Are Product Innovation and Flexible Technology Complements?

This paper analyzes the interdependence between the firms’ technology choice and innovation. Previous literature argues that product flexibility and product innovation are complements, because flexible machines handle a large variety of product designs with low changeover times. In a model where technology is chosen before uncertain demand is realized, we show that long-run technology, by imposing constraints on short-run production, does not only affect the cost of innovating but also its payoff. The results coincide with the literature in that the cost of product innovation is always reduced by flexibility, but we find that the operational profits from product innovation might be decreasing in flexibility. Consequently, flexibility does not necessarily complement product innovation. Empirical evidence from the German mechanical engineering industry supports the complementarity conjecture, since random shocks tend to trigger adjustments of both decision variables in the same direction.