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PART I
ENTREPRENEURSHIP AND ENTRANTāINCUMBENT DYNAMICS![]()
NEGOTIATING FOR THE MARKET
Joshua S. Gans
ABSTRACT
In a dynamic environment where underlying competition is āfor the market,ā this chapter examines what happens when entrants and incumbents can instead negotiate for the market. For instance, this might arise when an entrant innovator can choose to license to or be acquired by an incumbent firm (i.e., engage in cooperative commercialization). It is demonstrated that, depending upon the level of firmsā potential dynamic capabilities, there may or may not be gains to trade between incumbents and entrants in a cumulative innovation environment; that is, entrants may not be adequately compensated for losses in future innovative potential. This stands in contrast to static analyses that overwhelmingly identify positive gains to trade from such cooperation.
Keywords: Innovation; incumbency; dynamic capabilities; licensing; mergers; commercialization
One of the most important insights in strategy is that factors that diminish competition in a market (e.g., patent protection) can themselves intensify competition for the market. Of course, it is well known that this trade-off depends on whether those policies themselves generate intertemporal persistence of present market power (Scotchmer, 2004). For instance, broad patents can raise barriers to innovative entry and so allow current incumbents to persist. Critically, even where such persistence is not enabled by policy, competition for a market is not inevitable when incumbents and entrants can reach agreements that subvert that outcome (Gans & Stern, 2003; Salant, 1984); that is, when they can negotiate for the market.
Beginning with Teece (1987), scholars have asked what factors drive whether a start-up firm chooses to take a product directly to market (broadly termed competitive commercialization) or instead to engage in transactions whereby established firms bring those products to final consumers (broadly termed cooperative commercialization). Examples of the latter include licensing, alliances, or acquisition; that is, start-up firms become sellers in markets for ideas rather than product markets per se (Gans & Stern, 2003). Overall patterns of commercialization choices can be crucial in determining whether industries follow a Schumpeterian ācreative destructionā path where changing technological leadership is associated with changing market leadership or a cooperative path where the two roles are divorced from one another.
To understand these choices, several theoretical drivers have been hypothesized that could lead to a choice of cooperation as opposed to competitive commercialization. First, Teece (1987) emphasized the need to avoid duplicating complementary assets (e.g., manufacturing, distribution, marketing, regulatory expertise) held by established firms. Second, Gans and Stern (2000) emphasized the potential for cooperative deals to allow incumbents and start-ups to avoid direct competition and preserve monopoly rents.
By either avoiding duplicating complementary assets held by incumbent firms and/or preserving monopoly rents, joint surplus is higher for start-ups and for at least one incumbent from cooperative rather than competitive commercialization. Indeed, because these benefits should be realized whenever start-up or incumbent dealings can take place in a frictionless manner, observations of competitive commercialization are a puzzle. That puzzle has caused strategic management researchers to look to potential frictions to explain competitive commercialization. One set of frictions comes under the general classification of transactions costs. This would include the costs associated with brokering deals and also overcoming negotiation problems due to asymmetric information (Gans & Stern, 2003). However, these costs may arise even when entering product markets (Grossman & Hart, 1986), and, when considering implications in a nuanced way, would delay cooperative commercialization rather than drive competitive commercialization per se (Alian, Henry, & Kyle, 2016; Gans, Hsu, & Stern, 2008).
For these reasons, rather than focus on transaction costs, attention has been drawn to issues of the transmission of information that is often required to make cooperative commercialization attractive. For instance, Arrow (1962) identified disclosures that must be undertaken to sell ideas as a reason to avoid such trade. Gans and Stern (2000) demonstrated that this could lead to secrecy and, by implication, competitive commercialization, noting the caveat that, in some situations, competitive threats could overcome disclosure problems (Anton & Yao, 1994) or facilitate the transfer of know-how (Arora, 1995). Gans, Hsu, and Stern (2002) demonstrated that, because of this, stronger patent protection could have a key role in facilitating cooperative commercialization and confirmed this empirically (see also Arora & Ceccagnoli, 2006). Gans et al. (2008) then highlighted further evidence for frictions related to information transmission by looking at the timing of licensing transactions. Finally, Hsu (2006) found that venture capitalists with strong reputations and networks would facilitate a choice of cooperation over competition again as a means of mitigating potential barriers in information flows that might otherwise prove a barrier to such deals. Dushnitsky and Shaver (2009) highlighted similar forces with regard to corporate venture capital and the importance of disclosure issues when intellectual property protection is weak.
Thus, there has been significant progress made in understanding what factors may increase the value of cooperative commercialization relative to competitive outcomes as well as the frictions (and strategies to overcome them) that might cause cooperation not to be realized. However, as carefully documented by Arora and Gambardella (2009), there are many industries where licensing or other forms of cooperative commercialization are not favored over more competitive paths. In addition, there are many prominent examples of firms that, despite being targeted, chose competition ultimately to lead the market. They include, among others, Apple, Google, Genzyme, Intuit, and Facebook. Importantly, the current theoretical progress, as well as empirical analyses built on it, has focused on essentially static drivers of commercialization choice. This stands in contrast to informal discussions that emphasize dynamic considerations; specifically, that start-up innovators may be reluctant to relinquish control of their inventions lest it preclude them from future innovation or result in āselling their birthrig...
