Using a simple model of differentiated Cournot competition with endogenous choice of product variety, we find that innovation in one variety may lead to a decrease in product diversity in the catch-up phase, eventually decreasing the profit of the innovator and of all other producers.
Innovation and catch-up in the market for shrimp
Large-scale commercial farming began developing in the 1970s in the Eastern and Western Hemispheres based on farming local shrimp species. Both Asia and the West, however, had failed to set up a large-scale intensive shrimp aquaculture.
Independently from the species cultured, all attempts were affected by the same common problem: the periodical outbreak of diseases. With the high incidence of diseases, and the subsequent losses, shrimp aquaculture suffered of high volatility and uncertainty in the final volumes and profits, causing a drop in investments.
In the late eighties, researchers were able to develop Specific Pathogen Free (SPF) stocks of Litopenaeus vannamei that were free of IHHNV by re-adapting the breeding and selection concepts from the livestock and poultry industries.
“As a result of this innovation, total production of the US industry doubled, contributing to a sensible increase in profitability.”
However, the supremacy of the biosecurity methods developed in the US only became clear with the insurgence of a new disease, the Taura Syndrome (TS). By 1999, the first stocks of Taura syndrome resistant shrimp (called TVR for Taura Virus Resistant) were supplied to the US industry showing better survival and production increased 40% over the previous year.
For Asian countries, the economic incentives to switch from Penaeus monodon to the new SPF L. vannamei were outstanding, pushing producers to switch their production at a very rapid pace. Asian countries did not import the innovation but rather the product of that innovation, the SPF/TVR broodstock, allowing them to skip the earliest stage of production, which required a consistent investment to build up the facilities.
“Although Asian countries have recently attempted to launch their own production of domestic SPF broodstock, they are still largely relying on US exports.”
The US shrimp industry experience constitutes an illustration of the principle that R&D outcomes are
always meant to be (in the long run) non-rivalrous and non-excludable. In the case of the shrimp industry, conflicting interests with the broodstok industry have fostered the innovation’s diffusion, resulting in a very short catch up period.
The curse of innovation: a theory
Two representative firms, Home (h) and Foreign (f), produce shrimp. There are two varieties of shrimp on the market, the white legs shrimp L. vannamei (v) and the Tiger shrimp P. monodon (m). Each of the firms can produce only one variety. As producers decide their quantities but are price takers on world markets, and as the two varieties of shrimp are not identical, we model the market as a differentiated Cournot competition.
“Our focus is on the impact of innovation on competition and product diversity. We assume that when a firm benefits from an innovation, it gets a competitive advantage for one period.”
We model this advantage by a technology allowing reducing its production cost. Then, the laggard eventually catches up on the innovation and benefit from the same technology.
The game consists in three phases. In the Pre-innovation phase, both firms produce at constant marginal. In the Innovation phase, firm h can produce variety v at marginal cost, while the production cost for the other variety and the other firm remains, and in the Catch-up phase, both firms can produce variety v at marginal cost, while the production cost for the other variety m remains.
“There are several possible curses of innovation. The first one is the existence of multiple equilibria in the phase following the innovation.”
The second curse is a variant of the first. In the case in which two pure strategy equilibria with product diversity exist in the catch-up phase, firm h may end up specializing in the high cost variety, and receive a lower profit than before the innovation.
While this is a theoretical possibility, it may be reasonable to discard it using the same focality argument as for the first point.
The third possibility is perhaps the most realistic, and our focus of this paper. In the first two cases from this third option, innovation is unambiguously positive for the firm benefiting from it: firm h obtains a cost advantage and product diversity remains the same.
“There’s a fourth proposition, where innovation is also positive: despite the fact that a decrease in product diversity increases the intensity of competition, the cost advantage is so high that it compensates for the loss.”
But there is a third option where innovation gives a short-term advantage in the innovation phase, at the cost of a lower profit in the catch-up phase than pre-innovation.
The curse of innovation in the market for shrimp Figure 1 looks at the total production of L. vannamei shrimps by the five major producers (US, China, India, Thailand and Vietnam), that overall account for 80% of world production.
