Innovation, Market Structure, and Industry Dynamics
Innovation, Market Structure, and Dynamics
Market structure determines the intensity of innovation activity. Conversely, innovation activity determines market structure.
Market Structure and Innovation Intensity
- Monopoly:
- Favors appropriability.
- Yields extra profits.
- Generates scale economies in R&D.
- Favors access to financial resources.
- Competition:
- Stimulates innovation activity since firms have to get rid of competitive pressure.
- Avoids the “quiet life” syndrome.
- Encourages the “fast second” strategy.
Relationship Between Firm Size and Innovation Intensity
Positive Effects:
- Scale economies.
- Serendipity.
- Risk diversification.
- Complementary assets.
Negative Effects:
- Increasing coordination costs.
- Hierarchization and adverse selection.
Empirical Findings
The claim that market concentration is conducive to innovation does not appear to be strongly supported by recent empirical findings. On the whole, however, there is little empirical support for the view that large firm size or high concentration is strongly associated with a higher level of innovative activity.
Reasons for Unclear Mixed Evidence:
- Measurement problems.
- Joint treatment of Research and Development.
- Product life cycle issues.
- Technological regimes.
- Multi-level competition.
Technology Diffusion: The S-Curve
The s-curve for diffusion shows how the number of users of a new technology grows over time.
- Begins trending upward very slowly.
- At some point becomes much steeper.
- Eventually flattens out because there are fewer and fewer potential users that have not already adopted.
Models of the S-Curve
Heterogeneous Adopters:
- Benefits have a unimodal distribution.
- Costs decline monotonically.
- Adoption occurs when benefit > cost.
Epidemics Model:
- A small share adopts initially.
- They encounter the remainder randomly.
- Implies a 3-parameter logistic curve.
Both models suggest an s-shaped curve for diffusion.
Sunk Costs and Adoption Decisions
Adoption can be viewed as investment under uncertainty.
- Compare an upfront cost with a stream of future benefits.
- Adoption is an absorbing state in the sense that once costs are incurred, they are sunk.
The decision is not simply to adopt or not adopt, but instead to adopt now or wait to decide later.
Real Options Models:
- Uncertain payoff is modeled as a stochastic process.
- If it reaches a high enough value (strike price), the option to invest is exercised.
Product Evolution and Life Cycle
The Fluid Phase
The early phases in the development of a new product, before the emergence of a dominant design, are characterized by high uncertainty:
- Technological: vacuum tubes vs. transistor; germanium vs. silicon.
- Product: computing and capacity services vs. machines.
- Users: research, military vs. civil; companies vs. single customers.
- Design: mainframe vs. PC, multi-user vs. workstation, paper output vs. monitor.
- Architecture: modular vs. integrated; hardware and software.
- Process: integrated vs. components.
Product Life Cycle Dynamics
When uncertainty is high, new firms are often the innovators. When technological change takes a specific trajectory (emergence of a dominant design), scale economies, learning processes, and financial resources become relevant, leading to industry concentration.
Dominant Design Emergence:
A dominant design emerges according to selection criteria that are endogenous to the technological and economic environment:
- Technological dominance.
- Relationship with complementary products.
- Reputation.
Dominant Design Stability (Lock-in):
A dominant design remains stable (lock-in) due to:
- Specialization.
- Scale economies.
- Organizational learning.
- Network externalities.
- Complementary assets.
Technological Regimes
Key factors defining technological regimes include:
- Appropriability.
- Opportunity.
- Cumulativity.
- Knowledge base.