Ashish Arora, Fuqua School of Business, Duke Univ, and National Bureau of Economic Research

Profiting from innovation (PFI)and the evolving division of

innovative labor in the American Economy

The basic PFI schema

Anticipated profit

R&D investment

Anticipated profit

Total profit pool: relative invention quality, market size,

competition, ...Innovator’s share = appropriability

regime, complementary assets, timing

Appropriability regime = IP, replicability

Unit of analysis: Invention

Analytical focus: Success at commercialization

Positive & Normative Implications

Market entry strategies: case of weak appropriability regime (fig 3 from Teece, Research Policy, 2006).

Patentroyaltiesaregenerallysolowthattheprofitsfromexploitingone’sowninventionsarenotappreciablygreaterthanthosederivedfromtheuseofothers’knowledge.Itreallyscallsforsomeexplanation,whythefirmthathasdevelopedtheknowledgecannotdemandagreatershareoftheresultingprofits

Arrow, 1962, p 355

Underlying PFI (1986) is more than a decade of extensive scholarship ...

EJ (1976)• – Tech Transfer is costly (tacitness, context dependence,..)

TAAAPS (1981) • –markets for technology

JL & Econ. (w/ Monteverde)., 1982. • Own a specialized asset but hire more efficient outsiders to

use it

JEBO 1982, • Lumpy assets (e.g. know-how) à underuse AND whose

services cannot be efficiently rented out à diversification

JEBO 1980. • Economies of scope cannot explain multiproduct firms.

(explain joint production, not joint ownership)

REStat (w/ Armour) (1980) • common ownership of R&D and production facilities will

enhance technological innovation if different stages of production have technical commonalities à (VI à more R&D)

• Rescue us from the market power and innovation debate

• Transaction cost = Resource cost, not just opportunism

• A theory of the firm, not just the make-buy

– Innovate if have required assets– Acquire assets because innovate

(in past)

… and perhaps the historical context?

Extending the PFI framework

• PFI takes distribution of assets & capabilities as given

– Outcome of past investments

– Reflect anticipated costs and benefits

• Q: distribution of innovative activity – who invents, who commercializes and who profits

– Cf. Dynamic Capabilities (SMJ 1997 w/ Pisano, Shuen); Organizing for innovation (HBR 1999 w/ Chesbrough); Alliance (JEBO 1996); Industrial organization (JEBO 1994)

– But Smith & Ricardo (and Stigler + Bresnahan & Gambardella)

PFI + Economies of specialization

Firm strategy

Industrial organization of innovation

Shifting the focus: The organization of innovative activity

Whoinvents?Whocommercializes?Howhasthisevolvedovertime?

Thereisreallynoneedforthefirmtobethefundamentalunitoforganizationininnovation;...Ifprovisionismadefortherentalofnecessaryequipment,...amuchwidervarietyofresearchcontractswithindividualsaswellasfirms ...couldbearranged....researchinstitutesfinancedbyindustry...couldbemadetoplaymuchlivelierrole.

Arrow, 1962, p 624

Rise (and fall) of corporate research

"I am fully convinced that it has never, is not now, and never will pay commercially, to keep an establishment of professional inventors, or of men whose chief business it is to invent” … the duties of the patent department … (should be) … first and foremost on examining patents or inventions submitted by the public for consideration and second on examining descriptions of inventions forwarded by the company's employees.“ T.D. Lockwood, on the “Duties of the patent department”, at AT&T, 1885. (cited by Lamoreaux and Sokoloff, 1999)

The broad contours• Innovators different from

Inventors• Increasing integration

between complementary assets + invention after WWI till 1980s

• Trend reverses after 1980s?

WhyInternalResearch• Evaluateexternaltechnology• Generateinventions

• Growthimperative• Other:

• Attractsmartpeople• Signaltoregulatorsorcustomers• Windowonfuture

Golden age of independent inventors, 1850-1900

StanleyEdison

westinghouseSperry

Thompson

• Independent inventors – Assigned patents to multiple firms– Decline nationally after 1890– Specialized intermediaries

• Corporations– External technology and inventions– Internal R&D as quality control, absorp

capacitySources: Lamoreaux and Sokoloff, Usselman,

The golden age of corporate research 1930-80

Backtothefuture?DiminishingroleoflargefirmsinindustrialR&DintheUS,marketfortechnology,M&A,

outsourcing…

Source:NSF S&EIndicators

ShareoftotalprivatelyfundedR&DintheUS,byfirmsize,1984-2005

BlockandKeller,2009.

