Technological activities are a source of economies of scale and efficiency (Davies & Geroski, 1997; Gruber, 2000; Mueller & Tilton, 1969; Phillips, 1966) having a direct impact on the firms’ monopoly power.
Technological activities leading to innovations are captured by product and process patents. Product innovation increases the firm’s monopoly power through product differentiation as the firm now charges higher prices for differentiated products (Cohen & Klepper, 1996; Lunn, 1986; Vives, 2008).
Process innovation positively affects firms’ monopoly power through cost reduction that improves productivity and output (Crépon et al., 1998; Deolalikar & Röller, 1989; Griliches, 1980; Hall, 2011; Kamien & Schwartz, 1982). In this study, we analyse the impact of product and process innovation on firms’ market power for the Indian pharmaceutical sector.
Indian pharmaceutical industry provides an interesting research context to explore the impact of product and process patent on market power. This sector witnessed many structural changes in the last 50 years like patent policy reforms that have altered the industry’s competitive pressures. As until the 1970s, this industry was dominated by MNEs where both product and process patents were allowed (Duggan et al., 2016; Kale & Little, 2007).
The year 1970 marked a watershed year with policy change whereby only process innovation could only be patented in the fields of food, drug and agrochemicals for 7 years. Following this, MNEs left the market, while domestic firms improved their capabilities by conducting adaptive R&D (Duggan et al., 2016; Goldar, 2013; Kale & Little, 2007).
The next major change occurs with the re-introduction of product patents in 2005 to comply with the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPs).1
The presence of MNEs significantly alters the competitive forces in the Indian pharmaceutical industry. MNEs have access to technology developed by their parent organizations that provide them competitive advantage vis-→-vis domestic firms (Buckley & Casson, 1976; Rugman & Verbeke, 1992, 2003). Empirical evidences also suggest that innovation performance of MNEs is superior to domestic firms in India (Ambrammal & Sharma, 2016; Dhanora et al., 2018; Khachoo et al., 2018). Moreover, a group of studies also find that there is a significant knowledge flow from MNEs to domestic firms (Khachoo & Sharma, 2017; Marin & Sasidharan, 2010; Sasidharan & Kathuria, 2011).
MNEs are large and dominating firms due to superior technology and availability of finance. MNEs also have an edge over domestic firms in terms of investment capacity, absorption capacity, technology profile and productivity score (Cohen & Levinthal, 1989; Patel & Pavitt, 1997; Sharma, 2012).
Majority of studies in the Indian context utilized R&D expenditure to proxy firm-level innovation (Basant & Mishra, 2014; Kathuria, 2008; Narayanan, 1998; Sasidharan & Kathuria, 2011; Sharma et al., 2018) with little attention on patenting as a measure of innovation (Ambrammal & Sharma, 2016; Chadha, 2009; Deolalikar & Röller, 1989).
Utilization of R&D does not represent the actual technological capabilities of a firm because many firms in the developing country do not report their R&D and also all the R&D expenditure does not convert into successful innovation.
However, utilization of patent overcome these problems as it is the outcome of successful R&D. Patents are also positively associated with the commercialization of the new product and also new product sale.
Firm-level innovation activities are classified as technological and non-technological innovation activities. Technological innovations are product and process innovation whereas non-technological innovations are marketing and organizational innovations.
Accordingly, while examining the impact of patenting on market power, this study utilizes different types of technological innovations, that is, product and process innovation. These innovations are changes or essential improvements in the product (product innovation) and production method (process innovation).
This classification is essential because both product and process innovation influence the performance of firms through different channels. Product innovation enhances firm performance through price increasing channel whereas process innovation through cost reduction channel. In the context of developed countries, studies have incorporated types of innovation activities while analysing innovation and performance relationship (Lunn, 1986; Nemlioglu & Mallick, 2017).