Download pdf - The Innovative Firm: Theory and Empirical Evidence …dec.ec.unipg.it/~fabrizio.pompei/Lecture5.pdfThe Innovative Firm: Theory and Empirical Evidence Lecture 5 Fabrizio Pompei Department

The Innovative Firm:Theory and Empirical Evidence

Lecture 5

Fabrizio Pompei

Department of EconomicsUniversity of Perugia

Economics of Innovation (2016/2017)(II Semester, 2017)

Pompei Innovative Firm Academic Year 2016/2017 1 / 26

Contents of the Lecture*

1 Basic Concepts on Innovative Firm

2 Theories of the Innovative Firm

3 Innovative Firm along an Historical Perspective

4 Innovative Firms: a Comparative-HistoricalPerspective

5 Questions for lecture 5

*The Oxford Handbook of Innovation, Fagerberg, Mowery and Nelson R. (2013),chapter 2,


Basic Concepts on Innovative Firm

What is an Innovative Firm

On the wake of other important theories of the firm (for example, theCoase-Williamson theory of the firm) , also the Theory of Innovative Firmstudies the firm as a complex organisation/institution

For example the transaction-costs theory of Coase-Williamson focuses on theproblem of make or buy and analyses how firms can solve this problem andthe trade-off between the transaction costs (costs a firm has to bear if itdecides to buy the intermediate product on the market) and coordinationcosts (costs a firm has to bear if it decides to internalise the production ofthe specific component)

Likewise, the Theory of the Innovative Firm concentrates on how the firmsolves the problem to combine in original way specific sources andcompetences to produce new products and production process

Especially, what makes a firm innovative and how have the characteristics ofinnovative firms changed over time are important questions

To answer to these questions we often have to analyse the social conditionsof the innovative enterprise in the comparative-historical experiences of theadvanced economies


Basic Concepts on Innovative Firm

Social Conditions of the InnovativeEnterprise

As we will see, very often firms need specific social conditions to innovate, becauseinnovation needs learning and learning process is collective and involves, dependingon the socio-historical context, various members of the organisation within andoutside the firm

Innovation requires learning about how to transform technologies and accessmarkets in ways that generate higher quality and/or/lower cost products

The innovation process is uncertain because what needs to be learned abouttransforming technologies and accessing markets can only become known throughthe process itself

The innovation process is cumulative when learning cannot be done all at once:what is learned today provides a foundation for what can be learned tomorrow

The innovation process is collective when learning cannot be done alone, becauseit requires the collaboration of different people with different capabilities

When learning is collective it is necessary to integrate the work of people into anorganisation, that is the innovative firm


Theories of the Innovative Firm

Innovating Firm versus Optimising Firm:Marshall and Schumpeter

Over the past century the theoretical efforts of economists have focused mainly onthe optimising firms rather than the innovating firmThe optimising firm takes as given technological capabilities and marketprices (for inputs as well for outputs) and seeks to maximise profits on thebasis of the technological and markets constraintsThe innovating firm seeks to transform the technological and marketconditions that the optimising firms takes as ’given’, in order to differentiatesitself from its competitors in the marketBoth Alfred Marshall (in his book Principle of Economics, 1920) and JosephSchumpeter (in his books The theory of economic development, 1911 andCapitalism, Socialism and Democracy, 1942) viewed the innovating firm as theresult of the entrepreneurial work of an extraordinary individualEdith Penrose (The theory of the growth of the firm, 1959) conceptualised themodern corporate enterprise as an organisation that administers a collection ofhuman and physical resourcesAccording to Penrose, people contribute labour services to the firm, not merely asindividuals, but as members of teams who engage in learning about how to makebest use of the firm’s productive resources



Penrose’s theory of the firm and theResource Based View (RBV)

Penrose’s Theory explains us why firms are different even in the sameindustry:

At any point in time, learning mentioned above, endows the firm withexperience that give it productive opportunities unavailable to other firmsthat have not accumulated the same experience, even in the same industry

