Competitive Pressure and the Adoption of Complementary Innovations

Liberalization of the European automobile distribution system in 2002 limits the ability of manufacturers to impose vertical restraints, leading to a substantial increase in competitive pressure among dealers. We estimate an equilibrium model of profit maximization to evaluate how dealers change their innovation adoption strategies following the elimination of exclusive territories. Using French data we evaluate the existence of complementarities between the adoption of software applications and the scale of production. Firms view these innovations as substitutes and concentrate their effort in one type of software as they expand their scale of production. Results are robust to the existence of unobserved heterogeneity.


Liberalization
Restructuring of the automobile distribution system: Subdealers either became dealers of left the network: 21% decline in the number of dealers between 2002 and 2003.
Concentration vs. competitive effects: Larger dealers are more likely to comply with quality standards. Larger dealers engage in multi-branding more frequently. Vacant locations in less populated areas allow entry of Asian dealers. Overall, automobile prices decline by 12% between 1996 and 2004, which together with higher income and easier credit helps to explain the increase of sales per dealer (as opposed to only the exit of subdealers).
Some other restrictions such as exclusive dealing were also phased out after September 2002.
We will simply identify the change of regulation regime by variable LIB , which takes value 1 for years 2003-2004. Is this change in regulation a good proxy for competitive pressure?
Expiration of Regulation 1475/95 was predictable. The features of the new regulation regime were not completely anticipated.
The new regulation has little to do with the likelihood of dealers adopting innovations or not. The new regulation only affects the conditions of appropriability of the rents of innovation.
Simultaneously, they also choose the scale of production.
Together with the choice of other strategies, this determines the observable level of profits.
Returns of each strategy include observable and unobservable components.
Given a flexible distribution of the unobserved returns, estimates maximize the likelihood that each firm chooses the combination of strategies actually implemented.
Flexible functional approach.
The profit function is:

Scale Decision
Use the Envelope Theorem to obtain the optimal scale choice contingent on the innovation profile: Rewrite the profit function as: where: A firm will adopt both innovations if: or in terms of the unobserved returns: Non-observable returns are jointly distributed according to an unrestricted multivariate normal distribution. where: No direct effect of liberalization on innovation.
Positive effect on the scale of production.
Significant complementarity between scale and product innovation.
Significant substitutability between product and process innovation. Maximum likelihood estimates. Standard errors are reported in between parentheses. Significance levels are indicated with * for p-values less than 0.1; * * for less than 0.05; and * * * for less than 0.01. There is a total of Returns of product innovation is higher in smaller markets.
Returns of process innovation is higher in less affluent markets (where there might not be enough room for profitable product differentiation).
Larger scales in wealthier and less dense markets.
Storage costs dominate Syverson's pro-competitive effect of population density. The total effect of regressors on returns include indirect effects through complementarities, as each one of them also has an effect on the rest of endogenous variables.
Furthermore, unobserved returns are correlated.
Simulations decompose the total effects into direct and effects induced by complementarity.
This is the only unambiguous result. Empirical distribution of the direct, indirect, and total effects of 100,000 simulations. They measure the percent change in the scale before and after the liberalization. Profits are measured in euros. All other