Teece (1986) - Profiting From Technological Innovation

Article
Has bibtex key
Has article title
Has year	1986
In journal
In volume
In number
Has pages
Has publisher
© edegan.com, 2016

• This page is referenced in BPP Field Exam Papers

Reference

• Teece, D.J. (1986), "Profiting from technological innovation: Implications for integration, collaboration, licensing, and public policy," Research Policy. pdf

@article{teece1986profiting,
 title={Profiting from technological innovation: Implications for integration, collaboration, licensing and public policy},
 author={Teece, D.J.},
 journal={Research policy},
 volume={15},
 number={6},
 pages={285--305},
 year={1986},
 publisher={Elsevier}
}

Abstract

This paper attempts to explain why innovating firms often fail to obtain significant economic returns from an innovation, while customers, imitators and other industry participants benefit. Business strategy particularly as it relates to the firm’s decision to integrate and collaborate is shown to be an important factor. The paper demonstrates that when imitation is easy, markets don’t work well, and the profits from innovation may accrue to the owners of certain complementary assets, rather than to the developers of the intellectual property. This speaks to the need, in certain cases, for the innovating firm to establish a prior position in these complementary assets. The paper also indicates that innovators with new products and processes which provide value to consumers may sometimes be so ill positioned in the market that they necessarily will fail. The analysis provides a theoretical foundation for the proposition that manufacturing often matters. particularly to innovating nations. Innovating firms without the requisite ing and related capacities may die, even though they are the best at innovation. Implications for trade policy and domestic economic policy are examined.

The Question

Innovators, defined as the first to commercialize a new product or process in the market, often fail to capture the benefits of their innovation, despite a first mover advantage. This paper considers reasons why this might be the case.

Three Fundamental Building Blocks

The Appropriability Regime

The appropriability regime is made up of two components:

1. The nature of the technology (tacit/codified knowledge)
2. The efficacy of legal mechnisms of protection

Patents do not confer perfect appropriability:

• They can be invented around, often at modest costs
• They are especially ineffective at protecting process innovations
• Legal requirements for upholding their validity or proving their infringement are high

Trade secrets may be a viable alternative if the product does not reveal the technology (or it can not be reverse engineered). This is likely to be true when knowledge is tacit, rather than codified. Tacit knowledge is by definition hard to articulate, and can only be transmitted by demonstration. Simplistically, an appropriability regime might be regarded as strong or weak, with regard to good the protection is.

Dominant Design Paradigm

There are two stages of development of a branch of science (c.f. Kuhn):

• Preparadigmatic - there is no single generally accepted conceptual treatment of a branch of knowledge
• Paradigmatic - a body of theory appears to have passed the canons of acceptability.

The emergence of a dominant design signals normal "standards" upon which research proceeds. These remain in force until overturned by revolutionary science (c.f. Architectural Innovation). Abernathy and Utterback propose a similar notion for industries:

• First there is competition among designs
• Then there is competition over price, and to a new set of variables.

In the second phase scale and learning become important. Innovation then takes place at the component level until the next revolution. The framework is particularly suited to mass markets with homogeneous products. Niche markets do not have scale and learning and so penalize multiple designs less.

Complementary Assets

The successful commericialization of an innovation requires that the know-how be used in conjunction with other assets or capabilities for production and distribution. There are three types:

• Generic assets - general purposes assets which do not need to be tailored
• Cospecialized assets with a unilateral dependence: Either the innovation needs to be specialized to work with the asset, or vice versa
• Cospecialized assets with bilateral dependence: Both the innovation and the asset need to be specialized to work with each other

Cospecialized assets need relational specific investments from one or both side (c.f. Williams). In the context of incomplete contracts (Teece doesn't mention this explicitly), there will be the possibility of hold up, making contracting (without fiat) costly and difficult.