Moreover, the accumulation of innovative experience enables the firm toovercome the ’managerial limit’ that in the theory of the optimising firmcauses the onset of increasing costs and constraints the growth of the firm

From the 1980s many scholars cited the Penrose’s 1959 book as anintellectual foundation for a resource based view (RBV) of the firm

RBV focuses on the characteristics of valuable resources that onefirm posses and that competitor firms find it difficult to imitate

Limitations of RBV: it provided no perspective on why and how somefirms rather than others accumulate valuable and inimitable resources



Teece’s theory of the innovative firm anddynamic capabilities

The concept of dynamic capability helps us to understand why some firms are ableto build specific characteristics that shape their sustainable competitive advantageover time

David Teece wrote several influential articles in the 1990s and the 2000s in whichhe tried to explain the theory of innovative firms from the point of view of thestrategic management literature and the concepts of resources, competences anddynamic capabilities

Resources are firm-specific assets that are difficult or impossible to imitate

They are stocks, not flows, very often they are intangible assets, idiosyncratic innature

An important hint to distinguish resources from ordinary inputs that every firmsposses is to think at resources as assets that do not have a well developed marketin which they could be traded and therefore could pass from a firm to another

Examples of resources are process know-how, customer relationships and theknowledge possessed by groups of especially skilled employees, very often thisknowledge is embedded in a specific organisation and tend to be destroyed if oneor more members of the organisation leave the firm



Teece’s theory of the innovative firm anddynamic capabilities (II)

Competences are particular kind of organisational resource. They result fromactivities that are performed repetitively, or quasi-repetitively.

Organisational competences are usually underpinned by organisational routines

A firm uses its specific resources to perform some tasks and so doing it shows itscompetences

Competences can be quantified because they can be measured against particulartask requirements

How decisions are made, how customer needs are assessed, how quality ismaintained, are all tasks that produce different value among firms

A firm that performs its tasks very well, in order to survive the market, to gainprofit and to maintain a competitive advantage over time, surely possesescompetences that a researcher should identify

However, there will be a moment in which a need for renewal of specificresources/competences emerges, both in fast-moving environments (High-Techsectors) and in low-tech industries



Teece’s theory of the innovative firm anddynamic capabilities (III): an example onresources and competences

Let’s take a company that developed specific assets and competences in logisticsbecause the logistic manager for this department has applied a flexible workingtime, so workers (truck drivers) are able to easily adapt to all customer needs indelivering goods at whatever timeThe flexibility in working time is also supported by specific software that has beenimplemented in each truck in order to facilitate the task of each truck driverTrucks are ordinary inputs bought on the market, but trucks provided withsoftware that support logistics is a specific assets of that companyMore precisely, the aggregation of logistic manager, team of truck drivers thatspecifically use trucks provided with software, and truck themselves, are thespecific resources/assets of this companyThe mode with which the company performs the logistics is a specificcompetence producing value (for example, it allows to reduce costs andcompany’s profits increase)Resource and competences are idiosyncratic and result from complementarity andspecific conditions that emerge in this company



Teece’s theory of the innovative firm anddynamic capabilities (IV)

Dynamic capabilities are the firm’s ability to integrate, build and reconfigureinternal and external resources/competences to address and shape rapidlychanging business environments

They reflect the speed and degree to which the firm’s idiosyncraticresources/competences can be aligned and realigned to match the opportunitiesand requirements of the business environments

The essence of resource/competences as well as dynamic capabilities is that theycannot generally be bought: they must be built

It must be remarked that there are two ways, in the fast-moving industries,to produce what customers want next (and what technology allows next): aset of new firms entry the market and displace the incumbents, or theincumbents reshape themselves and address new opportunities and newthreats of the market

Dynamic capabilities refer to the capacity, on behalf of an incumbent, ofre-engineer the enterprise and its product offerings, its internal activities andits external relationship



