High Risk or Low Cost – Dichotomous Choices of R&D Strategy by Startups in Markets for Technology

Incumbent firms often acquire startups in pursuit of new technologies. While much attention is focused on startups producing radical innovations, in reality incumbent firms purchase technologies that range from the radical to the incremental. What explains this diversity? We build a model of R&D competition between an incumbent and a startup that incorporates a firm’s choice of both investment level and of success probability (risk) of a project. Once project success is revealed, the incumbent commercializes the most valuable project, and, where necessary, acquires the startup. We find that two locally optimal strategies for the startup can exist, characterized by higher risk or lower cost relative to the incumbent’s strategy. Depending on the R&D technology, either may be the startup’s globally optimal strategy. Extending the model to two startups, numerical analysis shows that either both pursue a high risk strategy, both pursue a low cost strategy, or each picks a different type of strategy. The intuition behind our results is that a startup pursuing a high risk strategy aims for technological superiority, while one following a low cost strategy banks on having the only successful R&D project. Our model thus suggests a dichotomy of innovation strategy choice by startups that seek to be acquired