3-4 page summary write up, double spaced, 1 inch all sides, with concise answers to each question related to the Tesla case study (pasted below). You should leverage both the assigned case and reading and previous class material and should not use external sources from the library or the internet.Questions: 1. Was Tesla’s appropriability regime weak or strong? Why? What about the strength of their complimentary assets? 2. What was Tesla’s commercialization strategy for electric vehicle (EV) technology? Do you feel this strategy will ultimately be successful? What are some other options Tesla could have pursued?3. What should Tesla’s technology strategy be moving forward?Reading: Ceccagnoli, M., Rothaermel, F.T. “Appropriability strategies to capture value from innovation.” [Available on Canvas]
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CHAPTER 1
APPROPRIABILITY STRATEGIES
TO CAPTURE VALUE FROM
INNOVATION
Marco Ceccagnoli and Frank T. Rothaermel
ABSTRACT
This chapter explores the extent to which an innovator is able to capture
innovation rents. After examining the two main drivers of such rents,
the strength of the appropriability regime and the ownership of specialized complementary assets, the chapter examines how their interaction
is so critical in affecting imitation, commercialization options, and firm
performance. After reviewing the underlying conceptual framework
and empirical evidence, and using a perspective that cuts across both
time and industries, the authors then discuss the implications of innovation profits for the resources to be devoted to the discovery of new or
improved product and processes.
Keywords: Appropriability regime; profiting from innovation;
complementary assets; intellectual property; patent protection;
first mover advantage
Technological Innovation: Generating Economic Results
Advances in the Study of Entrepreneurship, Innovation and Economic Growth, Volume 26, 3 31
Copyright r 2016 by Emerald Group Publishing Limited
All rights of reproduction in any form reserved
ISSN: 1048-4736/doi:10.1108/S1048-473620160000026001
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MARCO CECCAGNOLI AND FRANK T. ROTHAERMEL
INTRODUCTION
Although significant science and engineering competencies are needed to
invent new processes and products, the technological prowess that underlies
process and product innovations is simply not enough to benefit from
innovation. While invention is a necessary first step to innovation, it is not
sufficient for commercial success (Teece, 1986). Innovators frequently fail to
appropriate the returns to their innovations. This implies that protecting the
returns to innovation is a key strategic challenge in technology-intensive
industries. Commercially successful innovations create temporary monopolies, which in turn enable firms to extract transitory Schumpeterian rents.
In high-technology industries, competitive advantage can be sustained only
through a string of continuous innovations.1 Thus, a firm’s ability to
appropriate rents from innovation determines its performance and continued survival.
Table 1 depicts several high-profile examples in which innovators lost to
imitators (or second movers/fast followers), because the innovators were
unable to appropriate the returns to their own innovation(s). Why does
this happen so frequently? To answer this question, we focus on two factors
highlighted by Teece’s seminal treatise on profiting from technological
Table 1.
Innovators Failing to Appropriate the Returns to Innovation.
Innovator
Innovation
Lost to Imitator/Second Mover
or Fast Followers
EMI
CAT scanner
GE Medical Systems
RC Cola
Diet cola
Coca-Cola and Pepsi
Bowmar
Pocket calculator
TI, HP
DeHavilland
Commercial jet
Boeing
Ampex
Video recorder
Matsushita
MITS
PC
Apple, IBM
Xerox
GUI interface
Apple, Microsoft
Prodigy
Online service
AOL, EarthLink, other ISPs
Webcrawler, Lycos, Alta Vista
Internet search engine
Google
Apple’s Newton
PDA
Palm Pilot
Book Stacks
Online bookstore
Amazon.com
TiVo
DVR Set-top-box
Cable/Satellite Providers
Friendster, MySpace
Social networking site
Facebook
Appropriability Strategies to Capture Value from Innovation
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innovation: the appropriability regime and the complementary assets
(Abernathy & Utterback, 1978; Anderson & Tushman, 1990; Teece, 1986).
Today, it is widely accepted that innovators seeking to profit from their
inventions must understand the strength of the appropriability regime
and the nature of the complementary assets required to commercialize
their inventions.