Teece’s theory of the innovative firm anddynamic capabilities (V)

Teece suggests that it is more realistic to view continuous renewal as requiring anongoing set of activities and adjustments that can be divided in three clusters:

1 Identification and assessment of an opportunity

2 Mobilitation of resources to address an opportunity and to capture value fromdoing so

3 Continued renewal

Collectively, these are firm’s dynamic capabilities

The concept of dynamic capabilities provides a framework to explain thegeneration of new ideas that is larger than that one based on only R&D activity

This is because the global sources of invention and innovation become dispersed,therefore it is less likely, at least in some industries, that the enterprise can onlyrely on internal R&D, even in very large firms

Achieving new combinations of previous elements of knowledge could be as new asdiscover new products or processes within private laboratories of R&D


Innovative Firm along an Historical Perspective

Dynamic capabilities, social conditions andthe skill base of innovative strategy

Lazonick argues that the theory on dynamic capabilities do not specify socialconditions under which these capabilities develop

Given the complex structure of the firm, social conditions means analysing thedifferent agents that could be responsible for points discussed above (identifyingopportunities, mobilitation of resources, etc)

For example, the focus should be on what types of people are able and willing tomake strategic investments that can result in innovation (hence, mobilisingresources and recombine them)

Lazonick also deals with specific activities of firm very similar to those listed byTeece, such as:

1 Strategize: Firms choose the product market in which they want to compete andthe technologies with which they hope to be competitive

2 Finance: Firms make investments to transform technologies and access marketsthat can only be expected to generate revenues sometime in the future

3 Organize: Firms combine resources in the attempt to transform them into saleableproducts


Innovative Firm along an Historical Perspective

Dynamic capabilities, social conditions andthe skill base of innovative strategy (II)

Of central importance to the accumulation and transformation of capabilities inknowledge intensive industries is the skill base in which the firm invests inpursuing its innovative strategy

At any point in time a firm’s functional and hierarchical division of labor defines itsskill base

In the effort to generate collective and cumulative learning, those who exercisestrategic control can choose how to structure the skill base

In cross-national comparative perspective, the skill base that enterprises employ totransform technologies and access markets can vary even in the same industrialactivity during the same historical era

Since innovative enterprise depends on social conditions, the development andutilization of skill base that occurs in one institutional environment may not bepossible in another institutional environments

As the following comparative-historical syntheses illustrate, social conditions (i.e.strategic control over specific assets) determine the skill base, the collective andcumulative learning within or across firms and the possibility of emergence ofinnovative firms


Innovative Firms: a Comparative-Historical Perspective

The British Industrial Districts

In the late nineteenth century Britain’s productive power resided in industrialdistrict, where both machine tools and manufacture products (cloth and ships)were produced

Even though the mechanization of the factory is a universally acknowledgedfeature of the British industrial revolution...

...it was the skilled craft labor to play a central role in this type of innovativefirm

Regionally based on-the-job apprenticeship arrangements, through which craftworkers passed on their skills to the next generation constituted in effect the’national innovation system’ of Britain at that time

In some industries the central employment relation took the form of an internalsubcontract system:

For example, in the cotton-spinning industry employers paid piece-rates to seniorworkers known as ’self-acting minders’ that in turn trained, supervised and paidtime wages to junior workers known as ’piecers’ or ’doffers’

The localized, on-the-job character of skill formation was the major factorunderlying the innovation of the industrial districts



The British Industrial Districts (II)

Alfred Marshall was the first scholar to discover this type of innovative firm andfamous was his expression that in the British industrial district ...the industrial arts(or know-how) were in the air

To sum up, the characteristics of firms belonging to British industrial districts were:

1 Regional concentration encouraged vertical specialization and firm entry into aparticular speciality (free movements of skilled craft workers across firms or alsocraft workers that became founders of new firms)

2 Firms could be owned and managed by the same people ( no need to invest inmanagerial organization as was occurring in the US and Germany)

