This document provides an overview of innovation and theories of innovation. It discusses types of innovation including radical and incremental innovation. It describes Joseph Schumpeter's theory that innovation is driven by entrepreneurs and economic selection. Nelson and Winter's evolutionary theory that firms develop routines is also examined. The document analyzes how innovation occurs through a process of mutation and selection. It provides the example of Apple to illustrate how firms innovate.

1. Kingston University
Innovation and Evolution
Working as an Economist: EC6001
Radoslav Velyov
K1108346
Word Count: 5051

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Table of Contents
Introduction: 3
Types of innovation 3
Theories of innovation 4
Evolutionary building blocks 6
Process of innovation 7
Patents 9
What drives innovation 11
Innovation through International Trade 14
Innovation of Apple PLC 14
Conclusion 15

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Introduction:
Innovation is a process that exists since early times and it can be defined as a process
where a new invention has been introduced or prevailing idea has been improved or
modified in a better way. In the history such inventions could be the fire, the wheel,
the car, the Internet and so on. In today’s time, innovation is a major foundation of
change and evolution of businesses, markets and people. It is at high importance not
only for businesses and people, but for economies and entire countries as well.
Moreover, the technological innovation is one of the most important drivers of
economic growth in developed countries, where wealthier states and firms rely on
more advanced technology and resources that enable them to have more innovative
incentives. Furthermore in this paper we will see how the meaning of innovation has
been exercised by economists such as Joseph Schumpeter and Nelson & Winter. And
how their theories of innovation and evolution have contributed towards
understanding innovation more precisely. Additionally we will see how technological
innovation is applied in todays business by using a case study from Apple Inc. and see
what strategies are used by the firm to justify all theories and models described by
theorists.
Types of Innovation:
Innovation can take two forms. One of which is when an individual or a firm
introduces a new completely different product or routine and it creates a new market
for it. This innovation is called Radical innovation. On the other hand the second type
of innovation is focusing on improving present products or routines and it is called
Incremental innovation (Queensland Gov. 2008). These two types of innovation can
sometimes be combined and this could perhaps be a very useful way of innovating.
Combination of Radical and Incremental innovation can happen when firms or
individuals combine new idea of a product with an existing product or production and
vice versa (Queensland Gov. 2008). For example, in the manufacturing sector more
and more firms use robots and advance computer technology on the production line to
cut down on cost and increase production compared to when using a human hand.

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This new way of production is still working towards producing the same product but
with a modified and improved production.
Firms with innovative incentives usually go through the stages of innovation, to
assess and establish a successful invention and evaluate whether it will be useful and
how it will contribute towards the business’s success. This process differs in different
sectors and with different firms, so occasionally innovative incentives can come from
different parts of the business or market.
Theories of Innovation:
As we mention above, the innovation is at high importance for the growth of an
economy and increasing number of politics and economists are interested in the
constant technological change as a driver of economic growth (Himmelweit, S. 2011).
The economist Joseph Schumpeter was interested in the firms, which constantly bring
technological change to the market they operate in or in the economy in general. He
believed that the state of capitalist economy is never stationary and firms often cannot
reach equilibrium due to the innovation and evolutionary change that is constantly
happening within the markets (Ruttan, V. 1959). Furthermore, Schumpeter argued
that the firms and individuals with the most innovative incentives are the
entrepreneurs, as they are the ones who enter the market with new ideas and the aim
of growth. Besides, they are very important contributors to radical innovation within a
market (Sweezy, P. 1943).
Additionally, Schumpeter argued that the level of competition in a given market
highly contributes for the innovative incentives of a firm (Ruttan, V. 1959). This is
due to the fact that firms are often aiming for profit maximization, higher market
share or reducing costs. Therefore they are important factor to bring the radical and
incremental innovation in order to achieve these aims (Hagedoorn, J. 1996).
Moreover, the firms, which are successful in presenting new product or new more
efficient way of production, are often the fit firms that have more resources devoted
for innovation. Some weak firms, which are not able to bring innovation to the
market, tend to get selected out of the market. This is called the Economic Selection
(Himmelweit, S. 2011). This is one very important factor as the economic selection

