INNOVATION MANAGEMENT MODULE 1 INTRODUCTION
1. Introduction
1.1 What is innovation?
1.1.1 Changing the basis of competition through innovation
NDQ
1.1.2 Four types of innovation and their dynamics
4 types of innovation:
1) Product innovation
= the introduction of a good or service with improvements in functional
characteristics.
E.g., a new medicine
2) Process innovation
= the implementation of a new of significantly improved production or delivery
method.
E.g., the installation of a new or improved automated packaging system.
3) Marketing innovation
= the implementation of a new marketing method involving significant changes in
product design or packaging, product placement, product promotion or pricing.
E.g., Loyalty cards.
4) Organizational innovation
= the implementation of a new organizational method in the firm’s business practices
workplace organization or external relations.
Innovation (≠ technology)
= the implementation of a new or significantly improved product (or service), or process, a
new marketing method, or a new organizational method in business practices, workplace
organization or external relations.
Abernathy & Utterback graph: The
dynamics of innovation.
Dominant design
= suggests that as the rate of product
innovation declines, the rate of
process innovation starts to increase,
indicating a shift in the industry’s
focus from creating new products to
improving existing ones.
Product and process
innovation are not
, independent, rigid categories (= a certain industry or company doesn’t only do
process or product innovation)
The industries tend to evolve from one type to the other.
The fluid stage: there is a high rate of product innovation and a low rate of process
innovation.
1.2 The drivers of innovation
1.2.1 Why the market for innovation fails
The ingredients of economic growth
Economic growth = Labour (L) + Capital (C) + Solow residual (*)
(*) = the part of economic growth not explained by the increase in the amount of labour and
capital.
Graph of Aghion et al. (2005): is competition good for innovation?
Does the market provide sufficient
innovation?
Sufficient innovation
= do firms produce all the innovations that
the society would like to have?
Horizontal axis: 1 – Lerner index
(measures the market power of a
firm)
Vertical axis: citation-weighted
patents.
A patent with many citations is
considered much more valuable than a patent with zero or only one citation.
There is a positive relationship between competition and innovation, but in very
competitive industries, innovation starts to suffer.
Market failure for innovation
Underinvestment
= the private value of an innovation is less
than its private cost, but the social value
of the innovation is greater than its
private cost.
Explanation:
Is the private value smaller than
the private cost, the firm doesn’t want to invest in the innovation.
The social value of an innovation might be very, very high. Social welfare would
increase as a result of the innovation.
The social value might be way higher than its private cost. But we have seen that the
private value might be lower than the private cost, so the firm doesn’t want to start
the project to come up with that innovation. We have a market failure.
,Reasons for market failure for R&D
1) Uncertainty
Different types: technological, commercial, regulatory, and financial.
When firms try to innovate, you fail more than you succeed. That’s because
innovation is hard. It’s hard because you need to solve technological problems
and that can be very difficult.
Typically, low success rates in R&D projects.
On average 27% of R&D projects successful.
2) Inappropriability
It’s hard for firms to appropriate, to capture the full value of their innovation.
Once the innovative product or service is introduced into the market, you see
a return to the investor.
So, you start selling it and you earn back your R&D investments.
The bad news is outward knowledge spillovers.
o Some of the knowledge of all this R&D that you’re doing is going to
leak out to other firms.
o These firms start to produce these innovative products and start
earning money with that.
o But they didn’t have to do all these massive R&D investments.
o And this reducing the first firm’s ability to appropriate the full return to
its innovation.
1st Schumpeterian hypothesis
There is a positive relationship between innovation and monopoly power.
Positive effects
Ex ante: the anticipation of monopoly power encourages innovation.
o How?
Through exclusive rights (patents, trademarks)
By raising entry barriers (buying up raw materials, unique knowledge
and thus learning costs etc.)