3 As users and/or producers of machine tools, craft workers constituted the primesource of innovation

4 Specific resources and competences supporting innovation accumulatedthrough collective learning not at firm level but a district level

5 The localized, on-the-job character of skill formation was the major factorunderlying the innovation of the industrial districts

6 Social conditions (i.e., no hierarchical organization within firm) and specific verticalspecialization shaped the dynamic capabilities and innovation at district level



The Italian Industrial Districts

At the end of the World War I the cotton textile industry, which had accounted forone quarter of British exports until that time, entered into a long-run decline fromwhich it never recovered (other major British industrial districts suffered a similarfate)

It is worth noting that just 60 years later similar social conditions allowed theemergence of an innovative firm, similar to the British industrial district’sone, in Italy

From the late 1970s some Italian scholars (Becattini, 1990; Brusco, 1992)identified in a specific area of Italy (North-Eastern and Central Italy regions, alsoknown as Third Italy) highly specialized and localized districts

The industrial activities of the districts of the Third Italy focused on , among otherthings, textile, footwear and light machinery, just as the British districts has done

Large numbers of vertically specialized proprietary firms in which craft labor wasa prime source of competitive advantage populated each industrial activity andmany entrepreneurs had previously been craft workers

Two important differences between the British Industrial districts discussed byMarshall and the Italian Industrial districts discussed by Becattini, 1990; Brusco,1992; Belussi and Asheim, 2003:



The Italian Industrial Districts (II)1 Italy collective institutions remarkably supported the Italian small firms of the

districts: for example, favouring the development of business services inadministration, marketing and training

2 In some districts and some industries, leading firms could emerge drawing onthe resource of the industrial districts, differently from that had occurred in thecase of British industrial districts

Let us take for example the case of the Montebelluna district, localized in theVeneto region

Montebelluna is a district specialised in sport-system shoes, and the entry ofmultinationals during the 1990s has been quite significant

Thus, this district is no longer a canonical (Marshallian) industrial district, whereproduction is fractionated into a myriad of small and medium size firms

External acquisitions went on, during the 1990s, exactly when many local firmsstarted to abandon the district

External multinationals (i.e., Nike) were attracted by the existence of localcompetence and technological capabilities and tapped into the local district forabsorbing the relevant accumulated tacit knowledge

At the same time local firms, such as Geox, emerged as leading firms by combiningtacit and codified knowledge (R&D), patenting innovations and internationalising



The US managerial corporation

Both Marshall and Schumpeter argued that the limits to the growth of the firmconsisted in the problem of succeeding the original owner-entrepreneurThis problem could be solved by the separation of ownership and control

The separation of share ownership from strategic control was the essence ofwhat Chandler (1990) called ’the managerial revolution’ in American business

In the United States the managerial revolution began in the 1890s in industriessuch as steel, oil refining, meatpacking, tobacco, telecommunications, electricpower

The owners of the companies left their place to salaried managers that tookstrategic-decision positions within the firm

These managers often came from graduate schools in business administration

The managerial companies were very big and the key system was that of a massproduction of a standardised, precision-engineered part that could be usedinterchangeably in a product without the intervention of a skilled worker tomake the parts fit together

The productivity of the mass production enterprise relied upon the stableemployment of semi-skilled production workers who tended high-throughput andvery expensive machinery



The US managerial corporation (II)

To sum up, the main features of the US managerial corporation were:

1 A new class of graduate-professional managers coming from businessadministration schools that constituted the main knowledge assets of the firm

2 By expanding industrial corporations, managers aimed to cumulate internalcompetences and technology: capabilities for generating goods for one productmarket (including high internal R&D investments) could be used as a basis for newproduct markets

3 Managers that tended to develop skill-displacing technologies: differently fromthe small-size firms of British or Italian districts, the US corporation managershardly found skilled workers in the local pools of specialized craft labor

4 Despite the US corporation had powerful managerial organizations for developingnew technology (and it was a leading model from 1920s to 1970s) it failed tointegrate production workers into the company’s organizational learningprocesses, as the Japanese companies did, instead.



