s including Ford, Acura, and Mercedez have countered with luxury sport-utility vehicles of their own. In each of these cases, innovation has led eventually to widespread imitation-that is, diffusion. IMITATION AND RESEARCH AND DEVELOPMENT INCENTIVES IMITATION PROBLEMA firm’s rivals may be able to imitate its new product or process, greatly reducing the originator’s profit from its R & D effort. As just one example, in the 1980’s U.S. auto firms took apart Japanese Honda Accords, piece by piece, to discover the secrets of their high quality. This reverse engineering - which ironically was perfected earlier by the Japanese – helped the U.S. firms incorporate innovative features into their own cars. This type of imitation is perfectly legitimate and fully anticipated; it is often the main path to widespread diffusion of an innovation.In fact, a dominant firm which is making large profits from its existing products may let smaller firms in the industry incur the high costs of product innovation while it closely monitors their successes and failures. The dominant firm then moves quickly to imitate any successful new product; its goal is to become the second firm to embrace the innovation. In using this so called fast-second strategy, the dominant firm count on its own product-improvement abilities, marketing prowess, or economies of scale to prevail.Example: Royal Crown introduced the first diet cola, but Diet Coke and Diet Pepsi dominate diet-cola sales today. PATENTSImitation and the fast-second strategy raise an important question: What incentive is there for any firm to bear the expenses and risks of innovation if competitors can imitate its new or improved products? Why not let others bear the costs and risks of product development and then just imitate the successful innovations? Although we have seen that this may be a plausible strategy in some situations, there are several protections for, and potential...
