The Innovation-Based Comparative Advantages of Firms

Resource-based theories of product diversification argue that firms grow by diversifying into products that share common capabilities. We bridge the product diversification literature and the innovation literature by documenting the positive correlation between a firm’s innovation-based comparative advantages and the direction of product diversification. By constructing a novel firm-patent-product for China Compulsory Certificate (CCC) products, we find that a higher similarity between a firm and a product in the space of patent fields predicts a higher probability of diversifying into that product. We also find that new products introduced with higher innovation similarities last longer and exit the market with lower probabilities. Based on the intuition of comparative advantages of countries in different products, we interpret our innovation similarities as firms’ comparative advantages that direct product diversification