Ex post: the possession of monopoly power allows to:
o Extend monopoly power (and the innovations it’s based on) to new products.
o Finance innovation internally, which advantageous due to:
Moral hazard problem facing external investors.
Disclosure of information towards external investors.
o Compete better for scarce innovation talent.
Advantage in bidding for these services, given the imperfect market for
entrepreneurial talent.
Negative effects
Additional leisure is seen as more attractive than additional profits. (X-inefficiency)
The firm may be more concerned with protecting its current monopoly position than
to build a new one.
, The economic incentive to innovate, is the difference between post-innovation rents
and pre-innovation rents. It’s the difference between profits new product and profits
from older products that get obsolete because new product.
1.2.2 Patterns underlying successful innovation.
Difference between technology-push (TP) and demand-pull (DP)
Technology-push (TP)
Innovations rooted in scientific research.
o Despite the fact that the market for innovation may be unclear.
E.g., hovercraft, nylon, microwave, laser etc.
Demand-pull (DP)
Innovations as response to a real or perceived need.
E.g., the Braille system, the kaizen production technology, microcredit etc.
Technology-push versus demand-pull
The role of customer needs in innovation is often to select the dominant design from
the range of knowledge-push possibilities.
Demand is a crucial component in order to direct the trajectory.
Technology innovation is a complex process where opportunities arise from both
technology and the market.
Small versus large firms
2nd Schumpeterian hypothesis: large firms are more innovative than small firms.
Reasons for economies of scale in R&D
Spillovers due to more interaction possibilities.
o Increases specialization.
o Easier recognition of the importance of serendipitous discoveries.
Superior ability to exploit the output of R&D.
o Large firms can better exploit R&D discoveries due to their ability to enter a
new market.
o Large multiproduct firms can diversify R&D efforts to make better use of R&D
resources.
Cons large firms
Unexpected findings being overlooked more easily.
Lower motivation of researchers.
Pros small firms
Small firm innovation is twice as closely linked to scientific research as large firm
innovation.
High-value innovations.
Employees of small firms 13x more innovative than large firms.
1. Introduction
1.1 What is innovation?
1.1.1 Changing the basis of competition through innovation
NDQ
1.1.2 Four types of innovation and their dynamics
4 types of innovation:
1) Product innovation
= the introduction of a good or service with improvements in functional
characteristics.
E.g., a new medicine
2) Process innovation
= the implementation of a new of significantly improved production or delivery
method.
E.g., the installation of a new or improved automated packaging system.
3) Marketing innovation
= the implementation of a new marketing method involving significant changes in
product design or packaging, product placement, product promotion or pricing.
E.g., Loyalty cards.
4) Organizational innovation
= the implementation of a new organizational method in the firm’s business practices
workplace organization or external relations.
Innovation (≠ technology)
= the implementation of a new or significantly improved product (or service), or process, a
new marketing method, or a new organizational method in business practices, workplace
organization or external relations.
Abernathy & Utterback graph: The
dynamics of innovation.
Dominant design
= suggests that as the rate of product
innovation declines, the rate of
process innovation starts to increase,
indicating a shift in the industry’s
focus from creating new products to
improving existing ones.
Product and process
innovation are not
, independent, rigid categories (= a certain industry or company doesn’t only do
process or product innovation)
The industries tend to evolve from one type to the other.
The fluid stage: there is a high rate of product innovation and a low rate of process
innovation.
1.2 The drivers of innovation
1.2.1 Why the market for innovation fails
The ingredients of economic growth
Economic growth = Labour (L) + Capital (C) + Solow residual (*)
(*) = the part of economic growth not explained by the increase in the amount of labour and
capital.
Graph of Aghion et al. (2005): is competition good for innovation?
Does the market provide sufficient
innovation?
Sufficient innovation
= do firms produce all the innovations that
the society would like to have?
Horizontal axis: 1 – Lerner index
(measures the market power of a
firm)
Vertical axis: citation-weighted
patents.
