Product versus Process: Innovation Strategies of Multi-Product Firms

This paper studies the innovation strategies of multi-product firms
in industries with different scope for product differentiation. In
a simple model of multi-product firms, we show that returns to
product versus process innovation are industry-specific. Demand and
cost linkages induce a natural distinction between the returns to
product and process innovation. In highly differentiated
industries, the cannibalization effect is lower and, therefore,
firms invest more in product innovation. In homogeneous industries,
firms internalize intra-firm spillover effects and invest more in
process innovation. We test the predictions from the model using
Brazilian firm-level data, with information on investment efforts
over time. Following a major exchange rate devaluation, firms have
better access to foreign markets and exploit economies of scale in
innovation. However, detailed information on product and process
innovation allows us to evaluate differential effects across
industries. We con.rm the predictions from the theoretical model
and show that the type of innovation depends on the industry scope
for differentiation.