Implications for Profitability

In Strong Appropriability Regimes

Whether the protection is from patents, copyright or trade secrets, if it is iron-clad then whether the innovation occurs in a preparadigmatic or paradigmatic context, and whether the innovation needs cospecialized assets or not, it is anticipated the the innovator will (or at least can) succeed in capture the benefits of the innovation. If there is a need for cospecialized assets then there will still be hazards, but the innovator will not be competing with competitors for their control. Likewise, if the innovator comes to market in the preparadigmatic phase with an incorrect design, there should be time to refine the concept before being eclipsed by imitators.

In Weak Appropriability Regimes

Innovators must turn to business strategy to keep imitators at bay.

In the Preparadigmatic Phase

The innovator must 'float' the idea. This requires that the innovator be intimately coupled to the market so that user needs can fully impact the design. The probability of winning will be higher if the cost of prototyping is lower and the firm is more tightly coupled.

In the Paradigmatic Phase

Complementary assets are required - in this phase scale economies and least cost production matter critically. However, investments may be irreversible, and success depends upon the terms under which cospecialized assets can be accessed. (Generalized assets are by their nature generally available). The party controlling the cospecialized assets is at an advantage relative to the innovator, because the innovation is essentially appropriable.

Channel Strategy Issues

This section considers how one should access cospecialized assets, generally assuming a weak appropriability regime. The options are:

• Contracting
• Integrating

Under contracting the innovator will not have to make up front payments to build or buy the asset, which reduces risk and capital requirements. The contract can be for a strategic partnership rather than a simple buy-sell agreement, and in the former case can bring credibility to the innovator. But, in the paradigmatic phase, this has two problems:

• Suppliers must make relational specific investments, which opens them to risks along with the innovator (and hold up by the innovator, though this isn't mentioned), so the innovator faces the "attracting venture capital problem" of information asymmetries (not explictly mentioned).
• The supplier may appropriate the technology

Note also, that contracts are likely (certain) to be incomplete, meeting the full Williamson criteria for vertical integration, though the integration contract itself would still remain problematic.

Integration gives incentive alignment and control (assuming again that the integration contract can be achieved). If the innovator owns the complementary asset then he will recieve the spillover benefits from increased demand too - this makes buying up such assets (or taking futures contracts against them) very attractive. If the protection is iron-clad, the innovator may be able to buy at competitive prices. Otherwise the assets form a bottleneck, and should be ranked in order of their importance. Critical assets should be bought first, or traded for a minority position, assuming that this is feasible given the competitive environment. In industries that are changing rapidly, it is unlikely that a single firm will be able to hold all of the assets. Speed is also clearly of the essence.

In summary, if no complementary assets are required, the innovator should commercialize immediately. If this is not the case then, if the innovator is in a weak approbility regime, needs a critical specialized asset, has the cash to buy it, and his competitors aren't better positioned, he should buy it, otherwise he should contract for it. On page 297, Teece provides a basic grid, in terms of how advantageously positioned the innovator is in terms of complementary assets, how well positioned he is to obtain them and the approbility regime, to "predict" whether the innovator will win the race.

It should be noted that there are mixed modes between contracting and integrating, and the decisions may change as either the appropriability changes or the market changes (enters a paradigmatic phase).

Implications for R&D Strategy, Industry Structure and Trade Policy

The firm should adjust its R&D investment portfolio towards innovations that are appropriable and for which the firm already has complementary assets. Large firms are more likely to hold complementary assets. Likewise, in industries that have inherently weak appropriability regimes, the control of cospecialized assets will be needed for long-run survival. As industries mature, they are both more likely to be paradigmatic (I claim), and firms are more likely to hold cospecialized assets already, making entry harder. When entry does occur it will involve coalition formation (strategic partnering, etc) early on. In industries with a high degree of change, assets may become redundant, and firm boundaries may be fragile.

The paper concludes with some thoughts, in terms of appropriability regimes and cospecialized asset holdings, on international competitiveness and trade implications.