Lessthan500employees

500to999

1,000to4,9995,000to9,999

10,000to24,999

25,000ormore

0%

20%

40%

60%

80%

100%

120%

84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 00 01 02 03 04 05

Sector Licensing of Rights to Use IP

Protected as Industrial Property

Licensing of Rights to Use IP

Protected by Trademarks

Licensing of Rights to Use IP

Protected by Copyright

Licensing of Rights to Use a business format under a

franchise

Payments for rights to use Natural Resources and Other intangibles

Total

Manufacturing 59.5 9.4 1.0 2.9 - 72.8 Trade and Transp 1.0 6.9 0.1 5.1 - 13.1 Information 1.9 4.9 6.6 0.0 0.1 13.5 Fin and Ins 0.2 0.7 0.0 1.4 0.0 2.4 Prof and Bus Serv 3.0 0.2 1.6 1.5 0.4 6.7 Other Industries 1.0 0.7 0.1 4.8 0.8 7.5

Total 66.6 22.8 9.4 15.7 1.3 115.9

US distribution of technology licensing receipts by sector 2002, $B; Carol Robbins, BEA 2006, tab 7

shareofcontractR&D,

total

shareofcontractR&Dinmanuf.R&D

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

%oftotalR&D

ContractR&DasshareoftotalR&D,1993-2007

Thedivisionofinnovativelabor:Demand(Innovator)Perspective

Imitation(new-to-firm)

AllUSManuf(n=5500)

Innovation(new-to-mkt)

Nonewproducts

Internalinvention

Externalinvention

58%

42%

27%

16%

51%

49%

Supplier 14%Customer 27

Other Firm 8Consultant Serv provider 8Ind. Inventor 7

Univ 5

All specialists 17%

Sources of external invention

Innovation and the Sources of Invention in American Manufacturing, 2007-09: Arora, Cohen, Walsh, Research Policy 2016

Shareofpatentsacquired

Shareofpatentsacquired

Publicationstock/sales($25B)

Publicationstock/sales($25B)

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.90

1.00

centralized decentralized

Shareofpatentsacquired Publicationstock/sales($25B)

Centralizedfirmsinvestininternalresearchandmake

fewerandsmalleracquisitions…Source: Arora, Belenzon, and Rios, SMJ

0

10

20

30

40

50

60

70

centralized decentralized

Numberofacquisitionsper$100mminsalesAvg.patentsperacquisition%ofacquisitionsabsorbed

Structure(centralized

or decentralize

d)

External Knowledge

InternalR&D

InnovationStrategy

PFIrevisited:Innovationstrategyandorgstructure:

Internalvexternalinventions

... and centralized firms also derive proportionately less value from acquired technology relative to internal R&D investment

7 6 7

R&DStock,14

R&DStock,7InternalPatentsStock,9

InternalPatentsStock,7

ExternalPatentsStock,2 ExternalPatents

Stock,6

0

2

4

6

8

10

12

14

16

centralized decentralized

R&DStock

InternalPatentsStock

ExternalPatentsStock

Numberofacquisitionsper$100mminsalesSource: Arora, Belenzon, and Rios, SMJ

Both internal and external knowledge are viable paths to create value, but must be supported by the appropriate org structure.

Structure(centralized

or decentralize

d)

External Knowledge

InternalR&D

InnovationStrategy

Post1990- USfirmsarewithdrawingfromresearch

Shareofpublishingfirms

Shareofpatentingfirms

0

0.05

0.1

0.15

0.2

0.25

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006

ShareofpublishingandpatentingUSpublicfirms,1980-2007,Arora,Belenzon,Patacconi,2015

110/1,814 firms

437/1,814 firms

70

147

227

262

26%

Basic+Appliedas%oftotalR&D,3yrmovingaverage

32%

23%

0

50

100

150

200

250

300

15%

17%

19%

21%

23%

25%

27%

29%

31%

33%

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

constant2009$b

illions

Source:NSFS&EIndicators,2016,Appendixtables4.6-4.8

BusinessFundedR&D

USbusinessexpenditureonbasicandappliedresearch,asshareoftotalbusinessfundedR&D,1980-2012,3yearmovingaverage,andtotalbusinessfundedR&Dinconstant2009dollars