Innovation Management:
Lecture 1: Innovation and innovators
Why do firms exist?
• Transaction costs theory (Williamson, 1981)
What is innovation?
• Innovation radar (Sarney et al., 2006)
Who innovates?
• Incumbent curse (Chandy & Telis, 2000)
• Disruptive innovations (Christensen et al., 2015)
Summary Article 1: the Economics of Organization: The Transaction Cost Approach
- Oliver E. Williamson (1981)
Summary Article 2: the 12 Different Ways for Companies to Innovate
- Sawhney, M., Wolcott, R.C., Aronia, I. (2006)
Summary Article 3: the incumbent’s curse? Incumbency, size, and radical product innovation
- Chandy, R.K., Telis, G.J. (2000)
Summary Article 4: what Is Disruptive Innovation?
- Christensen, C.M., Raynor, M.E., McDonald, R. (2015)
Why Innovation Management?
Innovation is essential for the competitive position of companies
Theories of the firm:
- Transaction cost theory
- Behavioural theory of the firm
- Organizational learning
- Appropriability mechanisms (IP, specialized assets)
- Resource based view and Dynamic capabilities view
- Inter-firm partnerships and open innovation
- (Sustainable) business model innovation
Business cases analysis: opportunity to recognize patterns and apply theoretical concepts to real life situations
1
,Established firms versus start-ups
• Start-up entrepreneurs address customer needs in entirely new ways
• Differences in size, (age), resources, affect the way firms operate along several dimensions
Why do firms exist?
Neoclassical economists: firms as production functions that efficiently transform land, labour, and capital
inputs into goods and services. Competitive markets coordinate buyer-seller exchanges via price signals.
Ronald Coase (1937) posed two Nobel-prize questions:
• Why do firms emerge in a market economy?
• What determines the scale and scope of firms?
The main reason why it is profitable to establish a firm would seem to be that there is a cost of using the price
mechanism. (…) the operation of a market costs something and by forming an organisation and allowing some
authority (an “entrepreneur”) to direct the resources, certain marketing costs are saved. R. Coase (1937)
Transaction cost theory: the goal of an organisation is to minimize the costs (not directly creating value) of
exchanging resources in the environment and the costs of managing these inside the organisation
Transaction costs as unit of analysis:
Transaction: occurs whenever a good or service is transferred across a technologically separable interface
• Alternative governance structure should be assessed based on their capacity to economize on
transaction costs (trade-off)
• Economic efficiency and organizations’ internal structure are related
• Optimize transaction costs
• Boundaries of the firm as a decision variable
→ Firms exist to reduce transaction costs
Costs are simply a loss of value when transferring one type of capital to another. When we analyse different
ways of engaging in economic activities, we should minimise costs
Behavioural assumptions
Transaction agreements never cover all possible future contingencies (incomplete contracting). Transactors act
under:
1. Bounded rationality: transactors are constrained by cognitive limits on their capacities to process
information efficiently (incomplete contracting)
2. Opportunism: self-interest with guile could induce strategic behaviour by transactors to lie, cheat,
confuse, mislead their exchange partners
Forms of governance
Three forms of transaction governance:
1. Hierarchy (make): transactions among parties occur under a unified owner who settles disputes (firm
governance)
2. Market (buy): autonomous parties’ exchanges are governed by prices in supply-demand equilibrium
(market governance)
3. Hybrid (ally): long-term contractual relations that preserve parties’ autonomy, but provide added
transaction-specific safeguards as compared with the market
Make or buy decisions
Consider backward, forward, lateral integration options
2
,Boundaries of firms and governance structures
Critical dimensions for transactions
1. Uncertainty
2. Frequency with which transactions recur
3. Extend to which investments are transaction-specific
"The issue is less whether there are large, fixed investments [...], than whether such investments are
specialized to a particular transaction." → Specificity relates to costs, e.g., because of nonmarket ability
problems (and potentially also competition for those assets; see lecture 4)
Asset specificity can stem from 3 causes:
1. Site specificity
2. Physical asset specificity
3. Human asset specificity (learning by doing)
Firms versus markets
Advantages of common ownership (firm control)
1. Reducing incentives to suboptimize
2. Resolve differences
3. More complete access to relevant information
Advantages are a function of asset specificity
(and uncertainty)
∆C = Production costs differences between
internal organisation and market
∆G = Governance cost differences
∆C + ∆G > 0 → advantage market procurement
∆C + ∆G < 0 → advantage internal procurement
Representative net production and governance cost differences
3
, Overview of the elements
Which types f transactions can be handled most efficiently in which institutional form of
organisation/governance?
