Arnold Kling  

Innovation, Business Behavior, and Education

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William Baumol compares the innovation strategies and results of large firms with those of small entrepreneurial firms.


most private sector expenditure on research and development is attributable to very large corporations. These corporations are prime employers of scientists and engineers, personnel characteristically highly educated and technically erudite. But, despite this concentration of knowledge, talent, and expenditure in these major enterprises, an examination of the list of revolutionary technological breakthroughs since the onset of the Industrial Revolution suggests that they were contributed in overwhelming proportion by independent inventors and small, newly founded enterprises, not by major firms. Finally, and intriguingly, a review of the biographies of the most celebrated of these innovators shows, in a surprising share of these cases, a most remarkable absence of rigorous technical training and, in many cases, little education at all.

He goes on to suggest that education and organization support incremental innovation but inhibit radical innovation. Both types of innovation are needed. Thus, the economy benefits both from small firms founded by entrepreneurs lacking training in conventional approaches as well as from large firms that focus on education and training.

I find this topic fascinating, so that if you're like me you will want to read the entire article.

For Discussion. What factors inhibit large firms from developing and implementing radical innovations?


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COMMENTS (14 to date)
Lawrance George Lux writes:

William Baumol proposes what I have long thought true. The two prime factors for this lie in the construct of large firms. Corporate officers must clear such R&D with either Bankers or Stockholders in the form of a Board of Directors, niether of whom is noted for being excited about radical and chancy developments. The second major factor resides in the fact radical ideas and developments are extremely difficult to integrate with Corporate operating policy. They cannot be developed, produced, and sold according to the traditional operating procedure of the Corporation. lgl

Walker writes:

To the extent that large firms are inhibited, it is probably mostly due to a desire for a predictable return on investment. Another factor that might provide a disincentive for large firms is that in many cases a radical innovation in a field might hurt the firm's established business(es).

There are quite a few points that the authors omitted or did not give sufficient emphasis. For one, how many of these small entrepreneurs and innovators are really crawling out from under rocks vs. moving through established circles? How many of these folks aquired expertise, money, and reputation at large firms, government labs, or universities? The answer to this question determines whether the small innovator should be viewed as a either an independent complement or rather an offshoot of large institutions in the innovation ecosystem.

Second, it would be interesting to see an analysis of the extent to which a regulated monopoly or cartel might combine the strenghs of the small innovator and the competitive large firm. If through economies of scale and government regulation (price fixing, etc.) the monopolistic firm can be guaranteed a reasonable profit, the disincentives to pursue radical innovation that exist in an excessively competive environment disappear. Combined with regulatory incentives to innovate, this might in some cases be an ideal setup from an innovation standpoint. Real World example: the Ma Bell/Bell Labs relationship before the breakup.

nelziq writes:

see The Innovators Dilemma http://www.amazon.com/exec/obidos/tg/detail/-/0060521996/qid=1085787197/sr=8-1/ref=sr_8_xs_ap_i1_xgl14/002-1475653-1748814?v=glance&s=books&n=507846

Revolutionary new technologies actually can harm the large companies that develop them by undermining their existing business model. Therefore they dont persue anything that would kill the goose. A small company on the other hand can disrupt the market and gain an advantage against a much larger competitor with a revolutionary new product. This happens alot on the tech industry. Many startups try to develop "giant-killer" technologies and once they are proven technically and in the marketplace they are bought up by the larger company or one of its competitors.

David writes:

In summary, the big corporation doesn't plan for the big invention so it doesn't happen except by happenstance. The small guy shoots for the moon.

Sudhir writes:

One factor thus far overlooked is that even in big corporations, when an individual or team smells a radical innovation about to happen, they may choose to break away,form their own company and bring the innovation to fruitition, thereby reaping huge economic rewards of commercialisation. Admittedly, these people aren't the non-rigorusly trained variety.
Then again, there are the anti-establishment types who coordinate online and write diruptive tech software ( skype and gnutella are examples).

Steve Duncan writes:

The main reasons that large firms do not develop and implement radical innovations are, undoubtedly, economies of scale, the large amount of capital that is invested in existing manufacturing processes, and (last, but far from least) low profit-margins. It seems that a typical large firm exists to sell an already-existing product to a well-characterized set of customers. In other words, a large firm that funds radical innovations will have to do so from low-profit margins, will have to fund this research in the assurance of rendering obsolete existing (and expensive) investments, and will have to find more customers, willing to buy the resultant product, than those whom members of management "know" exist.