The Japanese Firm

In the 1970s and 1980s, Japanese companies challenged the US industrialcorporations in the very mass production industries (steel, memory chips, machinetools, consumer eletctronics and automobiles)

Japanese exports to US increased rapidly between 1970s and late 1980s and theseexports were not the result of Japanese low wage productions

For example Japanese cars (Toyota) and Japanese Hi-Fi products (Sony)appeared as high-quality products that were sold at competitive prices

There were three social institutions that in combination formed the foundation forJapan’s remarkable success

1 Cross-shareholding: provided the managers of Japanese corporations with thestrategic control to allocate resources to investments that could generatehigher-quality and lower cost products

2 Main bank-system: provided these companies with levels of financialcommitments that permitted them to sustain the innovation processes

3 Lifetime employment: enabled the companies involved to put in place a newmodel of hierarchical and functional integration that enabled them to mobilizeskills bases for collective land cumulative learning



The Japanese Firm (II)

During the 1980s, most Western analyses of Japanese competitive advantagefocused on the hierarchical integration of the shop-floor worker into theorganizational learning process

Moreover, Japanese companies captured higher value-added segments of theproducts markets thanks to their strategy in company-wide quality control inwhich the crucial point was not lower labour costs but savings on material costsand wastes reduction

Main differences between innovative US corporations and innovativeJapanese corporations:

1 Hierarchical segmentation of shop-floor activities from organizational learningprocess in Us corporations: Us engineers were not forced to communicate acrosstheir disciplines to solve real world manufacturing problems

2 High interfirm mobility of scientists/engineers across US firms (versus lowinterfirm mobility across Japanese firms): in Japanese firms the hierarchicalintegration of managers and workers and low levels of interfirm mobility ofengineering personnel fostered fuctional integration

3 However, the interfirm mobility revealed crucial in some US industries such asmicroprocessors and made it possible the emergence of new economy firms



The New Economy Model

During the 1970s and 1980s, while Japanese companies were challengingestablished US industrial corporations, there was a resurgence of the USinformation and communication technology (ICT) industries, providing thefoundation for what by the last half of the 1990s became known as the ’NewEconomy’

As argued in the previous lecture, by the end of 1950s in the US there was acombined business-government effort to boost the first generation of computers(mainframe mainly produced by the leading company IBM) that also improved thecapability of the semiconductor technology (embedding integrated electroniccircuits on a silicon chip)

Many venture capitalists (with prior managerial or technical experience in thesemiconductor technology) backed semiconductor startups clustered in the regionaround Stanford University that since then was named Silicon Valley

Intense and informal learning networks that transcended the boundaries offirms contributed to the success of Silicon Valley

Like the Marshallian industrial districts of a century earlier, also in the SiliconValley ’...the misteries of the trade were in the air..’

However, in its strategy, finance and organization, the New Economy businessmodel of Silicon Valley differed significantly from the Marshallian Districts



The New Economy Model (II)

Even though the interfirm mobility of skilled personnel was a crucial point forSilicon Valley, the strategic organizational learning very often occurred within firmsand allowed to some of them to grow and to employ ten of thousand of employees,in order to became leading companies in the Silicon Valley district

Of great importance in supporting the development of technology in this high-techindustrial district were state funding and universities

The founders of new ICT firms were engineers who had gained specializedexperience in existing other ICT firms or as university faculty members aiming tocommercialize their academic knowledge

The venture capitalists played a crucial role for the startups because they sharedwith the founding entrepreneurs not only the ownership of the company but alsothe strategic control

Besides sitting on the board of directors of the new company, the venturecapitalists would generally recruit professional managers that were compensated bymeans of stock-options

Stock options became an important mode of compensation (partially substitute forcash salaries) for attracting highly mobile people to the startup

the underlying stock would become valuable if and when they took the form ofpublicly traded shares



