part iii 1. rationality, bounded rationality and the ... · rationality, bounded rationality and...

Part III Knowledge-based Approach Rationality and the theory of the firm

Rationality, bounded rationality and the theory of the firm

ECONOMICS OF INNOVATION I: INNOVATION DECISIONS

Part III 1. Rationality, bounded rationality and thetheory of the firm

Uwe Cantner *’ and Simone Vannuccini *

*Friedrich-Schiller-Universität Jena

&’University of Southern Denmark, Odense

Cantner and Vannuccini Economics of Innovation I, 2017/18 103


Overview

Part I Basics in the Economics of Innovation

Part II Incentive-based Approach2.1 Optimal design of research and development projects2.2 Non-Tournament models2.3 Tournament models (Patent races)2.4 Neo-Schumpeter Hypotheses

Part III Knowledge-based Approach3.1 Rationality, bounded rationality and the theory of the firm3.2 Innovation and knowledge races3.3 Selective competition

Part lV Competing technologies and network externalities



The empirics of IPR: Costs of Imitation

Economics of

Innovation I

(C) UC 20163

The empirics of IPR: Costs of Imitation

Costs of imitation in % of costs of innovation(Wagner, Mansfield, Schwartz 1981)

0

1

2

3

4

5

6

7

<40 40-60 60-80 80-100 >100

%-classes

# o

f ca

ses

chemistry

pharmacy

electronics/ machinery



The empirics of IPR: Effectiveness of Patenting IEconomics of

Innovation I

(C) UC 20164

The empirics of IPR: Effectiveness of Patenting I

% of innovations for which the respective measure of protection has been considered effective (Cohen et al. 2000)

0 10 20 30 40 50 60

patents

other legal rules

secrecy

lead time

additionalservices

compl. productionknowledge

process innovations product innovations

% of R&D performing firms that give their highest rating to each appropriation method (Arundel 2001)

0 10 20 30 40 50 60

complexity

lead time

secrecy

designregistration

patents

product innovations process innovations



The empirics of IPR: Effectiveness of patenting IIEconomics of

Innovation I

(C) UC 20165

The empirics of IPR: Effectiveness of patenting II

Effectiveness of Appropriability Mechanisms for ProcessInnovations (% of respondents)

Mechanism 1st 2nd 3rd 4th 5th

Yale Survey 1983

Patents 3 6 8 27

Secrecy 4 14 21 4

Lead time 32 7 5 0

Sales & services 6 22 11 5

Carnegie-Mellon Survey 1994

Patents 0 5 4 14 21

Secrecy 28 8 6 1 1

Lead time 6 10 19 7 2

Sales & service 1 2 10 21 10

Manufacturing 12 22 8 2 0

Effectiveness of Appropriability Mechanisms for ProductInnovations (% of respondents)

Mechanism 1st 2nd 3rd 4th 5th

Yale Survey 1983

Patents 5 6 20 13

Secrecy 0 0 19 25

Lead time 17 21 6 0

Sales &service 24 19 1 0

Carnegie-Mellon Survey 1994

Patents 3 4 5 12 20

Secrecy 14 14 7 8 1

Lead time 22 6 10 4 2

Sales & service 3 9 11 15 6

Manufacturing 4 14 13 7 6



The empirics of IPR: Reasons to patent

Economics of

Innovation I

(C) UC 20166

The empirics of IPR: Reasons to patent

Reasons to patent: % of respondents by reason (Cohen et al. 2000)

0,0 20,0 40,0 60,0 80,0 100,0

measureperformance

for use innegotiations

enhancereputation

blocking

prevent suits

licensing revenue

prevent copying

product innovations process innovations



Knowledge conceptions: The production of innovations II

A second view

• Resources and the production of new knowledge- investment in the search (R&D)- accumulated knowledge and competencies (Teece et al. 1988)- creative capabilities

• Aim of the innovator- positive returns on R&D investment- earning some pofit/rent on accumulated knowledge and creative capabilities

• Imitator- often less than perfect abilities to understand knowledge generated elsewhere(absorptive capabilities) (Cohen/Levinthal 1989)

- information 6= knowledge



Knowledge conceptions: Know-how as latent public goodEconomics of

Innovation I

(C) UC 20168

Signals = Information

• Can signals be sent by producer?

• Can signals be understood by recipient?

• Can signals be used by recipient?