Ninehammer writes:

Large corporations are primarily political entities. Since politics in large part consists of submission to established norms, it should come as no surprise that radical innovation rarely comes about in such settings. Sucking up may enhance your political prospects, but it's not done on merits, and most command and control entities exist for the purpose of adulating their leaders. Large corporations optimize the rewards of their leaders. Most leaders have no interest in innovation.

Brad Hutchings writes:

Sudhir (above) pretty much tells Arnold's story of homefair.com, as well as the story of countless entrepreneurs. In the big firm, nobody else will see the opportunity, nobody will let you run with the idea, and if somehow they did, someone else would be there to take the credit. Additionally, loyalty to the firm is an antiqauted notion. While it was laudible for my grandfather's generation (he's 80-ish) and fairly normal for my father's (mid-50s), it's mocked by mine (I'm 30-ish) for good reason.

The article poses the question of what it takes to teach entrepreneurship. I've always thought and been told in various ways that a good entrepreneur can see an opportunity and muster resources to execute. While you hear things like Guy Kawasaki's "Don't worry, be crappy", a good entrepreneur's crappy is better than 95% of people's excellent. Formal education can effectively teach excellence, but rarely teaches how to identify an opportunity. In fact, that's where formal education doesn't help. The opposite of structure and direction in an educational context is by definition "flailing aimlessly". Could you imagine a teacher telling students to figure out something important to do and then put everything you have into it. Is that something you can teach or do entrepreneurial souls just have to figure it out on their own?

Mcwop writes:

One major hinderance with larger companies is the amount of efforts spent to keep the current (and often profitable) book of business running. Example: our web traffic has spiked dramatically over the past year. The existing secure session platform needs reworking to handle the higher traffic loads. This will eat up resources that I need to develop several new services. Whereas, a small company with little existing business need not make these tradeoffs.

Also, remember that a lot of small startups fail in the quest for success.

dsquared writes:

Arnold, there appear to be a number of problems with the list of "small business innovations" that Baumol has apparently taken wholesale from the Small Business Administration.

Just taking a few random samples, I quickly turned up four serious problems:

"Programmable Computer" - there are huge disagreements between historians over who invented the first programmable computer, but I'm not aware of any claims for an American small business. ENIAC was produced by the US Army.

"Integrated circuit" - Fairchild Semiconductor might fairly have been called a small company, but Texas Instruments certainly wasn't, and the two companies cmae up with this one roughly simultaneously.

"Assembly line" is one which relies on our believing that Ford Motor was a small business prior to installing its moving assembly line in 1913. This just isn't true. Ford was producing 26,000 Model T's a month before the assembly line was introduced and had 22% market share in US automobiles.

and the "Nuclear Magnetic Resonance Scanner" was invented by EMI corporation of the UK, which was neither an American corporation nor small.

Sorry to nitpick, but these things matter.

Mcwop writes:

D2 has listed some great examples. I might add that Baumol mentions Apple, but what helped that company is the Xerox PARC lab. They created the modern computer UI, which Apple commercialized. That UI is perhaps one of the more important innovations of the past 20 years.

triticale writes:

Note first of all that Xerox had no idea what to do with PARC or the computer concepts which were developed there, and it was relatively small and entrepeneurial companies which turned it all into product and profited from it.

A few large companies, 3M is one which comes to mind, have corporate cultures which are supportive of innovation.

David Foster writes:

This issue is addressed extensively in Clayton Christensen's "The Innovator's Solution," which I have reviewed at my blog. Part of the problem is that new technologies often show up in a form which is in some way *inferior* to the incumbent technology, and hence is easy for incumbent companies to disregard and even to sneer at. Another is that new technologies often start out relatively small, in market terms, and do not pass the "does it matter" screen for centralized decision-making in a large enterprise.

Erik Sargent writes:

It seems to me that large companies are often more focused on engineering than pure science. Look at Intel. Can anyone dispute that the vast sums of cash haven't lead to inovations in cost/performance? Could a small inventor have driven common chipsets through the industry which has helped drive adoption, reliability and mass production?

The problem with the hypothesis is that is to simplistic in its judgement against the big corporations. Yes, they are responsible to a board and shareholders, but that isn't bad. The small inventors can drive most of the "true" inovations, but it frequently takes the big boys to make it practical in the long run. And small inventors like Nike, Intel and Apple often become big players - if they have the discipline to do the R&D in engineering and marketing to make their inovations practical in the marketplace.

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