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Capitalizingon Innovation Hagiu
1. Capitalizing on Innovation: The Case of JapanStanford Program on Regions of Innovation and EntrepreneurshipFebruary 25th 2009 Andrei Hagiu - Harvard University (joint work with Robert Dujarric - Temple University, Japan) Copyright 2009 Andrei Hagiu; Please do not distribute without permission
2. Starting point: a “puzzle” Japan’s weakness in sectors in which production & innovation rely on “horizontal ecosystems”: Either total absence: e.g. software Or lack of competitive presence in international markets: e.g. animation, mobile telephony Contrast with manufacturing-based sectors… (maybe less of a contrast today!) Copyright 2009 Andrei Hagiu; Please do not distribute without permission
3. Outline 1) “Theory”: vertical integrated structures vs. platform-led ecosystems 2) Background on Japanese innovation 3) Evidence based on 3 industry case studies: a) software b) animation c) mobile telephony 4) Discussion and policy implications Copyright 2009 Andrei Hagiu; Please do not distribute without permission
4. 1) “Theory”: vertical integrated structures vs. platform-led ecosystems Copyright 2009 Andrei Hagiu; Please do not distribute without permission
5. Vertically integrated structures have been (are being) replaced by ecosystems governedby multi-sided platforms (MSPs) Gawer and Cusumano (2002) Evans, Hagiu and Schmalensee (2006) Boudreau and Hagiu (2008) Copyright 2009 Andrei Hagiu; Please do not distribute without permission
6. From “vertical” industry structures… Vertically Integrated Firms Competing Across All Segments Distribution Applications System Software Hardware (Computers, Switches, VCRs) Silicon IBM AT&T Siemens Matsushita Copyright 2009 Andrei Hagiu; Please do not distribute without permission
7. … to “horizontal” industry structures VARs Mail Order, Superstore, etc Distri Computer Dealers 1-2-3 1-2-3 Microsoft Excel Apps Quattro OS Microsoft DOS MAC Linux Microsoft Windows PCs Dell X86 PCs HP-Compaq, Lenovo,etc. MAC LCDs Sharp Samsung others Intel Clones CPUs Intel architecture Motorola Ecosystems revolving around multi-sided platforms (e.g. Microsoft, Apple, NTT DoCoMo) Copyright 2009 Andrei Hagiu; Please do not distribute without permission
8. Examples of ecosystems driven by multi-sided platforms (MSPs) + + Application Developers Users + + + PC Makers (Dell, HP, IBM, Sony, etc.) Copyright 2009 Andrei Hagiu; Please do not distribute without permission
10. Key characteristics of ecosystems revolving around multi-sided platforms (MSPs) MSPs facilitate direct interactions between third-party members of the ecosystem Reduce search and transaction costs Indirect network effects: Third-party complementors <-> customers MSP can indirectly control contracting beyond its boundaries: “platform governance” of access to and transactions within ecosystem (cf. Boudreau and Hagiu 2008) Copyright 2009 Andrei Hagiu; Please do not distribute without permission
11. What drives the shift from vertically integrated models to ecosystem & MSP-based industrial structures? Copyright 2009 Andrei Hagiu; Please do not distribute without permission
13. 1) Technological progress -> economies of specialization 2) Modularity & standards: decreasing transaction costs of coordinating through the market 3) Shift in consumer utility from “integrated solutions” to “preference for variety” Copyright 2009 Andrei Hagiu; Please do not distribute without permission
15. Sources of economic inefficiency in vertically integrated structures (or hierarchical ecosystems) “Lock out” of certain types of innovation: Japan’s software industry – or lack thereof Hold-up (opportunism) by ecosystem leaders: Japan’s animation industry Excessive dependence on incentives of ecosystem leaders: Japan’s animation industry Japan’s mobile phone industry Copyright 2009 Andrei Hagiu; Please do not distribute without permission
16. 2. Background on Japanese innovation Copyright 2009 Andrei Hagiu; Please do not distribute without permission
17. Japan’s economic structure Large domestic service sector (68% of GDP). Most internationally-competitive Japanese businesses are in manufacturing. Services/soft goods not competitive internationally. Hierarchical industrial systems the norm. Copyright 2009 Andrei Hagiu; Please do not distribute without permission
18. Japan’s twin economic challenges Increased competition in manufacturing from lower cost countries (China, South Korea, etc.). Increased share of the value-chain captured by services and soft goods where Japan is weak. Copyright 2009 Andrei Hagiu; Please do not distribute without permission
19. Japanese economic policy DNA Industrialization is the key to economic power (lessons of Meiji, immediate post-war). Hostility to foreign capital (low FDI/GDP ratio). “Life-time employment” in large corporations, hence little cross fertilization between firms and illiquid labor markets. Copyright 2009 Andrei Hagiu; Please do not distribute without permission
20. Industrial structures Pre-war zaibatsus (財閥) conglomerates. Post-war keiretsus (系列) structures (some pyramidal, others based on cross-shareholdings). Based on formal or informal hierarchical “closed systems” as opposed to “open systems” of platform ecosystems. Copyright 2009 Andrei Hagiu; Please do not distribute without permission
21. Legal systems Does the Common Law facilitate open ecosystems? Does Japan’s code law make open ecosystems more difficult? Weak contract-enforcement mechanisms put a premium on in-house development rather than on open systems where third-party contract-enforcement is essential. Copyright 2009 Andrei Hagiu; Please do not distribute without permission
