Consumer Interaction and Innovation Incentives

This paper examines the link between consumer interaction and innovation performance of firms. Consumer interaction is modelled as a network effect: consumers adapt their tastes in order to take into account the popularity of the submarket the product is traded on. Consumer interaction is shown to result in higher innovation incentives during the transitional dynamics for two types of industries. However, across these industries the firms benefiting from higher incentives are different. In one case larger firms are the ones gaining from consumer interaction, in the other case smaller firms collect gains.