start-up commercialisation strategy

8/9/2019 Start-up Commercialisation Strategy

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Start-Up Commercialisation Strategy and theMarket for Ideas

Joshua Gans

Melbourne Business School

Entrepreneurship Boot Camp

30th July 2010



Source: Thomson Venture/NVCA

Sources of entrepreneurial rents




Competition withestablished firms





Cooperation withestablished firms

Competition withestablished firms




Andrew Lacy



Andrew Lacy

$1 million per month40 million users

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Understanding commercialisation decisions

• What determines what type of commercialisation strategythat entrepreneurs choose?

• How does commercialisation choice impact on incentives

to innovate?

• How does intellectual property protection impact oncommercialisation strategy?



Competitive commercialisation



Start-Up




Start-UpEnter andCompete






Profit > entry costs





π > f



Start-Up

Cooperative commercialisation

π < f



Start-Up Sell or license


π < f



Start-Up Sell or license


Earn payment, t



Compete or cooperate?




Simple analysis suggests that the main predictor of commercialisation mode is ...





... start-up entry costs






Complementary assets held by established firms; Teece(1986)






Complementary assets held by established firms; Teece(1986)

If choose cooperation, start-up profits (t ) depend upon

whether complementary assets are loosely or tightly held



Compete and/or cooperate?




Start-Up




Enter andCompete

Start-Up

Sell or license




Enter andCompete

Start-Up

Sell or license

?




Enter andCompete

Sell or license

Start-Up




Enter andCompete

Sell or license

Start-Up π − f




Enter andCompete

Sell or license

Start-Up π − f t




Enter andCompete

Sell or license

Start-Up π − f t

Incumbent




Enter andCompete

Sell or license

Start-Up π − f t

Incumbent π




Enter andCompete

Sell or license

Start-Up π − f t

Incumbent π Π− t




Enter andCompete

Sell or license

Total

Surplus




Enter andCompete

Sell or license

2π − f Π Total

Surplus



Gains from Trade

2π −

f Π



Gains from Trade

>2π −

f Π



Gains from Trade

>

Competitive Commercialisation

2π −

f Π



Gains from Trade

>

Cooperative Commercialisation

2π −

f Π



What if entry isn’t feasible?

π < f Threat of competition not credible

Still possible that t > 0(i) multiple incumbents(ii) innovation adds value to

monopoly profits (ΔΠ)



Drivers of start-up innovation incentives

• Innovation prize = t

• t will be higher if

• Innovation has higher value to a monopolist

• Innovation has higher value if exclusively held under competition• Complementary assets are loosely held

• More established firms as potential partners



A little bargaining review

• What determines t ?

• Incumbent power

• Start-up forced to accept take it or leave it offer from incumbent

• t = max{π - f , 0}

• Nash bargaining solution

• Each gets the same share of total surplus

• TS = (1+Δ)Π - (2π - f )

• If π > f , (1+Δ)Π - t - π = t - (π - f ) or t = ((1+Δ)Π + f )/2

• If π < f , (1+Δ)Π - t - Π = t or t = ΔΠ /2

• Rubinstein bargaining

• t = max{ΔΠ

/2,π

- f }• Wolinsky bargaining (Gans & Stern, 2000)

• Incumbent can continue to search through negotiations (e.g., find patent workaround)

• t < max{ΔΠ/2, π - f }

• Implication: broader patent protection increases t



Cooperate Ex Ante? Aghion & Tirole, 1994

• Suppose

• Innovation has value, V

• Innovation generated with probability, p(e, E )

• e: start-up’s (non-contractible) effort & effort cost

• E : incumbent’s effort & effort cost

• Incumbent employs entrepreneur

• e* = 0 while incumbent earns p(0,E *(V ))V - E *(V )

• Independent entrepreneur with ex post licensing

• t = V /2 so both earn (net of effort costs) p(e*(V / 2),E *(V /2))V /2

• Allocation of property rights determined by

• Which party’s effort is more important

• Ex ante bargaining power of both parties as entrepreneur is wealth constrained(leads to too much incumbent ownership)



Patent races

• What drives innovation incentives when start-ups compete withincumbents?