In 1984, the US started to produce white legs shrimp. In 1992, the first SPF shrimp were developed (start-up era). 1999 is the breakthrough second generation of SPF shrimp giving US producers a major cost advantage.
Following this cost-reducing innovation, the quantity of L. vannamei shrimp is increases massively. The years 2001, 2002 and 2009 correspond to the sequential adoption of the new breed by major Asian producers. We observe that during those latter years the produced quantity continued to increase, but at a much slower pace.
The reason for this exchange ratio can be seen on Figure 2, decomposing the total production of L. vannamei in the US and in the rest of the world. The vertical dashed line (2003) marks the year all the Asian major competitors (with the exception of India) had terminated the production trials and began operating in the global market.
The increase in the US production of L. vannamei starts with the SPF innovation, and the decrease in the production starts when the production in the rest of the world increases, in particular following the adoption of L. vannamei by Thailand and China.
We report FAO estimates of the impact of the innovation on production costs in different countries. With the exception of China, whose costs were much lower even in the pre-innovation period, all other countries experienced a consistent reduction in cost by on average 30%.
“Data suggest a net acceleration in the rate of production following the adoption of L. vannamei in Thailand, Vietnam and India, while it didn’t affect China’s trend.”
The question of whether this innovation was sufficiently important to avoid a decrease in the US firms’ profit is however more complicated to assess. We computed quantity data from the FAO, the price data from the FED global shrimp prices time series (wholesale price in New York, $ per kilo), and the average production cost from.
The very low profits in 1991 correspond to the outbreak of the Taura syndrome, and the years 1995-97 correspond to the outbreak of the white spot disease. Then, 1999 is the year of the major breakthrough that gave US producers a cost advantage.
It is clear that this innovation coincides with the beginning of an increase in profits, and that the years when Asian countries switched to L. vannamei corresponds to a turning point in which profits start to fall.
“The story however does not stop there. In early 2000s, the decline in US market share and the dramatic rise in importation caused a 40% drop in employment in US shrimping factories.”
In the attempt to save their dying industry, the Southern Shrimp Alliance (SSA), a group of eight south-eastern states consisting of forty two shrimp processors successfully petitioned the US government to impose anti-dumping duties on imports from Thailand, China, Vietnam, India, Ecuador, and Brazil.
Also, in 2014, a new major disease, the Early Mortality Syndrome (EMS) wiped out Chinese and Thai production of shrimp by more than 50%, leading to price increases of more than 40% for a kg of L. vannamei shrimp. The disease only affected South-East Asia, and never reached US producers, leading to a new phase of profit increase for US producers, not specifically linked to any product innovation.
This paper is a first attempt at looking at the link between innovation and the endogenous level of product diversity. Our results suggest that innovation may constraint firms active in a previously diversified market to sell more homogeneous products, and that such an incentive may lead to more intense competition in the catch-up phase than pre-innovation.
Our static results suggest that the “curse of innovation” case, by decreasing the profit in the catch-up phase, may actually make the subsequent innovation more attractive, not less. It would also increase the advantage from staying one step ahead of the competitors in a model similar to Aghion et al. (2005).
While the empirical focus of this paper is on the shrimp industry, the theoretical results refer to any innovation that would make a variety cheaper to produce. This may apply more generally to the agricultural sector, where an innovation often consists in developing a more resistant or cheaper to produce variety.
It could also correspond more broadly to technological innovations in which the adoption of a, superior, common standard constraints product diversity.
This is a summarized version developed by the editorial team of Aquaculture Magazine based on the review article titled “OF SHRIMP AND MEN: INNOVATION, COMPETITION AND PRODUCT DIVERSITY” developed by: AMANDA DE PIRRO, Lancaster University Management School, RENAUD FOUCART, Lancaster University Management School.
The original article was published on MARCH 2022, through ECONOMICS WORKING PAPER SERIES under the use of a creative commons open access license.
The full version can be accessed freely online through this link: https://eprints.lancs.ac.uk/id/eprint/167872/