Lecture 6 - Incentives, firms and innovation
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  • 1. Lecture 6 Incentives, Firms and Innovation
  • 2. Outline • Resources and Capabilities: examples • The <value added> of recent theories • Firms in developing countries • • Firms and institutions
  • 3. Resources and Capabilities: examples
  • 4. Appraising Resources RESOURCE CHARACTERISTICS INDICATORS Financial Borrowing capacity Debt/ Equity ratio Internal funds/ generation Credit rating Tangible Net cash flow Resources Physical Plant and equipment: Market value of size, location, technology fixed assets. flexibility. Scale of plants Land and buildings. Alternatives for fixed Raw materials. assets Technology Patents, copyrights, know how No. of patents owned. R&D facilities. Royalty income Intangible Technical and scientific R&D expenditure. Resources employees R&D staff Reputation Brands. Customer loyalty. Company Brand equity. Product reputation (with suppliers, customers, price premium. government) Recognition. Human Training, experience, adaptability, Employee qualifications, Resources commitment and loyability of customers pay rates, turnover.4
  • 5. Resources What a firm Has... What a firm has to work with: Tangible Resources Financial * its assets, including its people and Physical * the value of its brand name Human Resources * Organizational * Resources represent inputs into a firm’s production process... Intangible Resources Technological * such as capital equipment, skills Innovation * of employees, brand names, finances and talented managers Reputation *
  • 6. Capabilities What a firm Does... Capabilities represent: the firm’s capacity or ability to integrate individual firm resources to achieve a desired objective. Capabilities develop over time as a result of complex interactions that take advantage of the interrelationships between a firm’s tangible and intangible resources that are based on the development, transmission and exchange or sharing of information and knowledge as carried out by the firm' employees. s Capabilities become important when they are combined in unique combinations which create core competencies which have strategic value and can lead to competitive advantage.
  • 7. The <value added> of recent theories
  • 8. Early contributions • Edith Penrose 1959: – Although firms may control similar ressource bundles, the services they can derive from resources may be very different. – Services change through experiential learning. – They rest on tacit knowledge.
  • 9. Firms-Innovation • The extreme proliferation of labels/taxonomies, – ”the knowledge-based view,” – ”competence perspective,” – ”core competencies,” – ”capabilities approach,” – ”dynamic capabilities approach,” • ”competence-based competition,” – ”the resource-based view,” – ”the evolutionary theory of the firm”
  • 10. Firms-Incentives Theory Central objective Industrial organization Market structure [influence of sectoral factors] Transaction cost economics Existence and limits of firms Positive agency theory Information asymmetries, incentives Resource-based theories Emphasis on internal resources Evolutionary theory Evolution of the firm in a broader context [routines vs. the selection process]
  • 11. Empirical justification • Inter-industry variation in returns significantly lower than intra-industry variation • For example, business level and corporation specific factors accounted for 37% and industry factors for only 16% of the variation in returns in Rumelt 1991, SMJ. • Thus, i.e., factors internal to firms more important than the environment. • The increasing specialization in knowledge production [strategic alliences designed to exchange knowledge in technological fields like ICT and biotechnology] • The importance of in-house integration capacity • ICT is improving understanding and increasing complexity • Creative destruction in organizational [not technological] practises
  • 12. To be practical, we are interested in this intersection of four areas of research Dynamic capabilities Know Evolutio- ledge- nary based theory of the firm Competence-based
  • 13. Background • Why the rise of capabilities approaches – particularly ”dynamic capabilities” approaches – during the last decade? • Knowledge economy background: Increasing importance of innovation, knowledge assets account for an increasing part of value added, ”innovation driven competition,” [Lecture 3] • A reaction against the neoclassical theory of production (Lecture 2] • The Resources Based approach is the <managerial perspective> in this area of research with a static quality in its analysis. • Other theories focus primarily on internal factors.
  • 14. Knowledge and Routines • Knowledge: – Knowledge forms: – 1) private, – 2) distributed, – 3) shared, and – 4) common. – Firms are seen as systems of distributed knowledge – ”Only APPLE as a firm knows how to produce the iPod.” – Given the stock of knowledge , how is coordination achieved? • That brings us to Routines; ways to: – Embed the firm’s knowledge. – Coordinate dispersed knowledge.
  • 15. Firms respond to pressure and change: Routines • “... an executable capability for repeated performance in some context that has been learned by an organization in response to selective pressures” (Cohen et al. 1996). • Capabilities, competencies, etc. may be characterized likewise. • Change also take place through”dynamic routines.”
  • 16. A basic vocabulary From an evolutionary point of view, the firm is a profit-seeking entity whose primary activities are to build (through organizational learning processes) and exploit commercially valuable knowledge assets. These assets co-determine the firm’s productive opportunity set and are applied in production through the operation of routines.