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acts as a motivation for innovation. For example, weaker firms will tend to have a
greater incentive for innovation or evolution of their products due to the fact that they
can be selected out of the market (Himmelweit, S. 2011). Schumpeter stated that
economic selection could also appear within the firm and on the production line. For
instance, when a firm introduces a new product that attracts a great amount of
consumers, it also becomes attractive to other firms too (Hagedoorn, J. 1996).
Therefore, in future other firms adopt the same invention in order to catch up with the
change and consumer demand, and then slowly some old inventions begin to wear-off
or selected out (Marsili, O. 2002).
Furthermore, another two economists Richard Nelson and Sidney Winter argued a
similar point of view to the Schumpeterian view on competition and innovation. They
pay close attention to the ‘nature of technology and focus on the nature of learning
that is exclusive to a specific technological environment rather than firm’s strategy of
entire technological change’ (Marsili, O. 2002). This environment is called a
Technological regime. Nelson and Winter argued similar point to Schumpeter’s point
of view on entrepreneurs, however they also compared the two sub factors of
technological regime, which are the entrepreneurial regime and routinized regime.
The two economists stated that technological change is influencing industrial
competition when they compared to the ability of new entrants (Entrepreneurial
Regime) to enter the market via innovation and already established firms (Routinized
Regime), which bring new innovation or improve on their existing inventions
(Marsili, O. 2002). Unlike Schumpeter, Nelson has come up with the argument that,
when comparing the two regimes, the routinized regime tends to have greater
innovation activity due to the fact that existing firms have more experience and this
allowed them to adopt better routines. Furthermore, entry of new firms would not be
able to occur in some industries where the knowledge is more ‘complex and systemic’
therefore, the larger firms with more resources and funds are the ones to innovate in
these markets (Marsili, O. 2002).

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Evolutionary building blocks:
Nelson and Winter as well as Schumpeter ‘place the firm at the center of the
evolutionary theory’ (Himmelweit, S. 2011). They have stated that the firms have to
adopt a specific procedure in order to determine their behavior. That is, they should
adopt specific routines that can help to identify core competencies. Routines are
usually adopted and can be improved through learning and tacit knowledge.
Moreover, as all firms differ due to their unique nature and capabilities, different
routines are usually developed. Some of the firms’ routines tend to be better than
others so in long run most firms try to develop similar efficient routines (Himmelweit,
S. 2011). Therefore Nelson and Winter argued that the firms behave in the same
manner over long run.
The evolutionary theories explained above include other characteristics that concern
firms and markets. One of these is the mutation, which is described as the innovation
process through which new variety of products or routines is created (Himmelweit, S.
2011). The mutation is an important process where firms usually search in the pool of
routines and adopt the most efficient. The second characteristic is, as described by
Schumpeter, selection. Selection process usually reduces variety, and as discussed
above, some units do not survive on the market. Selection process cannot exist
without mutation due to the fact that when creating variety of new efficient routines
some old routines get selected out through the Schumpeterian ‘creative destruction’
(Himmelweit, S. 2011). Additionally, the presence of selection drives the interaction
between mechanisms or firms and they compete for survival or for a greater share of
the market. Therefore the difference in the routines and nature of firms is the
characteristic that drives selection and evolution as stated in the neoclassical
economics (Himmelweit, S. 2011).
Similarly the second building block presents the firms with biological terms where
mechanisms and firms usually are created with the same genes (in biology) and
routines (in firms) respectively. This model was also stated in Alfred Marshal’s
‘Mecca of Economics’, comparing the firms to biological mechanisms, the genes to
routines and the sexual reproduction to innovation (Hodgson, G. 1993). However,
unlike biological genes that do not change completely overtime, firms can learn and