The New Economy Model (III)

During the 1980s and the 1990s the liberal use of stock as a compensationcurrency for both top executives and employees became a distinctive on the NewEconomy firms

During the 1990s the New Economy company grew large by using their stock,instead of cash, to acquire other smaller and younger New Economy firms

Intel, Microsoft, Cisco and other New Economy companies, by the end of thetwentieth century had grown remarkably

In 2002 the top 500 US-based companies by sales included twenty ICT firmsfounded no earlier than 1965 and had been neither spun-off from nor merged withan Old Economy firm

These 20 companies had revenues ranging from 35.4 billion dollars from DellComputer to 3.0 billion dollars for Computer Associates International

Nine of these twenty were based in the Silicon Valley

Many of these large New Economy companies have become important contributorsto the patenting activities of US-based corporations



Taxonomy of Innovative FirmsTo sum up ...

SocialConditions SkillBase DynamicCapabilitiesMarshallianIndustrialDistricts(1880-1920inBritain)Italianindustrialdistricts(from1970on)

Firmsownedandmanagedbythesamepeople

Regionalconcentrationofsmallfirmsandverticalspecialisation(interfirmdivisionoflabour)

Collectivelearningandknowledgecumulativenessatdistrictlevel

UScorporation Separationofshareownershipfrommanagerialcontrol;bymeansofInitialPublicOfferings(IPO)theoriginalowner-entrepreneurcouldcashinontheirownershipstakes

Graduate-professionalmanagersandskill-displacingtechnologiesasmainassets;productionworkersnointegratedinthelearningprocesses

Collectivelearningandknowledgecumulativenessatfirmlevelandonlyinvolvingmanagers

JapaneseCorporation CrossShareholding;mainbankingsystem;lifetimeemployment

Integratedorganizationsofmanagersandworkersthankstolifetimeemploymentmonitoredthebehaviouroftopexecutives;lowinterfirmmobility

Collectivelearningandknowledgecumulativenessatfirmlevelinvolvingbothmanagersandemployees

NewEconomyCompanies Founders(oftenscientistsspun-offfromuniversities)andventurecapitalists(oftenprovidedwithtechnicalandmanagerialcompetences)jointlyexertthestrategiccontrolofthefirm

Higherinterfirmmobilityofengineersattractedbystock-optioncompensationsystemthatventurecapitalistsandtopmanagerssetupwithintheNewEconomyfirm

Collectivelearningandknowledgecumulativenessbothatdistrictandfirmlevel


Questions for lecture 5

MULTIPLE CHOICE QUESTIONS FOR LECTURE 5 1. Which of the following definitions better fit to the Innovative Firm (IF): a) IF takes as given technological capabilities and market prices (for inputs as well for outputs)

and seeks to maximise profits; b) IF takes as given only technological capabilities and seeks to maximise profits; c) IF seeks to transform the technological and market conditions in order to differentiates itself from its competitors in the market; d) IF takes as given only market prices (for inputs as well for outputs) and seeks to maximise profits.

2. According to the Teece’s theory of dynamic capabilities, resources are: a) Assets that do not have a well developed market in which they could be traded; b) Ordinary inputs; c) Activities performed repetitively, or quasi-repetitively; d) Only intangible assets that firms can buy on the market. 3. According to the Teece’s theory, dynamic capabilities are: a) Assets that firms buy on the market; b) The firm’s ability to integrate, build and reconfigure internal and external resources/competences; c) Dynamic tasks that firms normally perform; d) Sets of ordinary inputs including different levels of quality. 4) According to the Lazonick hypothesis, what do Social Conditions mean for the innovative

firms: a) Analysing firms in order to identify their dynamic capabilities; b) Analysing agents that sell

external knowledge to the firm; c) Analysing the socialization of tacit knowledge occurring within the firm; d) Analysing the different agents that could be responsible for strategizing, financing and organizing innovative firms.
