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“No matter how great the technology or how big the market for it, there is no guarantee that the value from a new technology will go to the innovator,” notes Wharton management professor
“No matter how great the technology or how big the market for it, there is no guarantee that the value from a new technology will go to the innovator,” notes Wharton management professorSidney G. Winter in a chapter from the recent book, Wharton on Managing Emerging Technologies.
Winter, whose research areas include technological change and competitive advantage, looks at methods by which innovators can realize the gains from their innovation. The topic is especially relevant in such areas as gene therapy, information technology, intelligent sensors, digital imaging and superconductivity, where the benefits of a particular idea or advance frequently don’t accrue to the innovator. As Winter points out, “many of the gains may go to rivals who have either imitated the innovation or reached similar results on their own. The value could also be captured by buyers or suppliers of other resources involved in the processes of production and use.”
Wharton on Managing Emerging Technologies, edited by marketing professor George S. Day, a founder of Wharton’s Emerging Technologies Managing Research Program, and Paul J. H. Schoemaker, research director of the program, brings together insights from members of both academia and the business community. The book covers a range of issues related to the successful management of emerging technologies.
In a chapter called “Appropriating the Gains from Innovation,” Winter looks at four strategies used by the creators of innovation to ensure that they reap at least some of the financial rewards from their technological advances. The strategies include patents and related legal protection, secrecy, control of complementary assets and lead time.
The Importance, or Not, of Patents
Managers, Winter says, often put too much emphasis on intellectual property law as a way of protecting the gains from innovation, especially given that the general effectiveness of patents varies significantly across industries. Winter cites two studies showing that patents tend to be “quite effective” in the pharmaceutical industry, and less so in most other industries, even ones that are considered “highly progressive, such as computers and semiconductors.”
This tendency of managers to overemphasize the importance of patents leads to mistakes in selecting projects to pursue. “It creates a mindset that says, ‘If we can’t count on getting intellectual property protection for the results of this project, the project is not worth doing,’” Winter says. Not only is this assumption wrong, but it does additional damage if it quashes potential innovation because of the fear that significant protection from competition is not available.
As an example, Winter quotes Howard Schultz, CEO of the Starbucks coffee chain: “We had no lock on the world’s supply of fine coffee, no patent on the dark roast, no claim to the words ‘caffe latte’ ... You could start up a neighborhood espresso bar and compete against us tomorrow … What we proposed to do … was to reinvent a commodity. We would rediscover the mystique and charm that had swirled around coffee throughout the centuries … The best ideas are those that create a new mind-set or sense a need before others do.”
Starbucks is successful, says Winter, because it relied “not upon patents but upon lead time leveraged by complementary assets to appropriate gains from its innovation.”
Winter agrees that patents can be effective for inventions related to the early development of new technology-based industries – e.g. Alexander Graham Bell’s patents on telephony, and more recently the Cohen-Boyer patent covering gene-splicing techniques which earned an estimated $220 million for Stanford University. But the track record of patents in general tends to be mixed.
For example, patents are costly to defend and often require a substantial amount of time to do so. Even Bell Telephone, in order to keep its industry dominance, endured expensive and lengthy litigation involving more than 600 patent suits, Winter says. Lead time, he adds, is generally a more effective way than patents to protect, and profit from, innovation, suggesting it may be “more effective to get the researchers off the witness stand and back into the lab.”
In addition, competitors can legally “invent around” a patent, in part because ideas themselves cannot be patented, while an idea related to a “specific physical means for carrying it out” can be. The patent seeker, however, has to detail very precisely what those means are, which then can leave “abundant room for an imitator to achieve a similar result by somewhat different means, thus inventing around the patent,” Winter points out. As a result, R&D managers generally report that patented inventions are duplicated by rivals within a few years.
Not included in the chapter’s discussion of patents, Winter says, are two points related to patent protection that are increasingly relevant in today’s business climate. “The position presented in the chapter is correct if you are talking about individual patents, but does not discuss the importance to big corporations of accumulating large portfolios of patents and then using them as bargaining chips,” he notes. “By accumulating these patents, big companies are essentially buying a kind of technological protection, making sure they have something to take to the table if somebody challenges them.”
Winter also notes that his chapter does not discuss business method patents, a prime example of which is Amazon.com’s one-click checkout procedure. While the specialized court that hears patent case appeals has upheld infringement decisions in similar business method cases, “my feeling is that this decision will be reversed or limited before long because of its impracticability … The one-click system and some others like it are so obvious that you probably shouldn’t be able to patent them,” says Winter. “But for the time being at least there is a gold rush on to patent what seems to be these fairly straightforward business methods,” partly because the U.S. Patent Office does not have enough experience in this new area to screen out the “obvious” inventions.
