products become standardized innovation efforts will be focused on developing minor improvements for the present technology. We also examined how firms' R&D competence will affect their preferences for compatibility. Our results show that firms which are more efficient at developing at minor product improvements have a stronger preference for compatibility than firms which are less efficient in minor R&D. In contract, firms which are efficient in developing breakthrough technologies find standardization a less attractive option.