Criticism to Transaction Cost Economics (TCE):
- Opportunism: too much emphasis
- Trust: among individuals between organizations is an alternative basis for lowering transaction costs
- Learning curves: transactors become better over time
- Path dependence: the governance of a particular transaction may depend on how previous
transactions were governed
- Heterogeneity: TCE neglects differential capabilities and dynamics
What is innovation?
Innovation: new combinations of existing resources (Schumpeter, 1934). While invention is the first occurrence
of an idea for a new product or process, innovation is the first attempt to carry it out into practice
What is the role of innovation in economic and social change?
• Schumpeter’s notion of creative destruction: growth is brought by the introduction of new
technologies and creation of new firms, replacing existing technologies and firms
• Innovation introduces variety into the economic sphere. Should the stream of novelty dry up, the
economy will settle into a stationary state with little or no growth
→ Innovation is the engine of growth
Technological innovation
Technological innovation: the act of introducing a new device, method, or material for application to
commercial or practical objectives
• In many industries technological innovation is now the main driver of competitive success
• Increasing market segmentation & shorter product life cycles
• Diversification as part of competitive disadvantages
→ From new things to new value
Business innovation
Business innovation: the creation of new value for customers and firms by creatively changing one or more
dimensions of the business system
• For example: Starbucks is not the best company in coffee but came up with third place, a place beyond
home and work where people could gather, relax, and talk. This is their main innovation: create a
community feeling which makes people to pay a premium price
How many possible dimensions of business innovation are there, and how do they relate to each other?
4
Lecture 1: Innovation and innovators
Why do firms exist?
• Transaction costs theory (Williamson, 1981)
What is innovation?
• Innovation radar (Sarney et al., 2006)
Who innovates?
• Incumbent curse (Chandy & Telis, 2000)
• Disruptive innovations (Christensen et al., 2015)
Summary Article 1: the Economics of Organization: The Transaction Cost Approach
- Oliver E. Williamson (1981)
Summary Article 2: the 12 Different Ways for Companies to Innovate
- Sawhney, M., Wolcott, R.C., Aronia, I. (2006)
Summary Article 3: the incumbent’s curse? Incumbency, size, and radical product innovation
- Chandy, R.K., Telis, G.J. (2000)
Summary Article 4: what Is Disruptive Innovation?
- Christensen, C.M., Raynor, M.E., McDonald, R. (2015)
Why Innovation Management?
Innovation is essential for the competitive position of companies
Theories of the firm:
- Transaction cost theory
- Behavioural theory of the firm
- Organizational learning
- Appropriability mechanisms (IP, specialized assets)
- Resource based view and Dynamic capabilities view
- Inter-firm partnerships and open innovation
- (Sustainable) business model innovation
Business cases analysis: opportunity to recognize patterns and apply theoretical concepts to real life situations
1
,Established firms versus start-ups
• Start-up entrepreneurs address customer needs in entirely new ways
• Differences in size, (age), resources, affect the way firms operate along several dimensions
Why do firms exist?
Neoclassical economists: firms as production functions that efficiently transform land, labour, and capital
inputs into goods and services. Competitive markets coordinate buyer-seller exchanges via price signals.
Ronald Coase (1937) posed two Nobel-prize questions:
• Why do firms emerge in a market economy?
• What determines the scale and scope of firms?