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adapt new routines and change over time. This suggests that firms are able to imitate
routines of other successful firms, which is not always easy or successful. The
adaptation of new routines or inventions sometimes requires research that is quite
firm specific and would help the firm to evaluate how effective this invention will be
or how useful the adaptation of new routine is. Some firms invest significantly large
amounts of investment in R&D. Furthermore, some new ideas for innovation are not
always successful and this can be assessed through the process of innovation.
Process of innovation:
In the process of innovation there are some stages that each firm can go through to
identify whether the innovation will be able to fit the firm’s specific nature and how
capable the firm is to create this invention. When having an incentive to innovate,
even having the uncertainty whether the innovation will work, there should be some
sort of process, which the firms can use to find out (Callahan, R. 2006). The process
can take both formal and informal form depending on what the scope of innovation is
and what the consequences will be.
 The first stage is the finding of an idea for innovation, which usually occurs
after the firm answers a set of questions regarding the scale and scope of the
firm, the resources and capabilities and its mission and vision(Callahan, R.
2006).. Answering these questions could give the firm an idea of which part of
their business to innovate in. In some industries such as the Catering and
Hospitality industry, new firms (restaurants) enter the market with new ideas.
These could be new ways of customer service, new food and drink products,
and so on. In this case, the entrepreneurial regime tends to bring up with
radical or incremental innovation. In other industries, which are moderately
concentrated and entrepreneurs find it difficult to emerge with innovation,
well-established firms spent large amount of money into R&D to find new
ideas of innovation.
 The second stage is the preliminary assessment in order to find out how the
idea will be approached by the firm. It also involves researching whether the

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market really desires an invention of this kind should the invention be a new
product or service. Then the firm needs to assess how the other firms and
consumers will react to such new invention, how the idea will affect the firm
and will it meet the firms aims and objectives in long run. This is one
important stage of the business due to the fact that the ideas are exercised and
evaluated and if they do not fit the objectives of the firm, they can easily be
changed before any costs of development are involved (Callahan, R. 2006).
 The third stage involves the definition of the new idea or invention. In this
stage the firms are usually developing a strategy of how to realize the idea and
what resources the firm should involve for its creation. The firm is assessing
and planning and the costing of the new invention and meeting legal and
social requirements. This is one very important stage as the firms are now
putting the idea into a theoretical practice to find out the uniqueness and
strength of the invention and its contribution to the business’s success
(Callahan, R. 2006).
 The next stage is the development and creation of the idea, which involves
processes such as assembling and putting all theoretical thoughts into practice.
In this stage the firm is usually testing the invention to see how it functions
and whether it meets the necessary requirements to be presented to the market
(Callahan, R. 2006).
 After careful evaluation and testing, the new invention can go through the
stage of commercialization. In this stage the firm is looking for the most
effective way of presenting the idea into the market and capture a wider range
of audience. In this stage the firm is also legalizing and patenting the new
invention. This is a crucial step in the process of innovation as patenting,
which will be described later, will prevent other firms of appropriating the
idea and present it as their own (Callahan, R. 2006).
 Finally after the idea has been successfully presented in the market and
customers have tested it, it is the time for feedback and review. In this final

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stage the firm is assessing how this invention has contributed towards the
business’ success in terms of costs, profits, share on the market, reputation and
so on. It is important stage as now firms can compare the predicted results of
the impact of the invention with the real results occurred after the feedback is
received (Callahan, R. 2006).
Some firms will have the needed resources and capabilities to go deep within each
stage of innovation and repeat it in order to find out exactly how it will affect their
business. However, other smaller firms, which have less resources could have a less
formal and not so extended process of innovation. This is not at substantial
importance as great innovative idea can occur from all parts of the business. One
critical example of how extensive and informational the innovation process can be is
reflected by the pharmaceutical industry, where firms are usually required to invest
large amount of money and time into the innovation process in order to find out how
the new invented, say, medicine will benefit the firm, will it be safe for consumers
and will it meet the legal standards. In this particular case these factors are really
important and such firms can use the full process of innovation and constantly repeat
it until reaching the desired result.
As mentioned it is not a necessary for a firm to follow all requirements as stated
above, however it is essential that some structure be followed in order to plan and
approach the innovation. Furthermore it will give the firm an idea of how desirable
the invention will be on the market (Callahan, R. 2006). Additionally, if successful,
the new invention is likely to attract the consumer demand, and therefore this demand
pull for the new invention will push the other firms in the market to adopt the same or
similar ideas and be actual on the market and meet consumers demand like explained
by the theory of innovation and evolution. Therefore, the firm can protect its
invention via the use of patent licensing.
Patenting New Invention:
Patents are documents issued by the state or country where the firm is operating, that
protects the intellectual properties of an individual or firm of being appropriated from
a third party. The patenting is a process, which usually requires time and resources in

