Fortune favors the prepared firm

A critical factor in industrial competitiveness is the ability of firms to exploit new technological developments. The authors term this ability a firm’s absorptive capacity and argue that such a capability not only enables a firm to exploit new extramural knowledge, but to predict more accurately the nature of future technological advances. A stylized model is developed in which the authors focus exclusively on firm’s decisions to invest in their absorptive capacities. They first examine a monopolist’s investment decision, analyzing the path dependence of its investment and the effect of uncertainty. The authors then consider the effect of competition by modeling the impact of entry on an incumbent’s investment behavior. Implications for management and public policy are then discussed.