5. Profiting from innovation

approbiability regime

"appropriability conditions" = all factors that influence the possibility of profitable imitation of an inno. - availability & strength of legal protection; many patents can be "invented around"; weakest protection: process innovations - viability of secrecy (strong in cosmetics, recipes, Pharma); is knowledge tacit or codified? - characteristics of underlying technology - Inno may be inherently difficult to copy (tacit, complex, etc.)

difficulties w/ contracting for specialized complementary assets

- All contracts are incomplete: not all future contingencies can be taken into account - If one partner makes specific investments, a "hold-up problem" can arise Example - supplier invests in machines to manufacture an innovative product. The machines can not be used for any other purpose. → supplier is in weak negotiation position - the buyer could, e.g., complain about specification not being met, request discount, & threaten to cancel contract Implication: - Anticipating the hold-up, supplier will not be willing to make large investments - Ways out? put into contract: until investment is paid off, we pay you or: investment is paid for & owned by buyer

Profiting from innovation via markets for ideas

- Co-operate w/ other firms by signing agreements for the commercialization of the idea - Everything is in the price the new firm gets for the idea - sell high & go to the beach! - Can be hazardous - the threat of competition from incumbent may hang in the air Different types of co-operation strategy: - License technology to one or more buyers - Sell firm to incumbents - Joint ventures or strategic alliances

Risks and costs of co-operation

- Paradox of disclosure - WTP depends on their knowledge of the idea, yet the knowledge of the idea implies that potential buyers need not pay for it - Without IPR, buyers can claim they knew it already - Bargaining power of new firms - are their threats credible? - Finding partners & negotiating w/ them can be expensive & time consuming (incumbents tend to be slow)

Benefits of cooperation

- Shares the potential benefits w/ others - less competition for Schumpeterian rents - Allows new firms to build on other firm's existing competencies - Avoids costs of catching-up - Many firms are skilled users of new firms in their innovation strategies - GE acquires a new firm every day!

supplier's benefits

- innovator IN faces a demand curve p = 1- q for its innovation - fixed & marginal cost of IN are zero, except for each unit of innovation requires as input one unit of good G - G is sold by monopolistic supplier S, is produced at zero cost - assume: S sets price ps, innovator determines qty it buys at this price → what profit do IN & S make?

IBM PC

- mediocre product but: - reputation lead them to gain partners w/ good assets, e.g. Microsoft

use differential strategy when:

- there are close substitutes to the invention - elasticity of demand is low → do exclusive production (no licensing) & heavy marketing

dual sourcing

- two suppliers w/ specialized assets to you → they're dependent on you, you're independent

Cooperate vs compete: What factors should the entrepreneur think about when making this choice?

1. Go through the markets for products - Compete with existing products - Complement existing products 2. Go through the markets for ideas - Sell ideas - Sell your company - Make alliances

Profiting from innovation via product markets

Ability to acquire complementary assets to ensure that innovation offers novel customer value proposition - Incumbents may be risk-adverse & slow to respond - Product market entry by new firms - Be aggressive, quick & paranoid - Manage many factors - marketing, manufacturing, sales and service - Establish a market presence - Persuade customers of novelty of offering - Avoiding detection by incumbents - Gaining access to enforceable IPR

CAT scanner

EMI faild to partner w/ a company like Siemens → product was reverse-engineered and GE took over

complementary assets

Help a firm that produces dominant design come out on top Successful inno requires assets: - competitive manufacturing - distribuion - services - complementary technologies co-specialized assets: (bilateral dependence) e.g. knee implant (or iOS & apps) - instruments are specialized to the inno - one depends on the other specialized assets: (unilateral dependence) e.g. truck → can easily be converted to transport different stuff generic assets (general purpose assets which do not need to be tailored to the inno): e.g. electric energy for computer

imitability vs excludability

Nature of technology - cookie recipe or complex machinery? - Availability & strength of formal IPR available? - Is secrecy realistic? - Costs of imitation? - Reverse engineering - Time it will take to innovate around IPR - Danger of outright theft

Searle

NutriSweet → absence of imitators, patent was airtight & a similar patent would take aged → Searle developed complementary assets in the meantime to gain cost advantage

life cycle phase

assumption: industry in which new products are easy to imitate & mass market w/ homogenous consumer tastes. either: Pre-paradigmatic design phase: - Dominant design has not been established yet - Innovators' success depends on their ability to make theirs the dominant design or Paradigmatic design phase: - Dominant design established - Innovators' success depends on the control of complementary assets - competition shifts from design to price → firms make heavy investments (lower uncertainty) - surge of process innos + incremental innos → in industries w/ large developmental & prototyping costs & where innovation of the product concept is easy, the probability that the innovator would emerge as the winner at the end of the preparadigmatic stage is low." (Teece) → be flexible or be dominant design from the start

Complementary assets: Contract / integrate?

contract: pro: - less expensive to have service around the globe - less risk - add credibility for inventor con: - mutual dependence for specialized complementary assets - partner might take over (e.g. TYRX's pacemaker technology → TYRX acquired by Medtronic, who has more marketing experience, reputation) → use when appropriability regime is tight & complementary assets are good & competitive integrate (lateral, backward, forward): pro: - easier to capture spillover benefits → use when appropriability regime is weak & (specialized) complementary assets may result in bottlenecks (distribution & specialized manufacturers); problem: w/ fast tech developments nowadays, no firm can be sure it has monopoly over crucial assets

returns to innovation accrue not only to the innovator

e.g. innovation by manufacturer - innovation usually increases profit for multiple parties, e.g. ALCOA & aluminum can

tight appropriability regime

patent is iron-clad e.g. petrochemicals → innovator can come out on top w/out having complementary assets (he has enough time to get them)

weak appropriability

patent is not iron-clad → innovator must turn to business strategy in pre-paradigmatic stage: - make sure the design will be dominant - need to know market very well so you know user needs; can be influenced by managerial decisions) - if possible: use parallel & sequential prototyping (if not too costly); cannot be influenced by company in paradigmatic stage: - complementary assets gain importance (especially (co-)specialized ones, since they are irrevirsible → more risk, not readily available

customer's benefits

red: excess WTP by individual buyer grey: WTP lower than costs for monopoly

outcomes for innovators based on contracts/integration

usually: use of mixed modes

in the context of innovation & marketing new products, what is "deadweight loss"?

= the welfare loss to society that is caused by pricing above marginal cost