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order for the inventor to obtain one (USPTO. 2008). The patents can take several
forms; most common ones are the utility patents, which protects an individual’s
inventions ‘that have a particular function’ (McGrath, J. 2009); (USPTO. 2008). For
example, these could be machinery or new technology on the production line. The
second common patent is Design Patent, which is usually related to non-functional
inventons such as design or shape of a particular product (USPTO. 2008). The third
most common patent is the Plant Patent, which ‘protects the inventions of asexually
reproduced plants’ such as hybrids, or mutation of some kind (Yang, J. 2010).
These patents are not easily obtained due to the fact that the idea of innovation needs
to be assessed by the patent office (McGrath, J. 2009). So, as described above, the
firm needs to undergo the process of innovation to find out as much information as
possible of the potential useful function of the invention, so they can use it to apply
for a patenting document. The patenting office is assessing information, such as if the
invention being patented already, how unique it is and whether it is actual. The
process of patenting is long due to the fact that the intellectual property office needs
time to assess this information. However, if the patent is obtained, the inventor will
have the intellectual property rights over the invention and will be protected from
other firms stealing the idea (Yang, J. 2010).
The fact that the patent protects new inventions, is really important factor that
encourages firms and individuals to innovate. It encourages innovative incentives as
the firm or individual will have in mind that its invention will benefit the firm in a
sense that it will be recorded as their own and thus increase reputation, profits and
possibly share on the market. However, if the power of a patent is too strong it may
discourage ‘learning by doing’ (Allred, B. 2007). For example, some firms on the
market, as described above, learn by imitating other firm’s technology and catch up
on the market. That is, when a new unique and powerful invention (or routine) is
created, most other firms (mechanisms) tend to imitate it. Therefore, if a patent is too
strong it can discourage other firms in the market from catching up in the market with
similar trends. Consequently, this gives a monopoly power to some innovative firms
and discourages innovation from other smaller firms (Allred, B. 2007). This implies
that the selection process, which is described by Schumpeter, will affect many firms,
who are not able to imitate or learn by doing. Therefore, less variety is created and the

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evolution process will slow and this could slow economic growth in the particular
sector.
What drives innovation:
Innovation can be inspired from all parts of the business starting from an idea that
came from an individual or a team, idea that is generated through careful research of
the R&D departments of firms or from the consumers in the market.
Motivation is one factor that can drive innovation. Firms that have relatively high
aims for success are usually the ones to employ expertise, train the employees and
create routines that motivate the personnel in a way that they can work towards the
firm’s desired success. Such motivation can also come from external to firm factors
such as, the nature of the market and competition. Therefore, individuals or teams
within the firm usually will have stronger incentive to innovate.
The consumer demand can play a big role in innovation. Consumers are the ones,
whom the firms innovate for and the consumer is at great importance for the firms’
choice of invention. Therefore, firms usually perform a research to find the consumers
needs and wants. This is a useful tool as sometimes the public can inspire the firm.
Constantly firms receive feedback on their performance, products or innovation by
the press and public. Besides, this feedback can sometimes give signs and information
on what the consumers desire. This information, if carefully assessed can help the
company to improve on their existing products. For example, the mobile industry
captures a wide range of consumers and its market is very large. In the recent years
constantly new mobile devices are coming on the market. Apple PLC introduced its
iPhone 4S, which is no more than two years old, however until then the firm has also
introduced iPhone 5, 5S and 5C in a period of only two years. If compared, these
devices look similar but have significant design and software improvements such as,
lighter and slim design, fingerprint recognition, better photo camera and so on. All
these improvements were made due to the information from consumers and feedback
that Apple received after each invention was tested in the market.

