Naked Exclusion and the Volatility of Innovation

Abstract

The analysis shows that the volatility of a potential entrant’s innovation is an important parameter which shapes an incumbent supplier’s exclusivity strategy. Higher volatility encourages the incumbent supplier to adopt an accommodation, rather than a pure exclusion, strategy. When volatility is above a threshold, the incumbent always chooses accommodation regardless of the expected size of the entrant’s innovation. And since an accommodation strategy merely redistributes surplus without blocking efficient entry, it may not warrant a prohibition of exclusivity contracts by the antitrust authorities.

Keywords: Exclusivity Contract, Innovation, Volatility, Fixed Cost

JEL Classification: L42, K21