22. 3. Three industry cases studies Copyright 2009 Andrei Hagiu; Please do not distribute without permission
23. Japan’s software industry Observation: no standalone software industry in Japan (no companies; no exports); most software bundled with and dependent on hardware systems (Fujitsu, Hitachi, NEC, etc.) Key reasons: Early strategies of Japanese computer vendors: free, bundled and customized software -> customer lock-in Customer preference for customized products from long-term suppliers Government and private sector bias in favor of hardware (“monozukuri” モノ作り): cf. large-scale computing projects No catalyst for unbundling (cf. IBM in the US): weak antitrust enforcement No VCs; low labor mobility Copyright 2009 Andrei Hagiu; Please do not distribute without permission
24. Japan’s animation industry Observation: Extremely creative industry (all genres, all ages) BUT… No Disney/Pixar; no exports/licensing Animation producers small and fragmented Copyrights owned by distributors (TV, DVD, ad agencies), who dominate animation “ecosystem” Key reasons: “Production committees”: financing key bottleneck Weak IPR enforcement and recognition No VCs; banks unwilling to lend to businesses without “hard” collateral Animation producers cannot invest in developing their own copyright portfolio “Ecosystem leaders” inherently domestic-focused Copyright 2009 Andrei Hagiu; Please do not distribute without permission
26. Japan’s mobile phone industry Observation: World’s most advanced mobile telecoms & Internet market (handsets; services: e.g. contactless debit and credit payment systems on mobile phones) BUT… Handset mfgs very weak in global markets (e.g. top 3 in China: Nokia, Samsung, Motorola) Key reasons: Japanese mobile ecosystem extremely hierarchical and dominated by operators (DoCoMo, KDDI) – unlike US, Europe Innovation (services, features) driven by operators Mobile operators: inherently domestic Handset makers: relationship specific investments domestically without value in global markets Copyright 2009 Andrei Hagiu; Please do not distribute without permission
27. 4. Discussion and policy implications Copyright 2009 Andrei Hagiu; Please do not distribute without permission
28. Industry structures stuck in “inefficient” (self-reinforcing) equilibria Japan not capitalizing on some of its foremost innovations Rather than trying to create a “Japanese Silicon Valley” which would take decades Japan should capitalize on existing innovative industries (e.g. anime, telephony) What can be addressed by policy: Antitrust enforcement (cf. unbundling and the software industry) Recognition and enforcement of IPR – essential to knowledge and technology-intensive industries Development of venture capital and other sources of financing for SMBs Opening to foreign investment/skilled immigration Better contract enforcement mechanisms to diminish the advantage of intra-firm transactions over inter-company ones. Copyright 2009 Andrei Hagiu; Please do not distribute without permission
29. Thank you for your attention. Copyright 2009 Andrei Hagiu; Please do not distribute without permission
Editor's Notes
Hopefully not lowest common denominator super-modular collaboration hopefully.
Not theory as I usually do but draws heavily on more formal research I have done and applies broader economic insights to a question we think is interesting and highly relevant to this conference.
These books (particularly second one) explain why the transition to horizontal, MSP-led structures, makes perfect sense from a theoretical economics perspective. That answers question 1: cf. what follows.
This answers Question 2: ecosystems and MSPs are now the fundamental institutions.
This answers Question 3.Question 4: it’s not so much opportunism that explains the rise of MSPs, but rather factors mentioned above.Ecosystems can be more or less hierarchical depending on how much control is exerted by the MSPs
Opportunism is not as big of a concern as one might imagine in these industries.
While the economic reasons for which most technology-intensive industries evolve towards structures based on ecosystems and MSPs are fairly well established by now (at least in economics), much less well understood are the costs/risks of sticking with vertically integrated or highly hierarchical industry structures.Our key thesis in the paper is that Japan (and in particular the 3 industries we focus on) offer 3 great illustrations of the costs entailed by the mismatch between underlying economic forces pushing towards vertical disintegration and the persistence of vertically integrated or at least highly hierarchical industry structures.Two points to make:Why persistence? (self-reinforcing)How does persistence blunt or bias innovation?
These are relatively new and we believe they have not made their way into economic theory as of yet.While one could argue that 1 and 3 could be viewed as various forms of hold-up, I actually think they are quite different and the difference is interesting…Note that the first two are unambiguously negative, while the third element (over-dependence on ecosystem-leader incentives) is not necessarily so: if ecosystem leaders have the right incentives then no problem. Also, tradeoff (especially of 3) with better innovation coordination in hierarchical ecosystems (e.g. mobile telephony)
Insist on fact that in all 3 cases, the inefficiencies are self-reinforcing -> stuck in suboptimal equilibria which are hard to break without policy intervention
