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What are Sectorial Patterns in Innvoation? (Pavitt)

Technology Producing:

  • Science based (Pharma, biotech)
    • Large and small firms
    • Product and process
    • R&D and public science
  • Secialized suppliers (SW, tech consultancies)
    • Small firms
    • Product
    • Industrial design


  • Scale intensive (bulk chemicals, electronics, automotive)
    • Large Firms
    • Process
    • R&D Engineering

Technology using:

  • Supplier dominated (traditional services, traditional manufacturing)
    • Small firms
    • Process
    • Capital embodied
  • Information insentive (Banking, retailing, traveling)
    • Tend to be large firms
    • More Process
    • Central role of IT


What are the dominant drivers for innovation?

  • Costs:
    • Whoever stands to gain most from an innovation will (other things equal, in particular cost) be most likely to perform it 

  • Benefits:
    • Whoever has the lowest cost of doing an innovation will
      (other things equal, in particular benefits) be most likely to do it 

  • How to measure innovation in companies? 

    • Patents, revenue for new products...


What market structure is most conducive to innovation? 

Schumpeter I:

  • “Entrepreneurs” and new firms drive innovation → fragmented markets (typically) 

Schumpeter II:

  • Large firms drive innovation
    → markets with (some) monopoly power 


Explain Arrows model

Basic neoclassical model (Arrow 1962):

  • Linear demand curve
  • Constant marginal cost of c
  • Radical innovation reduces marginal cost to c’
  • Only the innovator benefits (no information spill-overs)
  • Three cases are compared:
    • Ex-ante perfect competition --> ex-post ponopoly
    • Ex-ante monopoly --> ex-post monopoly
    • Ex-ante social planer --> ex-post social planer



Case a) Ex-ante perfect competition, ex-post monopoly 

  • Price y-axis
  • quantity x-axis
  • demand curve: price spent for expected quantity 
  • c is the unit price costs. price must be higher thant the costs to create the product
  • Profits: (Price of q - c)* quantity 
  • Perfect competition: Nearly no margins due to high competency see lidl aldi .. if an innovator comes along, he can sell his product below the minimum costs and make profit --> all other competitors are out of the market
  • After innovation c becomes much less. Triangle between high price - low demand and low price - high demand is bigger than before

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Case b) Ex-ante monopoly, ex-post monopoly 

  • see exmaple a) but this time he is a monopolist and can therefore sell it at maximum costs / demand.
  • After innovation his benefits are lower, as he cannibalizes himself to a certain degree
  • radical innovation: new innovator can behave like a new monopolist after the innovation

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Case c) Ex-ante social planner, ex-post social planner 

  • what are the welfare options
  • everytime you buy a product that costs less than you would pay it iis a plus for you
  • social planner has the highest incentive

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Summary Arrows model: Who performs the innovation at fixed cost F?

  • ex-ante monopolist gets less
  • ex-ante perfect competition gets second
  • social planner gets most
  • Do innovation subsidies make sense?

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Assume that the monopolist InnovaTUM faces the demand curve = 100 − , where is the number of products produced and sold at price . The constant marginal cost of production are = 75. Fixed costs are zero.


  • Easy: Calculate the quantity , price , and profit that InnovaTUM will realize as a monopolist.
  • Still pretty easy: The R&D department introduces a radical innovation which allows InnovaTUM to reduce the marginal cost of production to ′ = 10. Calculate the quantity ′, price ′, and profit ′ in the ex-post monopoly, assuming the same demand curve as in the ex-ante monopoly = 100 − . How high is the net gain from the innovation?
  • A little tougher: To what level would c’ need to decrease so that we would speak of radical innovation in the Arrow sense? What is the maximum fixed cost F such an innovation may cost InnovaTUM to be economically viable? 


Name an example of market power

Giant American profit driven companies control the structure of the Internet. Therefore this structure might become less and less fertile to the kind of innovation that gave rise to the internet.


Market Structure and Innovation

  • In any case, efficiency and cannibalization effect are important elements of incentives to innovate. 

  • Empirical studies confirm that drastic innovations often come from new entrants, not from incumbents. 

  • Scherer (1992, p. 1430):
    – “Schumpeter overstated the advantages of large monopolistic

    corporations as engines of technological change.” 


Questions for Policy Makers regarding Innovation?

Questions that policy makers ask:

–  Support small or large firms?

–  Support entrepreneurs?

–  Support networking? Between firms, or with universities?

–  Support or inform about patenting?

–  Support internationalization? EU policy!

–  How to harmonize regional, national, and EU-wide policies? 


Liabilities and advantages of new firms


  • Roles and tasks have to be assigned
  • New organizations lack reputation and experience
  • Relationships with varoius actors need to be established
  • new firms have to rely on interaction with strangers


  • can start from scratch, no path dependencies
  • very flexible company structure
  • more open and flexible culture
  • hire new people that have exactly the skills needed
  • more flexible, young employees


Liabilities and advantages of small firms


  • limited resources (financial, personnel)
  • low varity of skills 
  • no buffer (to survive crisis)
  • disadvantage on the job market
  • low market power 
  • no resources for innovation/ slack time


  • more flexible processes
  • short ways, direct communication
  • fast decision processes
  • job satisfaction typically higher


Explain the concept of disruptive technologies

Alcatel, Ilucent vs. cisco. Package routing technology was not that advanced and bad for voice. 


Sustain change vs. disruptive change


Disk drive: 8 inch (more volume) vs. 5.25 inch (less volume but smaller and cheaper). Originally there was no market only niche. But new entrants pushed it and gained leadership.


Hydraulic excavator: to follow


  • Disruptive innovation is difficult for market-related reasons

  • Possible solution for incumbents:

    • Try to create entrepreneurship within existing organizations (“corporate venturing”, see TIM Advanced, or “corporate and/or strategic entrepreneurship”)

    • These young, small units can afford serving small, nascent markets 

  • ​Words of warning:

    • The concept is “oversold”; it is interesting, but only explains some cases

      of failure by established firms

    • If an innovation is disruptive can only be found out afterwards

    • Clayton Christensen is a marketing genius