A patent with many citations is
considered much more valuable than a patent with zero or only one citation.
There is a positive relationship between competition and innovation, but in very
competitive industries, innovation starts to suffer.
Market failure for innovation
Underinvestment
= the private value of an innovation is less
than its private cost, but the social value
of the innovation is greater than its
private cost.
Explanation:
Is the private value smaller than
the private cost, the firm doesn’t want to invest in the innovation.
The social value of an innovation might be very, very high. Social welfare would
increase as a result of the innovation.
The social value might be way higher than its private cost. But we have seen that the
private value might be lower than the private cost, so the firm doesn’t want to start
the project to come up with that innovation. We have a market failure.
,Reasons for market failure for R&D
1) Uncertainty
Different types: technological, commercial, regulatory, and financial.
When firms try to innovate, you fail more than you succeed. That’s because
innovation is hard. It’s hard because you need to solve technological problems
and that can be very difficult.
Typically, low success rates in R&D projects.
On average 27% of R&D projects successful.
2) Inappropriability
It’s hard for firms to appropriate, to capture the full value of their innovation.
Once the innovative product or service is introduced into the market, you see
a return to the investor.
So, you start selling it and you earn back your R&D investments.
The bad news is outward knowledge spillovers.
o Some of the knowledge of all this R&D that you’re doing is going to
leak out to other firms.
o These firms start to produce these innovative products and start
earning money with that.
o But they didn’t have to do all these massive R&D investments.
o And this reducing the first firm’s ability to appropriate the full return to
its innovation.
1st Schumpeterian hypothesis
There is a positive relationship between innovation and monopoly power.
Positive effects
Ex ante: the anticipation of monopoly power encourages innovation.
o How?
Through exclusive rights (patents, trademarks)
By raising entry barriers (buying up raw materials, unique knowledge
and thus learning costs etc.)
Ex post: the possession of monopoly power allows to:
o Extend monopoly power (and the innovations it’s based on) to new products.
o Finance innovation internally, which advantageous due to:
Moral hazard problem facing external investors.
Disclosure of information towards external investors.
o Compete better for scarce innovation talent.
Advantage in bidding for these services, given the imperfect market for
entrepreneurial talent.
Negative effects
Additional leisure is seen as more attractive than additional profits. (X-inefficiency)
The firm may be more concerned with protecting its current monopoly position than
to build a new one.
, The economic incentive to innovate, is the difference between post-innovation rents
and pre-innovation rents. It’s the difference between profits new product and profits
from older products that get obsolete because new product.
1.2.2 Patterns underlying successful innovation.
Difference between technology-push (TP) and demand-pull (DP)
Technology-push (TP)
Innovations rooted in scientific research.
o Despite the fact that the market for innovation may be unclear.
E.g., hovercraft, nylon, microwave, laser etc.
Demand-pull (DP)
Innovations as response to a real or perceived need.
E.g., the Braille system, the kaizen production technology, microcredit etc.
Technology-push versus demand-pull
The role of customer needs in innovation is often to select the dominant design from
the range of knowledge-push possibilities.
Demand is a crucial component in order to direct the trajectory.
Technology innovation is a complex process where opportunities arise from both
technology and the market.
Small versus large firms
2nd Schumpeterian hypothesis: large firms are more innovative than small firms.
Reasons for economies of scale in R&D
Spillovers due to more interaction possibilities.
o Increases specialization.
o Easier recognition of the importance of serendipitous discoveries.
Superior ability to exploit the output of R&D.
o Large firms can better exploit R&D discoveries due to their ability to enter a
new market.
o Large multiproduct firms can diversify R&D efforts to make better use of R&D
resources.
Cons large firms
Unexpected findings being overlooked more easily.
Lower motivation of researchers.
Pros small firms
Small firm innovation is twice as closely linked to scientific research as large firm
innovation.
High-value innovations.
Employees of small firms 13x more innovative than large firms.
