Summary

Three Fundamental Building Blocks of profiting from innovation

The paper is an investigation into why innovating firms often fail to obtain significant economic
returns from an innovation while customers, imitators and other industry participants do. An
examination of past cases such as RC Cola, EMI’s CAT scanner that failed to capitalise on their
innovations. Also seen in the case are successful follower-imitators such as IBM (personal computers
and Seiko (quartz).

The writer answers this fundamental question by analysing three fundamental building blocks of
profiting from innovation.

 Appropriability regime
 Complementary assets
 Dominant design paradigm

Appropriability Regime Key Dimensions

Appropriability as environmental factors that govern an innovators ability to capture profits

generated by an innovation. Appropriability regime is sub-divided into two components

Efficiency of Legal Instruments Nature of Technology

Patents Products
Copyrights Process
Trade secrets Tacit
Codified

Efficiency of legal instruments in relation to Nature of Technology

 Patents alone do not constitute perfect appropriability they can be invented around.
 Patents are not effective in protecting process innovation proving violation is difficult and
costly in a court of law.
 Patents are most suited for chemical and mechanical inventions
 Trade secrets are a better alternative to copyright and patents especially if the product does
not reveal the underlining technology or cannot deduced easily.
 The nature of the knowledge involved is also relevant. Tacit knowledge is harder to
articulate and transfer since it is often embedded in firms routines and capabilities.
However, it is subject to imitation through hiring employees with expertise skills.

Complementary Assets

Control of complementary assets through favourable contractual agreements or integration with sub
companies that have the assets is crucial for successful commercialisation of an innovation.
Complementary assets required to commercialise an innovation

Three types of complementary assets

Generic assets - general purpose assets that are easily available, they do not need to be tailored ,
the writer gives an example of capital investment.

Specialised assets - Specialized assets are assets needed by the innovator and are dependent on
them to succeed in the market.

Cospecialised assets - a interdependence between the provider of the asset and the innovator
himself. The writer gives the example of Mazda’s rotary engine and rotary engine repair shops.
Cospecialized assets need relational specific investments from one or both side

Dominant design paradigm

Two phases of scientific development.

Preparadigmatic phase Paradigmatic Phase

Design concepts are starting to emerge
Competitors are competing over prototype
designs.
Trial and error in market place
Dominant design meets the needs of
majority of users.
Competition shifts to pricing
Scale and learning become important.
Innovation then takes place at the component
level until the next revolution.
suited to mass markets with homogeneous
products
 Examples The Model T Ford

Implications

Tight appropriability situations

The innovator will win only if he does not loose focus on the complementary assets

 Iron Clad patents , copyright protection or trade secrets

 Trade secrets deny imitators access to the right information

Complementary assets

Generic - Licencing the products

Specialised and cospecialised - Investment required, it is anticipated the innovator will succeed in
capture the benefits of the innovation.

Dominant design paradigm

If the innovator comes to the market with the wrong design they is still enough room for making
adjustments to the design before it is copied by imitators

Weak appropriability situations

Innovators must use the correct strategies in order to have a competitive advantage. The writer
subdivides the strategies according

preparadigmatic stage

 Keep a float design until the dominant design has emerged. This will avoid imitators from
taking the design too early and making modifications Example new family of processors and
Steam cars/Internal combustion engine

paradigmatic stage

 This is heavily dependant on the ability of the innovator to enter into favourable contractual
agreements and integration strategies with complementary assets.
 Contractual agreements have dangerous hazards in the event the supplier out performs the
innovator because he is the is better position in terms of the asset
 Integration strategy requires more capital and it is time consuming
Contractual strategy

Is one where the innovator reaches out to the supplies of complementary assets through an arm’s
length deal where there are mutual benefits to both parties.

Contractual Modes

 Licence agreements with independent suppliers, manufacturers , or distributors

 Strategic partnerships
 Optimal strategy

Analysis of contractual Modes

Advantages of contractual modes

 Under contracting the innovator will not have to make up front payments to build or buy the
asset.
 reduces risk and capital requirements.
 Proves to be less timing sensitive
 Bring added credibility to the innovator in cases where the innovator is less known
 Take advantage of brand names and loyalty of well established companies. The writer gives
the example of Cipher Data products Inc that entered into a contract with IBM to create a
low priced edition of IBMs streaming cartridge drive. Once you create a product that meets
the necessary quality requirements to sell into IBM , you can sell in any arena
 No need to invest in many years of learning through trial and error therefor removing the
entry barrier of a stipe learning curve. For instance Microsoft used IBMs DOS operating
system software on the IBM PC an example of a successful strategic partnership.
 Optimal strategy is advantageous where the innovators appropriability regime is tight and
the complementary assets are available in competitive supply. There is no advantage in
owning complementary assets

Risks and disadvantages of entering into contractual modes

 Integration offers better advantages to contractual modes in the event where the innovation
is not tightly protected and easy to imitate. Therefor integrate in order to take better control
of complementary assets is a key success factor.
 The challenge of convincing the supplier of complementary assets to make irreversible
capital intensive commitments that are dependent on the success of an innovation.
 The risk of entering into a mutual contractual relationship (deal) that has balanced
incentives for both parties.
 Contractual agreements are difficult to write, execute and enforce especially in complex
developments . There is always a clause that is overlooked. Apple persuaded Canon to
participate in the development of the laser printer. It appeared to be a good deal but there
were risks in the execution of the contract.
 Risk of non-performance of a partner according to expectations.
 Contract manufacturers are potential future competitors :The difference is access, through
contracting or ownership, to complementary assets. EMI’s imitators had much better
medical technology manufacturing and distribution technology than EMI itself. Searle, on
the other hand, took deliberate steps to protect itself once its patent ran out, by establishing
a strong brand during the patent period, by limiting outside manufacturing (since those
contract manufacturers are potential future competitors),