• Competitive commercialisation

• Incumbent has higher preemption incentives (Gilbert & Newbery, 1981)• WTP depends on credibility of entry (Reinganum, 1982)

• Cooperative commercialisation

• Preemption incentives are equalised (Katz & Shapiro, 1985)

• t < ΔΠ; so in general incumbent has higher incentives unless start-up entry threat

credible

Willingne s to Pay Pree ption

Comp Coop Comp Coop

Start-Up π - f t π - f t

Incumbent ΔΠ ΔΠ Π(1+Δ) - π t



Impediments to Cooperative Commercialisation

• Static drivers suggest that start-ups will try to engage incooperative commercialisation but when will competition beobserved?

• Inefficiencies in bargaining

• Differences in perceptions (information asymmetries)

• Transaction costs and complexity

• Locating suitable partners (Hellmann, 2007; Hsu, 2007)

• Difficulties in transferring tacit knowledge (Arora, 1995)

• Non-monetary considerations

• Entrepreneur’s desire for control

• Avoiding bargaining altogether



Incentives to avoid bargaining




• Arrow’s disclosure problem

• If want someone to buy an idea, need to disclose the idea to assess quality. Makes

you vulnerable to expropriation.

• Example: Bob Kearns and the intermittent windshield wiper








• Disclosures can reduce the licensing payment to start-ups

• Let d be the knowledge disclosed and F ( d ) the probability that the incumbent can

use the knowledge to adopt the innovation with F ’( d ) > 0

• t = (1 - F ( d ))ΔΠ /2








• Disclosures can reduce the licensing payment to start-ups

• Let d be the knowledge disclosed and F ( d ) the probability that the incumbent can

use the knowledge to adopt the innovation with F ’( d ) > 0

• t = (1 - F ( d ))ΔΠ /2

• Incumbent competition and the scorched earth threat

• Suppose that there are two (or more) potential buyers of an idea and they competewith one another

• Threaten to give idea to rival firm if buyer does not pay (Anton & Yao, 1994)

• Very act of stealing an idea signals its value to others and creates competition

(Biais & Perotti, RJE, 2008)



Patents can facilitate disclosure & cooperation




• Suppose that disclosure requires effort and is also non-contractible (e.g., tacit

knowledge; Arora, 1995) but increases profits, Π’( d ) > 0.






• Will only choose to disclose prior to agreement (no profit sharing as it is non-

contractible)







contractible)

• Let s

be the strength of patent protection (e.g., the probability that theincumbent will be blocked). F is decreasing in s.







contractible)

• Let s


t = Π(d )− F (d , s)Π(d )







contractible)

• Let s


t = Π(d )− F (d , s)Π(d )

∂d *

∂s≥ 0







contractible)

• Let s


t = Π(d )− F (d , s)Π(d )

−

∂F

∂s′Π (d ) − ∂

2F

∂d ∂s

<0

Π(d ) > 0∂d *

∂s≥ 0



Dynamic drivers of commercialisation choice

• Cases of start-up choice over commercialisation suggest a dynamic concern

for creation and capture of future innovative rents






EMI and the CT Scanner

Powell claimed that the expertise developed by Hounsfield and his team, couplewith protection from patents, would give EMI three or four years, and maybemany more, to establish a solid market position. He argued that investmentsshould be made quickly and boldly to maximize the market share of the EMIscanner before competitors entered. Other options, such as licensing, wouldimpede the development of the scanner. If the licensees were the major X-rayequipment suppliers, they might not promote the scanner aggressively since itwould cannibalize their sales of X-ray equipment and consumables. Smallercompanies would lack EMI’s sense of commitment and urgency. Besides,licensing would not provide EMI with the major strategic diversification it wasseeking. It would be, in Powell’s words, “selling our birthright.”






