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The tradeoff between innovation development and innovation diffusion has been widely studied in the technology change and industry performance literature. This tradeoff arises from the fact that what we do to prevent free availability of existing innovative discoveries to all producers, although beneficial from an ex-post efficiency standpoint, will fail to provide the ex-ante incentives for further innovation (Arrow, 1962; Cohen & Levin, 1989; Cohen & Levinthal, 1990). Such a dilemma is called the appropriability problem.
In spite of its long history, the problem of how firms decide on innovation-related issues is still of much interest and importance. In its simplest form, the appropriability problem is concerned about a firm deciding on whether or not to innovate - or how much to innovate - based on the extent to which the innovation is appropriable (Arrow, 1962; Quirmbach, 1986; Ireland & Stoneman, 1986; Levin, 1988; Saracho, 1996; Sakakibara, 2002).
A newly emerging theme, mostly seen in Boldrin and Levin’s (2009a, 2009b, 2009c, 2009d) recent works is divisibility according to which, the knowledge embodied in goods or people is not costlessly available. Therefore, if one firm is to imitate another, it should devote some time, money and energy into buying some copies of the goods in which the knowledge is embodied (Boldrin & Levine, 2008, 2009a). In other words, there is no free and unpriced “spillover.” Therefore, the matter of interest, here, is not only the innovator deciding how much to innovate due to the degree of appropriability, but also, how the imitator decides on how much to imitate due to the degree of divisibility (which we will refer to as imitability). Boldrin and Levin (2009b, 2009c, 2009d) have studied the appropriability and divisibility decisions and their effect on market size and structure.
In this paper, we study the interdependency between innovation and imitation and show that a firm can be an innovator and an imitator at the same time. While the two-fold role of a firm has been addressed sporadically in the field literature (such as Spence, 1984), none of these studies have considered the interdependency between innovation and imitation. Not all industries can be partitioned into innovators (i.e. north) and adopters (i.e. south) as argued by Helpman (1993) and Akiyama and Furukawa (2009). This gap in the current literature might have led to some misdefinitions of the problem. For instance, it is always postulated that a firm has less incentive for investing on easily imitable innovations only because it may then be imitated by others (Arrow, 1962; Quirmbach, 1986; Ireland & Stoneman, 1986; Levin, 1988; Saracho, 1996; Sakakibara, 2002; Spence, 1984).