Topic 6: Capturing value in competitive markets

1. Topic 6: Capturing value in competitive markets • A. Conventional view of imitator/innovator • Reverse engineering & imitation • Competitive tactics • B. Capturing value as an innovator or imitator • Co-specialized assets • The evolving perspective on the use of secrecy, patents, lead-time • C. Sell-out to an incumbent or commercialize? • Capturing value in markets for ideas or organizations M&S 463, Capturing value

2. A. Strategies about imitation: Reverse Engineering • Two different examples • Wrebbit: the inventor out-smarts the imitators • Compaq: the imitator out-smarts the innovator • Not a tale where good guy always wins • Sometimes imitators win, sometimes innovators • “It depends.” It depends on what? Luck, strategy, etc. • Must always go through calculations about when imitation is worthwhile, about likelihood of being imitated, market conditions, etc. M&S 463, Capturing value

3. A. Wrebbit: an example where the innovator wins • The idea for the 3-d puzzle • What is the scarce resource? The ideas or the know-how to implement? • What precedent did the players have to use? • How easy is it for an established player to imitate the basic elements of the idea? • What kind of deal can Wrebbit make? • What assets do they bring to the table? • What assets does Milton Bradley bring to the table? M&S 463, Capturing value

4. A. Compaq: An example where the imitator wins • The idea for the Compaq computer • What is the scarce resource? The idea or the resources to implement? • What precedent did the players use? • How easy was it for the player to imitate the basic elements of the IBM computer? • Compaq had to solve one problem to realize their goal. Was it easy/hard to do? • Did their solution influence/inspire others to pursue related ideas? M&S 463, Capturing value

5. A. The basics behind the innovator/imitator situation • The costs of imitating an innovation • What is in the public domain? What is privately held? • Tacit/codified knowledge hard/easy to acquire or imitate • Easy/hard to hire necessary talent or acquire key assets • Speed and order of entry • One strategy: First, fast and in front (also free?) • The strategy of the “fast second” • Situation happening once? Are events regularly happening as part of product/technology cycle? • Featuritis among long time rivals M&S 463, Capturing value

6. A. Basic and obvious tactics • Innovators try to raise the costs to imitators • Keep knowledge out of public domain • Keep knowledge tacit, not codified • Keep talented individuals away from rivals • Innovators identify the sources of rivalry • Where do potential imitators come from? • How to soberly evaluate ability of imitator to succeed? • Imitators use assets/technical talent to move quickly • The hard part: knowing when & what to imitate • How to be a fast-second? Who can do this? Why? M&S 463, Capturing value

7. A. More tactics: It depends on industry/market situation • Large variation across industries • Imitation usually costs a fraction of invention costs • Imitation arrives quickly in most markets, not always. Why? • Why is imitation so hard in some markets? What is so special about those situations? • What firms use to protect their innovations • Patents/copyright, secrecy, first to market or first mover/complementary assets • Effectiveness differs across industries • More on this later M&S 463, Capturing value

8. B. What is missing from simple tactics? Who captures value? • Teece’s framework emphasizes complementary assets set inside the dominant design paradigm • Appropriability conditions • Tight: Patents work, can keep secrets, tacit knowledge • Loose: Mostly public and codified knowledge • Pre and post paradigmatic industries • Are consumer tastes known? • Are assets and modes of business established? • How firms make investments in anticipation of emergence of dominant design M&S 463, Capturing value

9. B. Co-specialized assets • What is a co-specialized asset? • It is complementary to commercializing technology • All commercialization used in conjunction with business assets and market focus • Assets which lose substantial value in other use • The “hold-up” problem • Teece: Own co-specialized assets at the outset • If not, then build new division in firm • Or contract for them • The many hazards of developing new assets (more later) M&S 463, Capturing value

10. B. The framework in tight regime • Capturing value in tight appropriability regime • Innovator wins most of the time • May share profits with co-specialized asset owners if innovator in poor bargaining position (but this depends on bargaining abilities of parties involved, so unpredictable) • Examples • Pharmaceuticals is strong, classic example • Biotech is becoming example where bargains are made and profits are typically shared (similar to Wrebbit) • Note: a bit vague on the contractual & bargaining details M&S 463, Capturing value

11. B. The framework in loose regime • Who is positioned to strike a tough bargain? • If both or neither is in good position • If innovator better than imitator • Innovator wins, but makes contracts or builds own assets • Consumer electronics, “building own web page” • If innovator worse than imitator • If both strong, then either could win, depends on bargain • Microsoft today, IBM in the past • If both weak, then innovator should give up • Wrebbit w/o patent protection M&S 463, Capturing value

