High Risk or Low Cost: Dichotomous Choices of R&D Strategy by Startups in Markets for Technology

Technology-focused acquisitions of startups by incumbents are highly diverse, comprising radical but also incremental innovations. We build a model of R&D competition between an incumbent and a startup to explain this diversity. Each player chooses investment level and success probability, or risk, of its project. After outcome realization, the incumbent commercializes the most valuable project, and, where necessary, acquires the startup to this end. We find that two locally optimal strategies for the startup can exist, characterized respectively by higher risk or lower cost than the incumbent’s equilibrium strategy. Depending on the R&D technology, either of them may be the startup’s globally optimal strategy. With two startups, numerical analysis confirms this finding. The intuition behind our results is that a startup pursuing a high risk strategy aims at technological superiority, while one following a low cost strategy banks on having the only successful R&D project. Our model thus suggests a dichotomy of technology-focused acquisitions of startups by incumbents.