Know-how versus Information

Knowledge conceptions: Know-how as latent public / private good

Idea

A

the senderthe receiver

Encoding

Idea

A*

Pre-existing

patterns

Decoding

Communication

Channel uses a

Language

A Theory of Communication for Two Agents (Denzau and North 1994:19)A theory of Communication for Two Agents (Denzau and North 1994:19)

Signals=Information- Can signals be sent by producer?- Can signals be understood by recipient?- Can signals be used by recipient?

Know-how versus Information



Knowledge conceptions: Overview on the Character of Know-howEconomics of

Innovation I

(C) UC 20169

criterion from to focus codification codifiable not codifiable,

tacit sender

willingness to codify and transmit open secret sender

breadth of application broad specific, local application of know-how

absorptive capacities high low/nil recipient

economic use unrestricted perfectly protected

institutional frame

character of technological know-

how public latent

public private

Knowledge conceptions: Overview on the Character of Know-how



Homo creativus, the creation of new ideas, and appropriation

• Market situation- Not necessarily public good feature of the new knowledge but

. latent public good (Nelson 1990)

. private good (tacit knowledge) (Polanyi 1967)- incentive to invent/innovate?

• Patent protection- questionable

Economics of

Innovation I

(C) UC 201610

Homo creativus, the creation of new ideas, and appropriation

• Market situation– Not necessarily public good feature of the new knowledge but

• latent public good (Nelson 1990)• private good (tacit knowledge) (Polanyi 1967)

– incentive to invent / innovate?

• Patent protection– questionable

R&D

production

costs

innovator

imitator

production

costs

new idea

absorptive

capacity

knowledge

& creativity



Entrepreneurship and the RBV of the firm

• Entrepreneurship- Schumpeter 1912 : sources of entrepreneurship and strategies of SMEs (smalland medium sized enterprises)

- Schumpeter 1942 : large firm innovation strategies

• Behavioral foundations- Concept of bounded rationality (Simon 1957)- Behavioral theory of the firm with firm as an entity with stable behavioral traits(Cyert& March 1963)

- Concept of routines, a form of adaptive control with a more flexible behavior(Nelson& Winter 1982). behavioral devices with a certain stability over time as they are based on often

idiosyncratic knowledge and competences. they will be changed, however, if their reward does not meet an aspirated level

• Further developments- resource based view (RBV) of the firm (Penrose 1957; Barney 1997)- dynamic capability view of the firm (DCV) (Teece et al. 1997)



Rationality concepts

• Innovative activities as rational choice ⇔ trial & error and learning

• Substantial and procedural rationality in stationary situations

• Situations of change / structural change / innovation- substantial uncertainty

. incomplete information (asymmetric information)

. weak uncertainty (risk)

. strong uncertainty (Shackle, Knight, Keynes)

- procedural uncertainty. bounded rationality (Simon)

"The rational person of neoclassical economics always reaches the decision that isobjectively, or substantively, best in terms of the given utility function. The rationalperson of cognitive psychology goes about making his or her decision in a way thatis procedurally reasonable in the light of the available knowledge and means ofcomputation.“ (Herbert A. Simon 1986: 27)

. competence gap (Heiner)



Situative determinism versus BehaviorismEconomics of

Innovation I

Situative determinism versus Behaviorism

(C) UC 201613

Industrial Organization (IO) Resource Based View (RBV)

Some Authors Porter, Rumelt Barney, Wernerfelt

Focus

External

- describes environmental conditions favoring high levels of firm performance

Internal

- describes firm’s internal characteristics and performance

Assumptions

Firms within an industry have identical strategic resources.

Resources are highly mobile (easily bought and sold) and therefore homogeneous.

Firms have idiosyncratic, not identical strategic resources.

Resources are not perfectly mobile and therefore heterogeneous.



RBV of the firm: basics

• Resource Based View (RBV) of the firm- RBV sees companies as different collections of physical and intangible assetsand capabilities, which determine how efficiently, how effectively a companyperforms its functional activities

- Attributes competitive advantage to ownership of valuable resources andcapabilities that enable a company to perform activities better or more cheaplythan competitors

- Combines internal analysis with external analysis

• Basic principles of the RBV model- Basic assumptions of RBV :

. Resource and/or capability heterogeneity: different firms possess bundles ofdifferent resources and capabilities

. Resource and/or capability immobility: Some of these resources and capabilitiesare inelastic in supply or costly to copy

- RBV posits that the sources of value creation are resources and capabilities. Value = Consumer surplus + Producer profit. To outperform industry norm, a company must create more value than its

competitors



RBV of the firm: Resources

• Resources

- Are defined as stocks of firm-specific assets- Cannot be easily duplicated- Cannot be easily acquired in well-functioning markets- Examples:

. patents and trademarks

. brand-name reputation

. installed base

. organizational culture

. workers with specific expertise or knowledge- Contribute either directly (e.g., reputation) or indirectly (e.g., through serving asthe basis of capabilities) to value creation

- Are converted into final products or services using bonding mechanisms suchas IT, incentive systems, trust, etc.