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The industry and economical condition are also very important factors that drive
innovation. For instance, large economies such as US have moderately advanced
technology, strong political and regulatory systems and allow large firms to expand
and small firms to set up on a constant basis. This economic stability generates variety
of many firms in many different sectors and this is key for having a large number of
innovators. Neil Foster reflected the innovation in each economy by stating the
number of patents applications in his document ‘Innovation and Technology transfer
across Countries’. He suggested that in US and Japan, patents applications were
between 50,000 -150,000 for the last 50 years. And in central and western Europe and
China it was 5,000 -50,000. Moreover, this indicates that these economically stable
regions are the ones with most innovative activities (Foster, N. 2012).
We mentioned above that competition is one very important driver of innovation. If
there is large number of firms in a particular sector, this suggests that the competition
level in this sector will be relatively high. As argued by Schumpeter, if all firms
compete with each other for a greater market share and higher profits, they will be
encouraged to a great extend to innovate. Additionally, the high number of firm on
the market suggests that there are a big variety of innovators. Furthermore, firms that
do not innovate enough can also learn from the variety of innovators and apply
similar routines and techniques to evolve. This creates a dynamic and constantly
interacting atmosphere within the market, where the firms constantly move towards a
general change and faster economic growth.
Innovation can be inspired from industries, which are less competitive as well. The
oligopoly markets, for example, have small number of large firms with relatively
large market share. As described in the Schumpeter’s theory, these are the fit firms.
Although their share on the market is big, they still compete with each other, but
when compared to other more competitive markets the firms in oligopoly markets are
bigger and have more resources to innovate. Such firms usually have relatively large
R&D sectors and invest millions into researching for new ideas and inventions. As
stated in the paper ‘Innovation and Economic Growth’ by Professor Nathan
Rosenberg, the amount of the investment in R&D reflects the incentive for innovation
by a firm (Rosenberg, N 2004). This is one very important factor as large firms in
wealthy OECD countries usually spend billions in total and these investments for

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researching are highly likely to end up with a new and unique radical invention that
will contribute towards the economic growth in future (Rosenberg, N 2004).
However, the oligopoly sector does not create innovation through firms’ variety, due
to the fact that it is difficult for entrepreneurs to set up with innovative incentives due
to lack of resources and greater cost. So sometimes this is a huge barrier to entry in
such markets and innovation cannot be created through variety. For example, in the
supermarkets industry, large firms such as Tesco, ASDA and Sainsbury’s, which
expand through economies of scale, innovate their service by giving out club cards or
loans, online shopping and home deliveries and so on. These factors are ones that
cannot usually be made by a small firm and entrepreneur due to the nature and size of
the firm.
In market structures such as Perfect competition, the innovation cannot be seen much
as it is seen in Monopolistic Markets and Oligopoly. This is due to the fact that in
Perfect competition, the number of firms is very large and each firm has a relatively
small market share. Moreover, as the firms are price takers on the market and operate
at the average cost level, this does not allow the firms to make any substantial profits
and thus not enough money can be spend into innovative activities. Another factor
that discourages perfect competition from intensive innovation is that the nature of the
market suggests that products and services are taking a simple form and are
homogeneous and this would not allow for much innovation to take place.
On the other hand in market structures such as Monopoly, where competition is
scarce or does not exist at all, innovation can also be discouraged. B. Sastry has made
this point in a paper from 2005, where he presented J. Arrows idea that firms
operating in a Monopoly markets, have fewer incentives to innovate (Sastry, B.
2005). He explained that if a firm is dominating the totality of the market share, the
firm is already profitable enough and not challenged by other firms. So, the incentive
to innovate decreases. Additionally, if a firm in a Monopoly innovates, it simply
replaces one profitable product for another profitable innovaton, which Arrow called
‘the replacement effect’ (Sastry, B. 2005).