The commercialization of the digital video recorder (DVR) set-top-box
provides a recent example in which the innovator, TiVo, lost to the imitators, the pay TV cable and satellite providers. TiVo was founded in 1997
by James Barton and Michael Ramsay after working at Silicon Graphics
on a centralized video-on-demand system for Time Warner which had been
canceled. They believed that a better way to deliver video-on-demand to
consumers would be in the form of a decentralized model that utilized a
set-top-box. Their new device would combine a TV tuner connected to an
external source such as cable or satellite TV service, a computer hard drive,
and a user-friendly interface. TiVo’s innovation would prove to be a gamechanger in how consumers watched TV and consumed digital content.
In 1999, TiVo launched their set-top-box product selling direct to
customers for an upfront fee for the equipment and an ongoing monthly
subscription fee. Shortly after the launch they also started selling their
service through cable and satellite providers. For example, their partnership
with DIRECTV included TiVo providing the design for a set-top-box and
DIRECTV manufacturing and distributing under a licensing agreement.
While the partnerships provided TiVo with a larger install base, they generated only a fraction of the revenue that the direct-to-consumer model
provided. TiVo struggled to generate profits, only achieving profitability
briefly in 2005. In addition, many of their partnerships with companies
such as DIRECTV started to unwind as the companies began to source
DVR components and production from generic providers. While TiVo
did possess some fairly strong patents, the actual design of the set-top-box
was relatively easy to reverse engineer since it was comprised of coupling
existing technologies. In later years, TiVo was able to be intermittently
profitable due, in part, to successful patent litigation, but never had
the necessary complementary assets to establish a sustainable competitive
advantage and provide profits from their innovation. Cable and satellite
companies, controlling access to a large installed base of users through
bundling rental of the set-top-box with service contracts, were able to
extract most of the profits associated with the TiVo DVR.
Another example of a company that has not yet established profits from
a radical innovation can be found in Tesla Motors. Tesla manufactures
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MARCO CECCAGNOLI AND FRANK T. ROTHAERMEL
and sells electric drivetrain vehicles. Their business model includes vertical
integration from design to manufacture to sales and distribution. In an
unusual move, their CEO Elon Musk announced in 2014 that they will
open up their patent portfolio for other companies to use in good faith,
without threat of litigation, possibly to help spur adoption of a de facto
standard based on their technology in electric vehicles. This leaves Tesla
with a relatively weak patent position. They are also racing to acquire
complimentary assets in a very capital intensive and highly competitive
automotive industry. It is yet to be seen whether Tesla will be able to
capture profits from their innovations.
APPROPRIABILITY REGIME AND COMPLEMENTARY
ASSETS: THE TEECE FRAMEWORK
TiVo’s strategy neglected the two most important determinants of innovation profits: the appropriability regime and the specialized complementary assets.
The appropriability regime mainly depends on legal and technological
factors. On one hand, the realization of rents from innovation depends
on strong, or effective, intellectual property rights (IPR) protection by
the legal system. On the other hand, characteristics of technology, such as
degree of codification, complexity, and ease of reverse engineering, determine the height of barriers to imitation, which in turn affect the ease with
which rivals can imitate the innovation. In the TiVo case, while the DVR
set-top-box was a remarkable advance in how consumers watched TV, it
only re-combined simple and well known technologies such as computer
hard drives and TV tuners coupled with interface software. Once the idea
about re-combining the different elements had become widely known, it
was difficult to protect because it was easy to replicate through reverse
engineering. In addition, while TiVo did possess some strong patents, they
were not effectively enforced early on. As a result, the appropriability
regime that TiVo faced when commercializing the DVR set-top-box
scanner was weak.
The second fundamental component of appropriability is the ownership
of specialized complementary assets. Teece (1986) highlighted the importance of complementary assets in understanding the performance implications of a new technology when he examined the reason many innovators
were unable to capture the economic rents flowing from their innovations.
Appropriability Strategies to Capture Value from Innovation
7
He argued that the commercialization of an innovation “requires that the
know-how in question be utilized in conjunction with other capabilities or
assets. Services such as marketing, competitive manufacturing, and after
sales support are almost always needed. These services are obtained from
complementary assets, which are specialized” (Teece, 1986, p. 288). The
commercialization of the DVR set-top-box provides a compelling example:
the innovator, TiVo, lost to the followers, the pay TV cable and satellite
providers, because of a lack of specialized complementary assets.