- Sometimes non-specific resources (like buildings, raw materials, unskilledlabor, etc.) are included in the definition of "resources"



RBV of the firm: Capabilities

• Capabilities

- Are defined as cluster activities that a firm does especially well in comparisonwith other firm. may reside within business functions (e.g., Daimler yield management). may be linked to technologies, product design (e.g., Honda engines). may reside in firm’s ability to manage linkages between elements of value chain, i.e.,

coordination skills (e.g., Ford product development). refer to a firm’s capacity to deploy resources, usually in combination, using

organizational processes to effect desired ends- Information-based, firm-specific processes which are created over timethrough complex interactions between resources

- Key characteristics :. valuable across multiple products and markets. embedded in organizational routines (well-honed patterns of performing activities). tacit (i.e., non-encoded or non-encodable, difficult to reduce to algorithms or

procedure guides)



RBV of the firm: individual vs. market level characteristics

• Resources and capabilities are distinct from key success factors

• Key success factors (KSF)- Refer to the skills and assets a firm must have to achieve profitability in aparticular market

- Market-level rather than individual characteristics- Necessary, not sufficient for achieving competitive advantage- Predictors of firm profitability (like resources and capabilities)

• Resources and capabilities- Are conceptually different from KSF- Sometimes overlap with KSF



RBV of the firm: RBV VRIO 1

• VRIO - resources and capabilities should be

- Valuable- Rare- Inimitable- Organization can effectively exploit them

• A VALUABLE resource or capability (or a combination thereof) must- contribute to fulfillment of customer’s needs- at a price the consumer is willing to pay, which is determined by

. customer preferences

. available alternatives (including substitute products)

. supply of related or supplementary goods

• SCARCITY of resources and capabilities- Resources and capabilities must be in short supply to create competitiveadvantage (and go beyond competitive parity)



RBV of the firm: RBV VRIO 2

• INIMITABILITY of resources or capabilities- Ease of imitation depends on

. Cost asymmetries

. Capabilities of competitors

- Sources of cost asymmetries / cost disadvantages fall into two categories:. Impediments to imitation: legal restrictions on imitation; superior access to inputs

or to customers; market size and scale economies; intangible barriers (causalambiguity; dependence on historical circumstances; other path dependencies;social complexity)

. Early-mover advantages: Set in motion a dynamic that increases the magnitude ofthat advantage relative to other firms over time

• ORGANIZING to exploit competitive potential of resources and capabilities- to effectively exploit the resources and/or capabilities the following has to beprovided:. Structure. Management and control systems. Compensation policies. Business processes. Complementary resources and capabilities



RBV of the firm: RBV VRIO 3Economics of

Innovation IRBV of the firm: RBV VRIO 3

(C) UC 201620

Valuable? Rare? Costly to Imitate ?

Exploitable by the Organization?

Competitive implications

Economic performance

No - - NoCompetitive Disadvantage

Below normal

Yes No - Yes Competitive Parity Normal

Yes Yes No YesTemporary

competitive advantage

Above normal

Yes Yes Yes YesSustained

competitive advantage

Above normal

Source : Barney (1997) Tables 5.2 and 5.3, p.163.



RBV of the firm: Dynamic capabilities• Dynamic capabilities (DCV of the firm)

- Definition : Ability to integrate, build and reconfigure internal and externalprocesses and competencies to address a rapidly changing environment;ability to maintain and adapt the capabilities that are the basis of competitiveadvantage

- Hypothesis : Competitive advantage of a firm lies with its processes- Roles of organizational and managerial processes :

. Coordination and integration

. Learning

. Reconfiguration- Bygones are rarely bygones: History matters- Path dependencies the more important, the greater the returns to adoption(e.g., through complementary assets, network externalities)

• Inherent limitations of firm’s dynamic capabilities- Learning is typically incremental, not path breaking- Search for new sources of competitive advantage is path dependent- Development of new products and capabilities can either enhance or destroythe value of complementary assets


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