Ecton

With such a clear focus and few distractions, the Ecton developmentteam had met most of their project milestones on schedule, atsignificantly lower cost than they had planned, based upon their pastexperience. The Ecton founders worried that if their company were

absorbed into a larger organization after acquisition, their developmentefforts for next-generation products would get mired … in complexity …Perhaps, they reasoned, their efforts would be more successful in thelong run if they remained independent until they had refined adevelopment process … that might survive acquisition and integration.






Palm

Dubinsky and Hawkins believed licensing the Palm OS right away wouldonly stifle Palm’s attempts to be the market leader. Furthermore, by havingmore entrants manufacturing Palm OS devices, Palm’s income would bereduced, thereby stripping away opportunities to invest in future

technologies. As far as Dubinsky was concerned, the timing of licensingthe platform was crucial. She stated, “Licensing will come later. Today itcertainly won’t add value. What will add value today is investing in productdevelopment, getting the next generation and the next generation out,

advancing the category, and building intellectual property.”




• Cases of start-up choice over commercialisation suggest a dynamic concernfor creation and capture of future innovative rents



Starting point



Starting point

• Segal & Whinston (2007) model of dynamic technological competition

• SW apply to antitrust practices

• SW consider entrants as competing and displacing incumbents -- on-

going change



Starting point

• Segal & Whinston (2007) model of dynamic technological competition

• SW apply to antitrust practices

• SW consider entrants as competing and displacing incumbents -- on-

going change

• Here, modifications• Remove static competition effects to focus on dynamics in

Schumpeterian, ‘winner-take-all’ or ‘for the market’ competition.

• Incorporate ideas markets

• Model dynamic capabilities (firms may not be long-lived)



Firms & Innovations



Firms & Innovations

• Discrete time, infinite horizon with common discount factor, δ



Firms & Innovations


• Innovations are sequential

• Innovation yields new product of higher quality than previous generation



Firms & Innovations




• Incumbent ( I )

• There is a single producer of the new product who can earn per period monopoly

rents, Π, until displaced.



Firms & Innovations




• Incumbent ( I )



• Ideas are scarce

• For each product generation only one firm conducts R&D

• Innovation leader drawn from pool of firms including the current incumbent

(O’Donoghue, Scotchmer and Thisse, 1998)

• I can be the innovation leader and prolong incumbency

• Otherwise, label leader as ‘entrant’ or E .



Firms & Innovations




• Incumbent ( I )



• Ideas are scarce

• For each product generation only one firm conducts R&D

• Innovation leader drawn from pool of firms including the current incumbent

(O’Donoghue, Scotchmer and Thisse, 1998)

• I can be the innovation leader and prolong incumbency

• Otherwise, label leader as ‘entrant’ or E .

• Innovation rate:

• Innovation leader generates an innovation immediately



Timeline

t t + 1t - 1



Timeline

Selection

t t + 1t - 1



Timeline

Selection Production

t t + 1t - 1



Timeline

Selection Production Innovation

t t + 1t - 1



Timeline

Selection Production Innovation Negotiations

t t + 1t - 1



Timeline


t t + 1t - 1

Innovationleaderchosen



Timeline


t t + 1t - 1


Capabilities Acquired



Timeline


t t + 1t - 1


Capabilities Acquired Commercialisationchoice



Negotiations



Negotiations

EntrantInnovates



Negotiations

EntrantInnovates

Competition



Negotiations

EntrantInnovates

I losesmonopoly

profits

Competition



Negotiations

EntrantInnovates

I losesmonopoly

profits

Competition E

becomes I

(earns Π)



Negotiations

EntrantInnovates

I losesmonopoly

profits

Competition

Cooperation

E becomes I

(earns Π)



Negotiations

EntrantInnovates

I losesmonopoly

profits

Competition

Cooperation

E becomes I

(earns Π)

I retains

monopolyprofits



Negotiations

EntrantInnovates

I losesmonopoly

profits

Competition

Cooperation

E becomes I

(earns Π)

I retains

monopolyprofits

E remains E

(earns τ )