12. B. Implications now a routine part of strategy curriculum • A likely loser: Good technology alone • Building or contracting for co-specialized assets essential • A winner: Control co-specialized assets • Example: Cable co. & the pipe bottleneck for ISPs, Local telephone firms & DSL after-sale service/quality assurance • Strategy: Identify co-specialized assets, but how do you know which assets these are? And which will be valuable? • Predicting winners/losers on the basis of uniquely situated co-specialized assets • Example: IBM and its marketing contact • Example: Microsoft and API protocols M&S 463, Capturing value

13. B. What’s missing from Teece? Firm strategy contains nuance • Surveys show that there are three “types” of appropriation strategies • Secrecy (includes non-disclosure, non-compete) • Patenting/copyright & other IP tends to be enforceable • Complementary assets/first to market works sometimes • Not mutually exclusive strategies: Often used together • The limits/benefits to contracting not articulated • How firms use hold-up ability in bargains. • The key differences between facing a bottleneck when innovating and not facing a bottleneck. M&S 463, Capturing value

14. C. Selling out to an incumbent or commercialize on own • G&S: Focus on decision by small firm to compete in output mrkt or sell “ideas market” • Note: Small firms usually choose one or other, not both • Note: Small = approx 50 employees or less. • Cooperating w/incumbent takes many forms • Marketing/distribution agreement (e.g., biotech/pharma) • Outright sale of unit (to e.g., Cisco) • Commercialization on own takes many forms • Build all dimensions of the business in dist, brand, manu… • Then compete with incumbent in output market M&S 463, Capturing value

15. C. The “drivers”: Excluding others, complementary assets • Can the inventor/start-up preclude effective development by incumbent? • If any of three types of appropriation strategies are effective • Would agreement with incumbent for use of their complementary assets enhance value proposition? • Bargaining problems that make agreement difficult • Disclosure: Price depends on revelation of info, but revelation makes owner of idea too exploitable • Contingency: Value depends on future (e.g., demand) • Perception: Value debatable prior to market experience M&S 463, Capturing value

16. C: A synopsis of the framework M&S 463, Capturing value

17. C: When complementary assets have little value • No strong IP (or its equivalent) • Intensely competitive product market w/no sustainable leads except through renewal of inventiveness • Effective bargain b/w entrant & incumbent unlikely • Entrants look for novel value proposition & aspire to rebuild many existing assets under own roof • Ex: Disk drives & other electronic component markets • Strong IP (rare: almost greenfield development) • Possibility for licensing an upstream “architecture” • Ex: Transistors, Qualcom & wireless? • Patent about basic science: DNA or university discovery • Too many firms wrongly think they live in this situation M&S 463, Capturing value

18. C: When complementary assets have value • No strong IP gives incumbent many choices • Incumbent has ability to exploit bargaining • Product market competition risky for small firm • Low incentives for innovative entrant – why bother? • E.g., the new windshield wiper & auto firms • Might be in incumbent’s interest to develop reputation for not exploiting bargaining power • Possibility for cherry picking external R&D development • Use of contract intermediaries, such as VCs, mkt-makers • Incumbent sets the tone: E.g., Brass-knuckle bargains w/Microsoft, few w/AOL, Yahoo M&S 463, Capturing value

19. C: Outcomes when complementary assets have value • W/strong IP • Incumbents look to coopt potential entrants • Entrants deliberately establish firm to sell-out (but price depends critically on bargaining power) • Entrants compete for priority w/incumbent • Frequent source of innovativeness, not market leadership • E.g., Biotechnology • New invention reinforces extant platform • Tend not to see challenges to existing platform • Except if “perception” of incumbent/entrant wildly differ about value of invention, which interferes w/bargain M&S 463, Capturing value

20. C: Implications from this approach • Ability to hold strong IP makes contracting feasible • Issue is often “when”, not “if. Waiting for prototype… • W/o explicit contracting  commercialize on own • W/o right tone from incumbent  small firm may avoid a deal and develop on own • Incumbent firms can influence direction of entrant • Committing to a path (MS announces ahead of time) • Commitment to soft bargain (Cisco’s purchase pattern) • Existing assets have value b/c alter bargain price • Shadow cast by “potential product competition” • Shadow cast by “potential R&D productivity” M&S 463, Capturing value

21. Learning Points • Understanding the innovator/imitator • Often incumbent/entrant, though not always • Capturing value from innovation • The importance of complementary assets • Bargaining for co-specialized assets • The option to sell-out instead of compete • Bargaining for ideas • Value of assets arises from their use in a bargain as well as in direct product market competition M&S 463, Capturing value