We analyze a model of industry evolution where the number of active submarkets is endogenously determined by pioneering innovation from incumbents and entrants. Incumbent pioneers enjoy an advantage of additional pioneering innovation via a dynamic capability that takes the form of an improved technology for innovation in young submarkets. Entrants are motivated in part by a desire to acquire the dynamic capability. We show that dynamic capabilities increase total innovation, but whether the capability confers an advantage in terms of marginal or average cost is important in determining how the impact of dynamic capabilities is distributed across incumbent and entrant innovation rates. We complement the existing literature-that focuses on exogenous arrival of submarkets or the steady state of a model with constant submarkets-by describing how competition, free entry, and the dynamic capability of incumbents drive the evolution of an industry. The shift from immature to mature submarkets can lead to a shakeout in firm numbers, and it eventually leads to a reduction in total dynamic capabilities in an industry.