  • 17. Dynamic Capabilities • Examples of dynamic capabilities: – Product development routines (e.g., Toyota). – Superior ability to absorp external knowledge and integrate it – e.g., alliance and aquisition routines (e.g., some biotech firms). – ”Patching” – reshuffling of corporate resources in response to changing demands (Dell’s ability to constantly segment operating businesses to match demands).
  • 18. Knowledge and economic organization • We will consider these recent attempts to turn ideas into a full theory of the firm in the sense of a theory that addresses the following aspects of knowledge development: – Existence -- why aren’t all knowledge transactions mediated over the market? – Boundaries -- what explains the firm/market boundary? – organization -- what explains the firms formal and informal structure?
  • 19. A theory on knowledge development provides hypotheses on the following questions: • Understanding the demand aspects of why resources are ”valuable.” • The creation and dynamics of resources (”dynamic capabilities”). • Organizing resources, organization as a source of competitive advantage. • Which resources to create? • Protecting resources through entry deterrence, understanding the context of competition. • System effects between resources. • Understanding firm heterogeneity and its dynamics. • Understanding how value sharing impacts on value creation.
  • 20. Key Ideas • A theory of firm level specialization based on knowwledge constraints. • Firms should be seen as heterogeneous agents of largely tacit knowledge assets (e.g., ”capabilities”). • They underlie competitive advantages and innovative performance (”dynamic capabilities”). • Economic organization shaped by attempts to capture rents from such assets (including economizing with the costs of building, protecting and leveraging them).
  • 21. Market selection as an evolutionary processes • Processes which generate variation in the pool of characteristics in a population • Processes which restrict and guide possible patterns of variation in behaviour • Processes which change the relative frequency of different entities within the population • Processes which determine the rate at which the above three processes change • Processes which determine the overall direction of evolutionary change Source: Metcalfe, J.S. (1998), Evolutionary Economics and Creative Destruction, London, p. 23
  • 22. Firms in developing countries
  • 23. Learning and Productivity in the Assimilation of Process Industry Technology Activities Affecting the Productivity of Capital and Labour Accumulated via Process Industry Investment Projects (a) Project implementation (b) Start-up and subsequent operation Specification Procurement of Project Initial Subsequent of product & inputs for selected Integration and Commissioning incremental process Technology completion and Start-up product/process Technology performance innovation improvement (1) Firm-level Investment in training capability Acquisition and experience- creation and/or Acquisition (“Learning- Development by- of Technology Operations and + + Spending”) for New maintenance Major Investment Design, engineering + + + + + Projects and project management Execution of: Project (3) Cumulative implementation Mobilisation Design/Engineering ASSIMILATION OF TECHNOLOGY EMBODIED IN PROJECT CAPITAL of Learned Technology Capabilities Development Experience Experience Experience Experience Experience Experience (2) Learning-by-doing
  • 24. THE LEARNING HIERARCHY IN TECHNOLOGY FOLLOWERS Large Large TNC Domestic R&D Occasionally Present (Rarely in TNCs) Scale Limited. Depleted by Crisis TECHNOLOGY Capabilities Limited, When DESIGN AND UPGRADING Present Often Limited ENGINEERING REVERSE ENGNRG Technology Development Role Usually Present, Often Focus of TECHNOLOGY Intensive Training Efforts, ACQUISITION AND Selected Key Skills Sometimes ASSIMILATION Weak BASIC OPERATING Present, Often Strong SKILLS AND and Regularly Upgraded TECHNOLOGY USE AND OPERATION CAPABILITIES
  • 25. INNOVATIVE CAPABILITY ACCUMULATION IN THE MALAYSIAN ELECTRONICS INDUSTRY Proportions of Firms Mastering Different Capability Levels TNC All Local Local Capability Levels Sub- Local Linkage Independent Mastered sidiaries Firms Firms firms (26) (27) (14) (13) Routine Operation 100% 100% 100% 100% Basic Innovation 100% 100% 100% 100% Intermediate Innovation 85% 85% 86% 86% Advanced Innovation 31% 37% 43% 31 Research-Based Innovation 8% 0 0 0 Norlela Ariffin: DPhil Thesis
  • 26. INNOVATIVE CAPABILITY ACCUMULATION IN THE MALAYSIAN ELECTRONICS INDUSTRY Times Required to Master Different Capability Levels TNC Local Local Capability Levels Mastered Sub- Linkage Independent sidiaries Firms firms (n = 26) (n = 14) (n = 13) Years Years Years Routine Operation (From entry) 3.8 2.9 3.4 Intermediate Innovation (From RO) 9.0 5.5 7.0 Advanced Innovation (From RO) 15 8.8 7.0 Research-Based Innovation (From RO) 20 - - Norlela Ariffin: DPhil Thesis
