Look through the contribution from Thomas Rønde, Professor at Copenhagen Business School, @ the seminar 'Germany in Danish Business Research'.

1. And the Winner is – Acquired.
Entrepreneurship as a Contest Yielding Radical
Innovations
Forthcoming in Research Policy
Joachim Henkel, TUM
Thomas Rønde, CBS
Marcus Wagner, University of Würzburg
GERMANY IN DANISH BUSINESS RESEARCH
CBS, Nov. 4, 2014

2. 2
Sources of Innovation: Start-ups or Incumbents?
• Schumpeter:
– I: entrepreneurs
– II: large incumbents
• Numerous studies, empirical and theoretical:
– start-ups ~ radical innovations
– incumbents ~ incremental innovations
• But:
– older studies usually assumed
product market competition
– reality: successful start-ups
often acquired by incumbents
• Does it matter for innovation if entrants aim for being acquired by
an incumbents?
Schumpeter, 1932
Source of figure: http://www.schumpeter.info/

3. Security Voice Routing Optical Wireless Content
3
Example for Innovation by Acquisition: Cisco
Switching
Storage
Home
Networking
Source: Cisco, presentation at TUM, 6/2005

4. 4
• Motivation
• Empirical study: EDA
• Sketch of model and analysis
• Conclusions
Agenda

5. 5
EDA Industry
• EDA overall (2006, ca.): $ 5 bn sales, 23,000 employees
• Three large incumbents
– Cadence ($ 1.48 bn, 5,200)
– Synopsys ($ 1.10 bn, 5,130)
– Mentor ($ 0.79 bn, 4,230)
• Numerous start-ups (1999: approx. 80)
• Many acquisitions
Quellen: 10-k‘s, A. Sangiovanni-Vincentelli (2003), Report Q3 2006 des EDA Consortiums

6. 6
EDA Industry
• EDA: “Electronic Design Automation”
• Automation of design of computer chips using software
LOGIC EDA CHIP DESIGN

7. 7
EDA Industry
EDA software is a system product. Example Synopsys:
Design for Manufacturing Product Family
TCAD from acquisition of
Integrated Systems Engineering
1993 founded as ETH spin-off
2004 acquired for $ 115 mio.
Source of figure: http://www.synopsys.com/products/solutions/dfm.html

8. å = 42
1989 1991 1993 1995 1997 1999 2001 2003 2005
å = 32
7
6
5
4
3
2
1
0
1989 1991 1993 1995 1997 1999 2001 2003 2005
8
Frequent Acquisitions
The three established EDA
firms acquire start-ups at a
high and increasing level
(å1989-2005 = 105)
7
6
5
4
3
2
1
0
Sources: Websites, 10k-Berichte
7
6
5
4
3
2
1
0
Synopsys
1989 1991 1993 1995 1997 1999 2001 2003 2005
Cadence
Mentor
å = 31 (11)

9. 9
Start-ups in EDA: Evidence from Interviews
Start-ups …
A) have to do innovate
– “[Innovative technology] is the only thing they sell, so it‘s either make it
or break it.”(2)
B) have to aim for radical innovation:
– “... there [in small firms] … has to be a radical core, I would say,
otherwise it is not possible”
• “So they are relying on start-ups, which then are starting from scratch …
so they can apply very new methodology with very new techniques without
being restrained by all customers or all the methodology”
C) can hardly remain independent in the long run:
– “The goal is always to be acquired. […] The more successful we are,
the more urgent it becomes to be acquired.”(3)
Numbers (2, 5, 3) denote the interview patner.

10. • Motivation
• Empirical study: EDA
• Sketch of model and analysis
• Conclusions
1100
Agenda

11. 1111
Set-up
• One established firm (I) and N entrants
• All conduct R&D to develop a new product
• Firms choose from a given set of possible R&D projects,
characterized by their success probability p
• Profit for I from a project, if successful: p(p); otherwise: 0
• The function p·p(p) assumes its maximum in ]0,1[ at p = p*
• Only the incumbent can market the innovation
Þ start-ups aim at being acquired by I
• All firms maximize expected profits:
– Entrants: Expected acquisition price
– Incumbent: Expected product market profit minus acquisition price

12. The Assumptions – Illustration for p (p) = 1- p
12
p* p
0
p(p) pp(p)
1

13. 1133
Timing
time
• Stage 1: firms pick their R&D projects (pI , p1, p2)
• (Nature: R&D outcomes are realized)
• Stage 2: Competition among the start-ups to be
acquired by the incumbent
• (Product is sold, profits are realized)
Alternative interpretation:
patented inventions are traded
in a market for technology

14. Analysis: Game Theory
• A “Game” is a situation where:
– The “players” have to make decisions
– The payoff is affected by other players’ actions
– The case in setup considered here
• We look for a stable situation (or, “Nash equilibrium”):
– Everybody is expected to behave in a certain way
– All players are doing the best that they can for themselves given what
the other players are expected to do
– Nobody has an incentive to deviate from the expected behavior

15. The Equilibrium – Illustration for N = 2
15
p p 1
p *= p* 2
* pI
*
0
p(p) pp(p)
1

16. Intuition
• Entrants choose risky strategies as they need to have the best
available technology to be acquired
• Incumbent chooses a safer strategy to have a fall-back option and
a good bargaining position in negotiations with a successful entrant
• The more entrants there are, the stronger is the push to pursue
radical projects with low success probability/high value:
– Success probability of the most radical project undertaken in
equilibrium is decreasing in the number of entrants
• Result is robust to a number of changes:
– More entrants, more incumbents, different timing of the game, etc.
16

17. 17
• Motivation
• Empirical study: EDA
• Sketch of model and analysis
• Conclusions
Agenda

18. 1188
Conclusions
• Explains focus of start-ups on riskier and, if successful, more radical
innovations, based only on their need of being acquired
• Incumbent chooses a safer strategy to have a fall-back option and a good
bargaining position in negotiations with a successful entrant
• Parsimonious model with very rich structure
• Model fits well what we observe in EDA
– in real life, mixed with other mechanisms (HR, organizational rigidities, focus on
existing customers)
• Industries where model fits are characterized by systems products:
– Software, electronics, telecom
• Contribution to understanding sources of innovation and markets for ideas
Thank you