In his conceptual framework, Teece (1986) differentiated among three
different types of complementary assets: generic, specialized, and cospecialized. Complementary assets that are generic need not be adjusted to the
innovation, because they can frequently be contracted for in the market
on competitive terms. General purpose manufacturing equipment falls
into this category. Specialized complementary assets must be tailored to
the innovation. For example, GE Medical System’s stellar reputation
for quality and service in hospital equipment is considered a specialized
complementary asset. Such a complementary asset can be leveraged to
commercialize a variety of innovations in hospital equipment and create
unilateral dependence of the innovations on the complementary assets.
Cospecialized complementary assets are specialized complementary assets
with bilateral dependence between the innovation and the complementary
assets. Specialized repair facilities for Tesla Motor’s innovative electric
vehicles would be cospecialized complementary assets due to the bilateral
dependence between the innovation and the complementary assets (both
are more valuable when used in conjunction). Because the distinction
between unilateral and bilateral dependence of the complementary assets
and the innovation in question is not critical to our analysis, we use the
term specialized complementary assets here to denote both specialized and
cospecialized complementary assets.
Why are complementary assets so critical in commercializing innovation? When large-scale and high-quality manufacturing capabilities are
necessary complementary assets, the owner of such assets is in a position to
satisfy a large surge in customer demand, while maintaining product
quality. A lack of large-scale manufacturing capabilities was the reason,
for example, that innovator Immunex, a biotechnology firm, lost out to
second-mover Johnson & Johnson, a healthcare conglomerate, in commercializing a biotechnology-based drug for rheumatoid arthritis. Immunex
was the innovator in this market through its breakthrough development of
the drug Enbrel in 1998, and sales reached quickly $750 million in 2001.
Surprised by the large demand for its highly successful new drug, Immunex
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MARCO CECCAGNOLI AND FRANK T. ROTHAERMEL
had not created the necessary large-scale manufacturing capabilities to
satisfy such an exponential surge in demand. This strategic oversight
provided Johnson & Johnson an opportunity to enter the market for
biotechnology-based rheumatoid arthritis drugs with its own product
(Remicade), developed by its fully owned subsidiary Centocor. Remicade
has now surpassed Immunex’s Enbrel sales and was one of the top-ten biotech drugs by sales in 2008 (cf. Table 3). Immunex’s innovative advantage
dissipated due to a lack of the necessary complementary assets in manufacturing (Hill & Jones, 2007).
Furthermore, large-scale manufacturing capabilities allow companies to
ride down the experience curve faster due to learning effects and scale
economies, and thus reach a low cost position that is not attainable by
competitors lacking such manufacturing capabilities. This is one of the
problems currently facing Tesla Motors. While it acquired manufacturing
facilities and is in the process of building battery production capabilities,
Tesla has yet to create a manufacturing capability necessary to produce
the quantity and quality that could satisfy the potential demand for its
products at a profitable cost position.
In summary, strategy scholars have highlighted the importance of
ownership of specialized complementary assets in profiting from innovation. These assets are frequently built over long periods of time and thus
are path dependent and idiosyncratic (Teece, Pisano, & Shuen, 1997). Their
market availability is limited because firms tend to gain control over them
to avoid potential bargaining problems. Overall, specialized complementary
assets constitute the bulk of a firm’s resources and capabilities that are
valuable and difficult to imitate, and they can therefore be a source of
sustainable competitive advantage (Barney, 1991).
Interaction between Appropriability Regime and Complementary Assets
In this section, we discuss whom
the innovator or imitator
is more
likely to extract innovation rents. In the following section, we discuss in
more detail the strategic options on which an innovator can draw when
attempting to commercialize an innovation.
The interaction between the strength of the appropriability regime and
the ownership of specialized complementary assets determines the degree
to which firms profit from their innovations. A strong appropriability
regime is typically sufficient to capture at least a positive fraction of the
innovation rents. But even in such a case, a greater degree of specialization
9
Appropriability Strategies to Capture Value from Innovation
in complementary assets corresponds to greater rents for its owner. When
the innovator owns such assets, it can capture almost all of the value
associated with its innovation. When assets are specialized and owned by
a different firm, rents have to be shared through an alliance, which in
high-tech industries typically takes the form of technology licensing agreements (further discussed in this volume), such as in the pharmaceutical
industry after the emergence of biotechnology (Rothaermel, 2001a, 2001b;
Rothaermel & Hill, 2005). Teece’s (1986) conceptual framework depicting
the interaction between the appropriability regime and complementary
assets is summarized in Fig. 1.