Another mechanism for appropriating the gains from innovation is secrecy, which Winter characterizes as a “straightforward but limited type of protection that the owner can provide without aid from a government.”
In the knowledge strategy of an innovative company, Winter says, “there is virtually always some role for secrecy,” although the amount of protection provided varies significantly. A competitor, for example, can acquire an innovative product simply by posing as a customer, buying it, and then reverse-engineering it. While innovators can sometimes make their products resistant to reverse-engineering (as when semiconductor manufacturers enclose their devices in epoxy resin, the removal of which destroys the circuit) or can retain physical control of the product and just sell its services, reverse engineering is generally a major threat to product design secrecy.
In general, Winter says, it’s easier to keep secrets about processes than about products, especially if those processes are large and complex, such as detailed operating techniques in a semiconductor lab or the combined knowledge of a firm’s expert team of consultants. There are of course exceptions. A competitor can easily view, and imitate for example, the manner in which a company’s service representatives relate to customers.
Problems can arise when companies that try to make it easier to transfer internal knowledge by “codifying the key information [end up inadvertently] facilitating the escape of the secrets to imitators,” Winter says. On the other hand, too much secrecy can hinder both current innovation as well as future R&D activity. For example, “strict isolation of projects will postpone the sharing of success and perhaps sacrifice the learning from failure. Numerous small ‘wheels’ may have to be reinvented time and again.”
Rules about secrecy can also be counterproductive when they limit or prevent communication with others in the industry but outside of the company. As Winter points out, “while secrecy aims to prevent valuable information from leaking out, the sealants may be equally effective in preventing valuable information from leaking in.” Many companies, for example, try to prevent their engineers from talking with engineers from rival companies, even though such conversations are an important way to solve problems. Winter suggests that informal professional networks serve a function by increasing the productivity of scientists and engineers and helping the flow of new ideas into an organization.
He also touches on the subject of trade secrets. Companies can take advantage of trade secret laws by, for example, keeping up physical security on the premises and insisting on confidentiality, nondisclosure and noncompete agreements with employees. Such measures are not only helpful in themselves but help satisfy a “crucial precondition for legal action against anyone who might surmount the barrier,” he says. As with the crime of breaking and entering, the offense does not legally exist if the owner takes no precautions.
Trade secret law, however, does not give an innovator protection if a rival “independently thinks of the same information or discovers it by parallel research.” This makes trade secret law different from patent protection which is designed to prevent the use of the patented invention by an independent inventor.
On a practical level, Winter suggests that when an individual comes up with a new idea for a product or process, the goal should be to “maintain a core of secrecy if possible … You should be very careful about your marketing plan or about even disclosing the formula behind the idea because you do not want others to understand what that formula is. It might require somewhat deliberate deception about the nature of the strengths that you are relying on. Basically you are in a secrecy game, and you should train for it by reading spy novels.”
Winter notes that there has recently been enthusiasm for another strategy for protecting, and capitalizing on, innovation – simply giving it away, as when software is put in the public domain. “The information age has indeed given us impressive new kinds of ‘free lunch’ – but as always, the ‘free’ part has to be viewed with some skepticism,” he says. “Sometimes the real idea is advertising revenue, or simply advertising more powerful versions of the product, or selling support services. Often the hope is that this innovation will become the standard in that particular industry, allowing the innovator to charge for follow-on products down the road. It’s giving up immediate dollars in order to reap bigger rewards later.”
An interesting question these days for the e-commerce industry, Winter adds, is what actually is sustainable, or ‘protect-able’ within the new Internet companies. “Is it the software/hardware assets of these organizations that are most valuable and long-lasting, or are the principle assets becoming things like customer databases and customer histories? There’s a very strong market for the technical talent required to mount a large and sophisticated web site,” he says. “My guess is that the technical people rather than the companies” will be the ones to get rich.
Complementary Assets: From Biotech to IBM
Controlling complementary assets – such as access to distribution, service capability, customer relationships, supplier relationships and related products – is a third way to realize the gains from innovation, Winter says. He provides two examples: The biotechnology industry and its pharmaceutical branch in particular, and IBM.
In the early days of the biotech industry, new technology came out of university laboratories usually via relationships with entrepreneurial start-ups. Some of these companies developed – and patented – new drugs, but it was the large pharmaceuticals that held the complementary assets needed to actually get these drugs to market, Winter points out. These assets included, for example, the ability to arrange clinical trials, get FDA approvals, establish manufacturing facilities and market and distribute the drugs.
Both “partners” benefited, Winter says, in that the arrangement allowed the big pharmaceuticals to “come into the biotech game relatively late, and profit from it,” while the patent protection of the startups helped them “retain the gains that otherwise might easily have been seized by their giant partners.”