The main reason why it is profitable to establish a firm would seem to be that there is a cost of using the price
mechanism. (…) the operation of a market costs something and by forming an organisation and allowing some
authority (an “entrepreneur”) to direct the resources, certain marketing costs are saved. R. Coase (1937)
Transaction cost theory: the goal of an organisation is to minimize the costs (not directly creating value) of
exchanging resources in the environment and the costs of managing these inside the organisation
Transaction costs as unit of analysis:
Transaction: occurs whenever a good or service is transferred across a technologically separable interface
• Alternative governance structure should be assessed based on their capacity to economize on
transaction costs (trade-off)
• Economic efficiency and organizations’ internal structure are related
• Optimize transaction costs
• Boundaries of the firm as a decision variable
→ Firms exist to reduce transaction costs
Costs are simply a loss of value when transferring one type of capital to another. When we analyse different
ways of engaging in economic activities, we should minimise costs
Behavioural assumptions
Transaction agreements never cover all possible future contingencies (incomplete contracting). Transactors act
under:
1. Bounded rationality: transactors are constrained by cognitive limits on their capacities to process
information efficiently (incomplete contracting)
2. Opportunism: self-interest with guile could induce strategic behaviour by transactors to lie, cheat,
confuse, mislead their exchange partners
Forms of governance
Three forms of transaction governance:
1. Hierarchy (make): transactions among parties occur under a unified owner who settles disputes (firm
governance)
2. Market (buy): autonomous parties’ exchanges are governed by prices in supply-demand equilibrium
(market governance)
3. Hybrid (ally): long-term contractual relations that preserve parties’ autonomy, but provide added
transaction-specific safeguards as compared with the market
Make or buy decisions
Consider backward, forward, lateral integration options
2
,Boundaries of firms and governance structures
Critical dimensions for transactions
1. Uncertainty
2. Frequency with which transactions recur
3. Extend to which investments are transaction-specific
"The issue is less whether there are large, fixed investments [...], than whether such investments are
specialized to a particular transaction." → Specificity relates to costs, e.g., because of nonmarket ability
problems (and potentially also competition for those assets; see lecture 4)
Asset specificity can stem from 3 causes:
1. Site specificity
2. Physical asset specificity
3. Human asset specificity (learning by doing)
Firms versus markets
Advantages of common ownership (firm control)
1. Reducing incentives to suboptimize
2. Resolve differences
3. More complete access to relevant information
Advantages are a function of asset specificity
(and uncertainty)
∆C = Production costs differences between
internal organisation and market
∆G = Governance cost differences
∆C + ∆G > 0 → advantage market procurement
∆C + ∆G < 0 → advantage internal procurement
Representative net production and governance cost differences
3
, Overview of the elements
Which types f transactions can be handled most efficiently in which institutional form of
organisation/governance?
Criticism to Transaction Cost Economics (TCE):
- Opportunism: too much emphasis
- Trust: among individuals between organizations is an alternative basis for lowering transaction costs
- Learning curves: transactors become better over time
- Path dependence: the governance of a particular transaction may depend on how previous
transactions were governed
- Heterogeneity: TCE neglects differential capabilities and dynamics
What is innovation?
Innovation: new combinations of existing resources (Schumpeter, 1934). While invention is the first occurrence
of an idea for a new product or process, innovation is the first attempt to carry it out into practice
What is the role of innovation in economic and social change?
• Schumpeter’s notion of creative destruction: growth is brought by the introduction of new
technologies and creation of new firms, replacing existing technologies and firms
• Innovation introduces variety into the economic sphere. Should the stream of novelty dry up, the
economy will settle into a stationary state with little or no growth
→ Innovation is the engine of growth
Technological innovation
Technological innovation: the act of introducing a new device, method, or material for application to
commercial or practical objectives
• In many industries technological innovation is now the main driver of competitive success
• Increasing market segmentation & shorter product life cycles
• Diversification as part of competitive disadvantages
→ From new things to new value
Business innovation
Business innovation: the creation of new value for customers and firms by creatively changing one or more
dimensions of the business system
• For example: Starbucks is not the best company in coffee but came up with third place, a place beyond
home and work where people could gather, relax, and talk. This is their main innovation: create a
community feeling which makes people to pay a premium price
How many possible dimensions of business innovation are there, and how do they relate to each other?
4
