Unconventional Times: Competition, Capability, and Innovation in the Oil and Gas Industry

We develop a formal model to analyze innovation as a firm choice affected by market competition and firms’ technological capabilities. Our model accounts for a short-term selection effect, that an increase in market competition will increase the threshold of firm capability for staying in the industry and slow competition growth for surviving firms, thereby reducing firms’ survival-based incentive for innovation. With lower survival pressure, firms focus more on short-term profit than long-term survival and decrease innovation efforts as competition intensifies. In addition, high capability firms, because they are less vulnerable to survival threats but more sensitive to price levels for total profits, their innovation efforts will be more negatively affected by competition than those of low capability firms. We test these predictions by examining firm investments in unconventional wells in the United States between 2010 and 2018.