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Slide 1 © Carliss Y. Baldwin and Kim B. Clark, 2004
Insights from Agency Theory into User Innovation
Carliss Y. BaldwinHarvard Business School
LMU-MIT International Workshop on User Innovation and Open Source SoftwareMunich, Germany, EUJune 21, 2004
Slide 2 © Carliss Y. Baldwin and Kim B. Clark, 2004
Institutions of Innovation—Agenda Goals of our research
– Derive “Institutions of Innovation” from the basic properties of designs
– Users are principals, designers are agents– What do the designs and the users need from the
economic system? Definitions and Basic properties of designs The Problem Domain Agency alternatives
– “Employment”– “Outsourcing”
Conclusions and next steps
Slide 3 © Carliss Y. Baldwin and Kim B. Clark, 2004
First, some definitions/axioms
Slide 4 © Carliss Y. Baldwin and Kim B. Clark, 2004
Designs
Instructions that turn knowledge into things Span all artifacts and human activities
– Tangible, intangible– Transacting, contracting, dispute resolution– Government
The wealth of an economy inheres in its designs
Slide 5 © Carliss Y. Baldwin and Kim B. Clark, 2004
The Great Chain of Design and Production
Architecture Procurement
+ Design + Production Product
Use Users' Willingness to Pay
Competition + Price * Quantity
Market Structure – Cost
– Investment
"Free Cash Flow" Discount for Value
Time and Risk $$$
Rational Investment in New Products and Design Architectures
Finance lives here!Must value everything that is made, including designs
Designs are the start of everything that is made
Slide 6 © Carliss Y. Baldwin and Kim B. Clark, 2004
Design Architecture
Small designs “just get done” by one person or a small team
Large designs require architecture– “The design of the design process”– Forward-looking, future oriented– Analogous to physical architectures
» Create and constrain” movement and search
Major social technology, but not much studied– In engineering or the social sciences
Slide 7 © Carliss Y. Baldwin and Kim B. Clark, 2004
Innovations are NEW Designs
Ex ante: a problem = “the design problem”
Ex post: a solution = “the design”
Slide 8 © Carliss Y. Baldwin and Kim B. Clark, 2004
Users are Principals
Users willingness to pay determines value of a new design
Slide 9 © Carliss Y. Baldwin and Kim B. Clark, 2004
Designers are Agents
A designer may also be a user, But one user-designer can’t solve all
problems!–Remember Wedgwood!
Slide 10 © Carliss Y. Baldwin and Kim B. Clark, 2004
Institutions of Innovation
Aoki => Institutions are equilibrium patterns of interaction
Function is to bring User-Principals and Designer-Agents into a voluntary, productive relationship– User-designers are excluded from this analysis
(will be dealt with later) Institutions are costly—in a free economy,
they must “pay for themsselves”
Slide 11 © Carliss Y. Baldwin and Kim B. Clark, 2004
Our goal
Derive candidate institutions from basic properties of designs;
Compare institutions with different cost structures;
Predict which institutions will be seen in which problem domains
Slide 12 © Carliss Y. Baldwin and Kim B. Clark, 2004
Basic Properties of Designs
Designs are– non-rival
»My use does not prevent yours
– ex ante uncertain;– ex post rankable by outcome; – ex post contingent; – have an architecture
»Modular/integral» indivisible at module level;
– costly
Slide 13 © Carliss Y. Baldwin and Kim B. Clark, 2004
Basic Properties of Designs
Designs are– non-rival (non-exclusive use);– ex ante uncertain;– ex post rankable by outcome; – ex post contingent; – have an architecture
»Modular/integral» indivisible at module level;
– costly
Slide 14 © Carliss Y. Baldwin and Kim B. Clark, 2004
The Problem DomainHypothetical Distribution of Problems
By Number of Users and Value per User
0
0
1
10
100
0 10 20 30 40 50 60 70 80 90 100
Number of Users with Problem, Nj
Value of Solution per User, Vj
Slide 15 © Carliss Y. Baldwin and Kim B. Clark, 2004
Problems on the Same IsoquantHave the Same Total or Social Value
0.01
0.10
1.00
10.00
100.00
0 10 20 30 40 50 60 70 80 90 100
Number of Users with Problem, Nj
Value of Solution per User, Vj
Isoquants in the Domain
Increasing Social Value
Slide 16 © Carliss Y. Baldwin and Kim B. Clark, 2004
Two Agency Alternatives
User = Principal
Designers Specialized Firm
Designers
User employs Specialized Firm Designers employs Designers;
Sells solutions as Products
Slide 17 © Carliss Y. Baldwin and Kim B. Clark, 2004
Coase Theorem—
Frictionless Economy No Transactions or Agency Costs ALL institutions (agency alternatives) are
equivalent
Assume Cost per Solution, C = 5
Slide 18 © Carliss Y. Baldwin and Kim B. Clark, 2004
Under the Coase TheoremCoase Boundary on Problem Solving
Cost per Solution = 5
0
0
1
10
100
0 10 20 30 40 50 60 70 80 90 100
Number of Users with Problem, Nj
Value of Solution per User, Vj
These Problems deserve to be solved
These Problems aren't worth solving!