Selection: Dynamic Capabilities




Prior Activity




Production

Only

Prior Activity




Production

Only

Prior Activity

InnovationOnly




Production

Only

Prior Activity

InnovationOnly

Production & Innovation

S C




Production

Only

Prior Activity

InnovationOnly


Example

S l i D i C bili i




Production

Only

Prior Activity

InnovationOnly


Example

I not an

innovation leader

S l i D i C bili i




Production

Only

Prior Activity

InnovationOnly


Example

I not an

innovation leader

E as innovationleader

S l ti D i C biliti




Production

Only

Prior Activity

InnovationOnly


Example

I not an

innovation leader


Merger or I asinnovation leader

S l ti D i C biliti




Production

Only

Prior Activity

InnovationOnly


Example

I not an

innovation leader



Probability of becoming Leader

S l ti D i C biliti




Production

Only

Prior Activity

InnovationOnly


Example

I not an

innovation leader




σ p∈[0,1]

S l ti D i C biliti




Production

Only

Prior Activity

InnovationOnly


Example

I not an

innovation leader




σ p∈[0,1]

σ i∈[0,1]

S l ti D i C biliti




Production

Only

Prior Activity

InnovationOnly


Example

I not an

innovation leader




σ p∈[0,1]

σ i∈[0,1]

σ ip≥ max{σ

p,σ

i}

C ti ti ff



Continuation payoffs

Contin ation pa offs




I Innovation Leader





I Innovation Leader

E Innovation Leader





I Innovation Leader

E Innovation Leader

I Non-Innovator





I Innovation Leader

E Innovation Leader

I Non-Innovator

Cooperation





I Innovation Leader

E Innovation Leader

I Non-Innovator

Cooperation Competition

Gains from Trade (Licensing)





+ +






+ +>





Π − τ + δσ pV I + δ (1− σ

p)v

I + τ + δσ

iv E

≥ Π + δσ pv E + δσ

iV I + δ (1− σ

i)v

I





(σ

p−σ

i ) V I −v E

−v I ( )

≥0





(σ

p−σ

i )(σ

ip−σ

i−σ

p )≥

0





(σ

p−σ

i )(σ

ip−σ

i−σ

p )≥

0

Caveat: if incumbents innovate at a slower rate, both will have an interestin choosing a commercialisation mode that maximises the probability that

the incumbent is the innovation leader

Licensing Equilibrium Outcomes




σ ip

σ ip

σ p

σ i

Licensing Licensing

Competition

Competition V I ≥ v

I + v

E

V I < v

I + v

E





σ ip

σ ip

σ p

σ i

Licensing Licensing

Competition

Competition V I ≥ v

I + v

E

V I < v

I + v

E

Does high σ i drive

competition?

Gains from Trade (Acquisition)




Π− τ +σ ipδ V

I

i+ (1−σ

ip)δ V

I + τ

Joint Payoff from Cooperation

≥ σ pδ V E +Π +σ iδ V I i

+ (1−σ i )δ V I

Joint Payoff from Competition





(σ

ip−σ

i)δ (V

I − v

I ) ≥ σ

pδ v

E




Ga s o ade ( cqu s o )

(σ

ip−σ

i)δ (V

I − v

I ) ≥ σ

pδ v

E

1−

σ ip> 1

−σ

i −σ

p




( q )

(σ

ip−σ

i)δ (V

I − v

I ) ≥ σ

pδ v

E

1−

σ ip> 1

−σ

i −σ

pimplies positive externality

on potential entrants

Acquisition Equilibrium Outcomes



q q

Acquisition

Competition

V I

i≥V

I +V

E

V I

i<V

I +V

E

Does high σ i drive

competition?

σ ip

σ ip

σ p

σ i

V I ≥ v

I + v

E

V I < v

I + v

E

Conclusions



• Even in the absence of static rationales, dynamicconsiderations can drive commercialisation choices

• Need to look at relative capabilities

• Capabilities here are based on experience

• Empirically, examine commercialisation choice based on start-upexperience in R&D variables and incumbent experience inproducts and production

start-up commercialisation strategy

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