Teece (1986) analyzes the case of weak appropriability in greater detail,
most likely because during the decades preceding his work courts typically
provided weak protection to patent holders. Weak appropriability and
generic complementary assets seem to be the unfortunate case of many
entrepreneurial ventures seeking to “build a better mousetrap.” Think
about simple toys, for example, where entrepreneurial inventors often
introduce tiny improvements from which they hope to generate quick
revenues. Such simple inventions, however, are easily imitated and complementary assets (especially manufacturing-related) are easily acquired, with
customers appropriating most of the value created by the innovations.
Appropriability Regime
Weak
Strong
Complementary
Assets
Generic
Consumers capture
most of the value
(e.g., a better
mousetrap)
Complementary
Assets
Specialized
Generic
Innovator captures minority
share of value.
Owners of specialized assets
capture largest share
(e.g., TiVo)
Fig. 1.
Innovator captures
most of the value
(e.g., semiconductor
design firms
outsourcing to
foundries)
The Teece Framework.
Specialized
Innovator and owners of
specialized assets share
value (e.g., biopharma);
may own both
IP/complementary assets
(Eli Lilly/Prozac)
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MARCO CECCAGNOLI AND FRANK T. ROTHAERMEL
The combination of a weak appropriability regime and specialized
complementary assets typically allows the owners of such assets to capture
the lion’s share of the value created by the innovation, as for the TiVo
example discussed above.
With stronger appropriability, the innovator usually captures a greater
share of the profits. It may be able to capture most of the profits if it is able
to easily acquire the necessary complementary assets. When specialized
assets are required, an alliance should allow the parties to earn a return
commensurate with the assets they bring to the table and with their respective bargaining power. A strong appropriability regime typically safeguards
the innovator, which can disclose and protect its inventions to its potential
alliance partners without fear of imitation.
A strong appropriability regime does not simply happen by coincidence, but can be strategically enacted by the innovator not only through
patenting, but also through following up with aggressive patent litigation.
The U.S. semiconductor firm Intel is said to follow such a legal strategy
(Somaya, 2003). Apple Inc., which dominates several high-end mobile
device markets, is another example. In particular, Apple’s domination of
the tablet computer market is a well-suited example. Apple maintains
its competitive advantage in this market by both maintaining a strong
appropriability regime and by controlling key specialized assets. From
the IPR perspective, Apple tightly controls its intangible assets in a
“legendary” fashion, by aggressively maintaining and enforcing trade
secrecy, patents, trademarks, and copyrights (Duhigg & Lohr, 2012;
Stone & Vance, 2009). Apple also owns several specialized complementary
assets: a strong cult-like brand; several complementary technologies which
successfully transferred from its digital music player, the iPod; in-house
digital rights management software; tacit technical capabilities that deliver a product with proverbial design; and an easy to use interface. Apple
also controls key cospecialized assets such as the App and iTunes Stores;
huge marketplaces owned by Apple that enhance the user experience
through the online purchase of functional applications and music. Their
use in conjunction with Apple’s innovations is value enhancing. On the
one hand, Apple benefits from the virtual stores since they encourage its
consumers to remain loyal and enhance its bargaining position; on the
other hand, the iPad benefits the virtual stores, since it provides developers and artists a large installed base of Apple customers. Finally, Apple
aptly outsources production and assembly associated with the iPad, since
these are generic complementary assets that are available in competitive markets.
Appropriability Strategies to Capture Value from Innovation
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Interestingly, the fact that innovators may choose, to some degree,
the strength of the appropriability regime, highlights an important
and somewhat counterintuitive point. Companies that possess specialized
complementary assets may choose to purposefully weaken the appropriability regime (Alexys & Reitzig, 2013; Pisano & Teece, 2007), for example,
in areas where standards and compatibility issues limit incentives to innovate. This is one of the reason why Elon Musk opened-up Tesla’s patent
portfolio (Musk, 2014), as mentioned above. Arguably, the company is
attempting to profit through ownership of a key cospecialized asset such
as its well-recognized, almost cult-like, brand and specialized investments
in complementary assets such as electric battery R&D and manufacturing.
Conversely, some argue that Apple maintained too strong IPR in the
late 1980s in the PC business, neglecting opportunities for network effects
and favoring the diffusion of IBM compatible PCs (Fisher & OberholzerGee, 2013).
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