Slide 19 © Carliss Y. Baldwin and Kim B. Clark, 2004
First thought experiment—Robinson Crusoe
Every user hires designers Cost of hiring = .2*C
– Includes search, mundane, and opportunistic transaction costs
Slide 20 © Carliss Y. Baldwin and Kim B. Clark, 2004
Employment by Robinson Crusoe Users
Robinson Crusoe Problem SolvingCost per Solution, C = 5; Users' Hiring Cost = .2*C
0
0
1
10
100
0 10 20 30 40 50 60 70 80 90 100
Number of Users with Problem, Nj
Value of Solution per User, Vj
These Problems "deserve" to be solved, but won't be—Institutional Opportunity
These Problems aren't worth solving!
These Problems will be solved redundantly
Slide 21 © Carliss Y. Baldwin and Kim B. Clark, 2004
Second thought experiment—Specialist Manufacturers
Upstream Mfrs offer solutions to some problems
Cannot charge more than Users would pay under the alternative employment scenario
Mfrs have costs:– Variable cost per transaction = .2*C– Fixed cost for setup and data = 15*C
Slide 22 © Carliss Y. Baldwin and Kim B. Clark, 2004
Upstream Manufacturers will efficiently solve some problems
Users and Upstream Manufacturers(One Type)
0
0
1
10
100
0 10 20 30 40 50 60 70 80 90 100
Number of Users with Problem, Nj
Value of Solution per User, Vj
Not worth solving!
Solved by Mfrs (efficiently given T-costs)
Solvedredun-dantly
Not solved, institutional opportunity
Slide 23 © Carliss Y. Baldwin and Kim B. Clark, 2004
Third thought experiment—Two Types of Manufacturer
Blue Type has costs (as before):–Variable cost per transaction = .2*C–Fixed cost for setup and data = 15*C
Green Type has lower variable and higher fixed costs–Variable cost per transaction = .01*C–Fixed cost for setup and data = 90*C
Slide 24 © Carliss Y. Baldwin and Kim B. Clark, 2004
Two Mfrs with Different Cost Structures
Two Mfrs with Different Cost StructuresBlue= High Variable; Green= High Fixed
0
0
1
10
100
0 10 20 30 40 50 60 70 80 90 100
Number of Users with Problem, Nj
Value of Solution per User, Vj
Not worth solving!
Solved by Blue (efficiently given T-costs)
Solvedredundantly
Not solved, institutional opportunity
Green can Compete
Slide 25 © Carliss Y. Baldwin and Kim B. Clark, 2004
New ScaleTwo Mfrs with Different Cost Structures
Cost per Solution = 5
0
0
1
10
100
0 100 200 300 400 500 600 700 800 900 1000
Number of Users with Problem, Nj
Value of Solution per User, Vj
Not worth it
Solved by Blue or GreenWhich will dominate?
Not solved, institutional opportunity
BLUE
Green
USERS
Slide 26 © Carliss Y. Baldwin and Kim B. Clark, 2004
Thank you!