In the case of IBM, the company early on developed a strong sales force and service/support organization so dominant that by the mid 1950s its domestic market share was about 85%, a position it held for three decades, Winter says. “IBM’s position allowed it the opportunity to make about five times as much use of any given innovation as the rest of the domestic industry combined.”
What made IBM unique, he adds, was not its ability to reap gains from a single innovation “but across a wide range of innovations. IBM created a strong dynamic capability – the ability to make continuing improvements in a related set of products and processes by re-deploying related assets and capabilities in R&D, manufacturing, marketing and other functional areas … In the large firm, dynamic capability is the proverbial goose that lays the golden eggs of innovation.”
Taking an Early Lead
Lead time is considered by some to be the most effective mechanism for protecting product innovations, although again it varies across industries. One survey Winter cites ranks lead time effective in communications equipment, auto parts and cars and trucks, but not as effective in the electrical equipment industry.
In instances when the technological basis for an innovation is available to everyone on reasonably similar terms, the company that moves fastest in developing the innovative application will gain until others in the industry start to catch up, Winter says. Then “the length of the lead time is determined by the good luck, flexibility and skills of the leader as well as the bad luck, inertia and incompetence of the others.”
While there has been extensive discussion of “first mover advantages,” Winter notes, it is also clear that not all “aspiring innovators should aspire to be first … Extreme efforts to rush a product to market may lead to an excessive sacrifice of quality, reliability and readiness to provide service support.”
Winter uses the example of Nucor’s introduction of the compact strip production. “on (CSP) process in steel making to illustrate how lead time plus a problem-solving culture can ensure long-term gains from innovation even in a highly-competitive industry dominated by larger rivals.
The impact of lead time is also affected by “product characteristics, particularly durability,” Winter says. The more durable the product, the more valuable a given lead tends to be.” An example of this is the commercial airline industry where companies typically only buy new aircraft to replace planes in their existing fleets or to support more flights. Existing stock becomes obsolete, however, when an innovation is introduced. The result is an increase in purchases. However, “once this bulge in demand works through, the manufacturers confront only replacement demand again. Thus, the company that is first in bringing to market a major improvement may be able … to be the supplier for a major” part of the stock.
Lead time advantages are also increased when the innovator can establish a strong reputation (as often happens in consumer markets) or when customer switching costs are high.
Finally, “lead time may offer not only the opportunity to do some profitable business before rivals appear on the scene, but also to lock up complementary assets – with the result that the rivals find life quite frustrating, even when they do appear on the scene,” Winter says.
No Magic Formula
How to evaluate and/or implement any of the four mechanisms described above in emerging technologies is the big challenge for managers. While he has no “magic formula, no one-size-fits-all answer” in the specific context of new industries arising from emerging technologies, Winter does offer some advice.
Identify the uncertainties: For example, it’s unclear how effective secrecy is in safeguarding competitive advantage in an information services start-up where talented programmers can be lured away by deep-pocketed competitors. “Trade secret law may provide some protection against [these kinds of losses] but in the tumultuous context of a young industry, the protection is often weak,” says Winter. “To a very large extent, equity participation is the main kind of incentive that an employer in such circumstances can offer to a valued employee.”
Similar uncertainties can surround the advantage of complementary assets in a highly dynamic context. Winter uses Amazon.com as an example: The company may be an innovative online retailer but it also needs the complementary assets that allow it to physically warehouse and distribute its goods. If competition for these warehouses and delivery services intensifies, Winter points out, many of the gains from online retailing will accrue to firms like Ingram’s or UPS (or to the consumer).
Those pursuing lead-time advantages in an emerging technology-based industry have even less certainty. One company’s strategy to establish long-term dominance may be suddenly up-ended by another company’s entirely different, and better, approach. Especially vulnerable to uncertainty here is the telecommunications industry, “where the quest continues for more and cheaper bandwidth to support the needs of the information age and where both technical and regulatory uncertainties abound,” Winter says.
Assess and reassess the knowledge environment. Look at who your competitors are, keep in touch with the sources of knowledge in your field, figure out how quickly the knowledge is advancing, consider what the prospects are for strong patents, and finally, “guard the golden goose.”
As Winter says, “there is no better hedge against failure (to capture the gains) from an innovation than the ability to come up with the next innovation at modest incremental cost …
“Consider turning attention to building and sustaining the dynamic capabilities that permit the company to track and sometimes lead the portions of the technological frontier that are most relevant to its business. Long-term survival depends on figuring out what to do for an encore, and then for an encore to the encore, and ultimately on building the dynamic capability to support sustained innovative accomplishment.”