Delegation,R&;D and competitiveness in a Bertrand duopoly

This paper studies the profitability of centralized investments in R&D versus decentralized price determination in a duopoly for Bertrand consumer markets. As a direct effect, R&D investments lower the firm’s production costs and thus increase c.p. the firm’s profits. However, as an indirect effect, lowering production costs causes market reactions and alters the competition between the firm and its competitors. In the extreme, aggressive competition can occur that diminish an investing firm’s profits. Delegating the price decision using an incentive contract distorts a manager’s perceived costs and induces a virtual cost increase in equilibrium. Trading off the factual cost reduction against a virtual cost increase we find that competition makes strategic delegation more attractive compared to investments in R&D. If firms are allowed to apply both strategies in combination, they concentrate on just one of them for strategic considerations.