  • 27. Technology Strategies in Developing Countries Role in Markets The Technology Dimension 1 Passive importer (pull) Assembly skills, basic production capabilities Cheap Labor assembly Mature Products Dependent on buyers for distribution 2 Active sales of capacity Incremental process changes for quality and speed Quality and cost-based Reverse engineering of products Foreign buyer dependent 3 Advanced production sales Full production skills Marketing department establis Process innovation Overseas marketing started Product design capability Own designs marketed 4 Product marketing (push) R&D for products and processes begun Sell direct to retailers Product innovation capabilities and distributors overseas Build up product range Start own-brand sales 5 Own-brand (push) Competitive R&D capabilities Market directly to customers R&D linked to market needs Independent distribution channels, Advanced product/process innovation direct advertising In-house research Sources: Marketing stages derived from Wörtzel and Wörtzel (1981): Technology stages derived from Hobday (1995a)
  • 28. A checklist of T echnology Strategy in latecomer Firm s P rod u ct S tru cture S ize B u sin ess Strategy T ech n ology strategy Selection, Specialization & E m bodim ent Sources of Technology C apability B uilding International C onform ance Innovation N etworks R &D Investm ent R &D O rganization M an ufacturin g Strategy L inks with C orpo rate/Technology Strategy L ocation C apacity Practices Process T raining L ikely T rajecto ry T echnology C haracterization Product O bsolescence Process O bsolescence Firm Trajectory Strategic T echnological C hallenges
  • 29. Firms and institutions
  • 30. The Innovation Development System: A Framework CUSTOMERS INDUSTRY LINKAGE OTHER KNOWLEDGE SOURCES Research Large TNC Knowledge Linkage, Institutes Transfer and Development Export Organisations Large Universities Domestic Metrology and Vocational Standards Training SME Domestic Foreign Start-Ups Technology Sources Policy and Incentive Systems Financial and Funding Systems Legal Frameworks Organisational Structures INSTITUTIONAL CONTEXT
  • 31. The linkage structure of NIS’s An NIS consists of institutions, Facts: – The degree of complexity of modern technology requires a) specialisiation AND – that formulate policy goals and co- b) cross-disciplinary cooperation ordinate (govt. agencies) – Technology becomes more science based (science based patents increased from – that finance and fund R & D 17000 in 1987 to >50000 1994) (science funds, special loan – Labour is the most powerful transmission programmes, etc) mechanism of “tacit knowledge” – that act as bridge between decision Policy instruments for “high growth and making and fund redistribution: innovativeness” goal: research councils and associations – that are responsible for knowledge • Different depending on creation: private R&D labs, universities – industrial structure, – degree of development of knowledge – That forster diffusion: technology creation institutions transfer and diffusion, promotion of – given strength of science technology technology-based firms, human linkages resource mobility
  • 32. BASIC SYSTEM CONCEPTS (see Edquist, for overview) 1. ‘National’ Systems (Freeman, Nelson, Lundvall, etc.) 2. ‘Sectoral’/Technology Systems (Carlsson, Malerba, etc.) 3. ‘Regional’ Systems (Cooke & Morgan, ‘Milieux’, etc) 4. ‘Cluster’ Systems (Saxenian, Schmitz, Bell and Albu, etc.) System Scope - What is ‘in’ the system? What is ‘Outside’?
  • 33. IMPORTANT SYSTEM CHARACTERISTICS 1. Scale - relative to………… 2. Internal Structure - relative importance of actors/activities 3. Internal ‘Coherence’ - (relative) strength of links 4. External Links - ‘openness’ to inputs, collaboration - ‘Active/Passive’ learning
  • 34. KEY ANALYTICAL ISSUES FOR POLICY Origins, Evolution and Change in System Characteristics Differing Characteristics : Effectiveness at Different ‘Stages’ Rates of Change in Key Characteristics Responsiveness of Rate to Policy (What Policy? Whose Policy?)
  • 35. A first analytical step: the specialisation pattern of a NIS • Where lies the intellectual and technological strength of a nation? • How does knowledge generation change in reaction to new policies, technological innovation, etc. ? Revealed Technological Advantage (RTA) – Science: e.g. France, Germany and Italy are specialised in chemistry, physics, mathematics; USA wide spread – Engineering: e.g. Austria, Netherlands, Nordic countries, UK specialisation in clinical medicine;
  • 36. Emerging Specialisation Patterns: Patenting
  • 37. The increasing importance of technology markets
  • 38. A case study in our list of readings [Cohen, at al.] • Comparison of appropriability conditions and spillovers between Japan and the US • Puzzle to explain: higher R&D spending in Japan but difficult to protect rents • A NOTE: the creation of secure assets in new technological knowledge has been one of the main characteristics of the US technological innovation in the 19th century [NBER, 10966]
  • 39. Readings… • An overview of theories: Galende • The evolutionary perspective and dynamic capabilities: Nelson, Teece • Firm level analysis: large firms in advanced countries (Pavitt), technoloogy followers (Forbes) [additional reading: Hobday] • NIS: Cohen