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Innovation through International Trade:
The model used to describe innovation in high economic growth countries differs
from countries with low economic growth and where firms have not got the sufficient
amount to invest in R&D (Foster, N. 2012). However, as stated earlier, economies can
also learn from each other just like firms and adopt similar techniques to encourage
innovation and therefore economic growth. This is due to the fact that even if an
invention is discovered and patented in one country, it can sometimes be adopted,
modified and patented by someone else in a different country depending on how
strong the patent is and what is the scope of the invention. Thus, firms can learn from
each other on international scale also and usually innovate through incremental
innovation.
Innovation of Apple Inc.:
Apple is one of the leading phone and computer manufacturing firms. It operates in a
dynamic market where firms are constantly bringing new technological invention that
attracts consumer demand. Apple is one of the oligopoly firms on the mobile
technology market and it gained its large market share in the last ten years mainly
through radical inventions such as the touch screen iPhone and iPod and iPad, the
Mac and App Store softwares, and so on. According to statistics presented by Apple
Insider, the company has spend $1.3bn in research and development in fiscal year
2012 and investments were to grow year after year (Hughes, N. 2013). These
investments suggest of how innovation orientated Apple is and that every year this
innovative incentive is increasing.
One factor that drives the firm to innovate is the competition in this industry. Other
firms such as Samsung and HTC are constantly bringing up new inventions and this
contributes towards the fast technology improving and dynamic market. Therefore
fast innovative activities are important if the firm wants to continue maintaining its
market position and this fact justifies the need of Apple to spend large amounts in
R&D in the near future (Hughes, N. 2013). Apples incentives to innovate are reflected
into their recently innovated products. For example, the firm invented the touch
screen iPhone and then in 2010 it invented the iPad, the following few years, it

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invented the Apple TV hardware, and so on. These all-different radical innovations of
apple suggest how well the firm is routinizing its operations and to what extend the
company understands the consumer needs and wants in order to bring these
innovations (Neilson, J. 2012).
The firm is using one indeed useful strategy, they have developed their products in a
way that can be interlinked. For example, the introduction of iPhone and Apple Store
that allows the customers to download softwares and programs for the touch screen
device, gives the firm the advantage of selling mobile phone devices that will
constantly access the unique Apple App Store and purchase programs. In this way the
company is increasing the chance of consumers spending money with App Store
products rather than general products from the internet.
The firm is one good example to show how innovative large firms are based on the
fact that large amount of money and resources are invested into researching for new
technology. If compared to smaller firms and entrepreneurs, who also bring
innovation, the large firms such as Apple are the ones that bring the evolutionary
radical change within their markets and the entire economy as well (Neilson, J. 2012).
Conclusion:
From this paper it is evident to argue that innovation can occur in any form and be
driven by competition, the ability to protect the innovation via patents and the stable
economic situation.
We have seen that firms operating in a competitive market are the ones that bring
innovation due to the fact that they are in constant pressure and competition from
other firms so they need to protect their profits and market share by bringing new
innovation. We can conclude that small firms and entrepreneurs are constantly
bringing up for the variety of innovative firms and thus drive the economic growth
through variety.
Additionally, we can conclude that the firms, which are bringing the evolutionary
radical innovation, are the ones that have the sufficient funds and resources to invest

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and research for new ideas. As seen, Apple is one company with high market share in
Oligopoly market, which invests into R&D in order to innovate (Foster, N. 2012). As
Nelson and Winter have pointed out that such firms have greater knowledge and
resources, stronger routines and more complex system that allow for a greater
technological change through the routinized regime. One important part of the
innovation as we have seen is the process of innovation itself. Moreover, firms such
as Apple are usually the firms, which have the relevant resources to perform the entire
process (Neilson, J. 2012). The process as seen is one very useful way that the firms
can use to find out how useful the innovation will be and to what extend it will
contribute to the market and to the firm.
Furthermore, it is evident that economies with high economic growth do allow for
higher innovation incentives due to the fact that the confidence of consumers and the
confidence of new firms to set up in a particular market is greater than economy with
low growth. As Schumpeter stated, new variety can be created if new firms constantly
set up, therefore innovative incentives are likely to increase with the presence of
mutation (Himmelweit, S. 2011).

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