Part III Knowledge-based Approach Rationality and the theory of the rm Rationality, bounded rationality and the theory of the rm ECONOMICS OF INNOVATION I: INNOVATION DECISIONS Part III . Rationality, bounded rationality and the theory of the rm Uwe Cantner *’ and Simone Vannuccini * * Friedrich-Schiller-Universität Jena & ’ University of Southern Denmark, Odense Cantner and Vannuccini Economics of Innovation I, /8
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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
Part III Knowledge-based Approach Rationality and the theory of the firm
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
Cantner and Vannuccini Economics of Innovation I, 2017/18 104
Part III Knowledge-based Approach Rationality and the theory of the firm
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
Cantner and Vannuccini Economics of Innovation I, 2017/18 105
Part III Knowledge-based Approach Rationality and the theory of the firm
The empirics of IPR: Effectiveness of Patenting IEconomics of
Innovation I
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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
Cantner and Vannuccini Economics of Innovation I, 2017/18 106
Part III Knowledge-based Approach Rationality and the theory of the firm
The empirics of IPR: Effectiveness of patenting IIEconomics of
Innovation I
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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
Cantner and Vannuccini Economics of Innovation I, 2017/18 107
Part III Knowledge-based Approach Rationality and the theory of the firm
The empirics of IPR: Reasons to patent
Economics of
Innovation I
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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
Cantner and Vannuccini Economics of Innovation I, 2017/18 108
Part III Knowledge-based Approach Rationality and the theory of the firm
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
Cantner and Vannuccini Economics of Innovation I, 2017/18 109
Part III Knowledge-based Approach Rationality and the theory of the firm
Knowledge conceptions: Know-how as latent public goodEconomics of
Innovation I
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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
Cantner and Vannuccini Economics of Innovation I, 2017/18 110
Part III Knowledge-based Approach Rationality and the theory of the firm
Knowledge conceptions: Overview on the Character of Know-howEconomics of
Innovation I
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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
Cantner and Vannuccini Economics of Innovation I, 2017/18 111
Part III Knowledge-based Approach Rationality and the theory of the firm
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
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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
Cantner and Vannuccini Economics of Innovation I, 2017/18 112
Part III Knowledge-based Approach Rationality and the theory of the firm
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)
Cantner and Vannuccini Economics of Innovation I, 2017/18 113
Part III Knowledge-based Approach Rationality and the theory of the firm
Rationality concepts
• Innovative activities as rational choice ⇔ trial & error and learning
• Substantial and procedural rationality in stationary situations
"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)
Cantner and Vannuccini Economics of Innovation I, 2017/18 114
Part III Knowledge-based Approach Rationality and the theory of the firm
Situative determinism versus BehaviorismEconomics of
Innovation I
Situative determinism versus Behaviorism
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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.
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Part III Knowledge-based Approach Rationality and the theory of the firm
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
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Part III Knowledge-based Approach Rationality and the theory of the firm
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"
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Part III Knowledge-based Approach Rationality and the theory of the firm
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)
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Part III Knowledge-based Approach Rationality and the theory of the firm
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
Cantner and Vannuccini Economics of Innovation I, 2017/18 119
Part III Knowledge-based Approach Rationality and the theory of the firm
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)
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Part III Knowledge-based Approach Rationality and the theory of the firm
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
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Part III Knowledge-based Approach Rationality and the theory of the firm
RBV of the firm: RBV VRIO 3Economics of
Innovation IRBV of the firm: RBV VRIO 3
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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.
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Part III Knowledge-based Approach Rationality and the theory of the firm
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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