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Summary of ALL lectures Innovation Managament - GEO4-2268
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Innovation Management FULL summaryLecture 1: Innovation & innovators
This lecture is about transaction costs and how these form the base of the creation of firms. It is also about the
incumbent curse (the difference between start-ups and incumbent) and about disruptive innovation. What this
lecture also focusses on is whether to make the product yourself or whether you want to outsource it.
Notes form Matthijs
We start with analysing what organisations are. For that purpose, a seminal theory is discussed: transaction cost
economics, based on the concepts of transactions, asset specificity and uncertainty. This theory has played an important
role in understanding firm boundaries. We then explore why and how firms innovate, firms are heterogeneous and
innovations can occur in many forms. Finally, we focus on how innovation by new ventures can disrupt a market
previously dominated by established companies and how established companies can react to this disruption. We will
address the challenges that firms face when they need to transition to new technologies and provide several reasons
why incumbents struggle to innovate.
📚 Williamson, Oliver (1981) The Economics of Organization: The Transaction Cost Approach - (skip section IV-V)
Short summary
Goal of the paper = Transaction cost economics is understood as alternative modes of organizing transactions
(governance structures – such as markets, hybrids, firms, and bureaus) that minimize transaction costs.
Major conclusion =
📚 Sawhney M. (2006), The 12 Different Ways for Companies to Innovate
Short summary
Goal of the paper = There is a radar with 12 points of innovation.
Major conclusion =
📚 Chandy, R.K (2000), The incumbent’s curse? Incumbency, size and radical product innovation
Short summary
Goal of the paper = Difference between radical innovation between start-ups and incumbents.
Major conclusion =
📚 Christensen C. M. (2015) What Is Disruptive Innovation?
Short summary
Goal of the paper = The new-market and low-end foothold are interesting for disruptive innovations.
Major conclusion =
Quotes from the slides
R. Coase(1937) Our task is to attempt to discover why a firm emerges at all in a specialized exchange economy.
(. . . ) The main reason why it is profitable to establish a firm would seem to be that there is a cost of using the
Innovation Management FULL summary 1
, price mechanism.(. . . ) the operation of a market costs something and by forming an organisation and allowing
some authority (an “entrepreneur”) to direct the resources,certain marketing costs are saved.
(Schilling, 2009) Technological innovation is the act of introducing a new device, method, or material for
application to commercial or practical objectives
(Sawhney et al 2006) Business innovation: The creation of substantial new value for customers and the firm by
creatively changing one or more dimensions of the business system
(Chandy Tellis, 2000) Incumbent curse: An entrepreneur [...] invents a design for a radically new product. This
person then makes the rounds of incumbents in the industry, seeking support to develop further and
commercialize the revolu- tionary product. But the entrepreneur encounters indifference or even hostility from the
incumbents. [...] the entrepreneur man- ages to piece together the funds to introduce the radically new product.
Transaction costs
Website with additional explanation
🥵 Transaction costs = these are costs that a company or person incurs during the buying and selling process.
(1) Service provided → Additionally to the price paid for the goods, you have to pay transaction costs to the bank or
the broker, in exchange for the services provided. Example: the real estate broker closes a sale and therefore
receives a payment in the form of a commission (part of the money paid for the house). Because the buyers and
selling do not receive a portion of this money - it is called a transaction cost.
🥵 Broker = the person who buys and sells goods and assets for others.
(2) Labor provided → Also, transaction costs include the costs of labor needed to distribute a product. Example:
clothing brands have to pay shipping companies to take their inventory from the warehouses to the stores.
Why are transaction costs important?
Transaction costs are important because they impact the amount of net return a company can make. With lower
transaction costs, it is possible to maximize the amount of profit made from selling goods and services.
Examples of transaction costs
There are 3 main types of transaction costs
🔍 (1) Search and information costs
Customers pay search and information costs, when they are looking for data which they need to determine whether to
buy a product / service or not. They might pay brokers to help them find the correct information for the purchase (for
example with real estate). These search and information costs can also be expressed as ‘time’ - instead of costs.
Paying commissions to a (real estate) broker
Going on vacation and using a booking company or a travel search engine
Purchasing concert tickets
Investing and asking help of finance professionals (who receive a commission)
Working on online platforms - such as Blackbear
🗯 (2) Bargaining and decision costs
When 2 parties come to an agreement, the terms of the agreement often include a cost. This cost (mostly) benefits
the 2 parties. An example is a member card in a clothing store; where both parties benefit from it (for the store:
collecting data about the customer and for the member: receiving discounts)
(3) Policing and enforcement costs
This transaction cost included the expense of hiring compliance officers. These costs cover the time and effort it takes
for these officers to monitor parties that have signed the contract. Paying for policing and enforcement costs.
Then, why do forms exist?
Innovation Management FULL summary 2
, When you want to make and sell something, there are costs attached, that are ‘’costs of using the price mechanism’’,
which means that it costs money to operate in a market - these costs are called transaction costs. When you have a
larger firm with an authority that directs resources, it is possible to save some of these market costs. This means: firms
exist to reduce the transaction costs - the TCE explains that an optimum organizational structure is one that achieves
economic efficiency by minimizing the costs of exchange.
🥵 TCE = transaction cost economy
Criticism to TCE
(1) Opportunism = too much self-interest
(2) Trust = lowering transaction costs can be done by applying trust on individuals between organization
(3) Learning curve = transaction costs will be better (lower) over time
(4) Path dependence = this is how transactions are dealt with - they may depend on the previous handling of
transactions
(5) Heterogeneity = the TCE neglects differential capabilities and dynamics.
Behavior of the firm
There is ‘incomplete contracting’ because transaction agreements never cover all the possible future events (which
cannot be predicted with certainty). Therefore transactions act under 2 things:
🔐 (1) Bounded rationality
The transactors are constrained by cognitive limits on their capacities to process information efficiently - this means
that rationality is limited when individual make decisions.
🤥 (2) Opportunism
This is about self-interest, which could induce strategic behavior by transactors to lie, cheat, confuse and mislead
their exchange partners.
💭 What is the difference between rational and non-rational thinking?
Rational thinking is defined as thinking that is consistent with known facts. Irrational thinking is thinking that is
inconsistent with unknown facts (unsupported by facts)
Transaction governance
According to Williamson, there are 3 main fundamental forms of transaction governance. These different types depend
on the degree of internalization (how much is done within the company). The first one has the highest degree of
internalization, called hierarchy, also known as ‘make’. This means that transactions among parties occur under a
unified owner who settles disputes. The second is market, also known as ‘buy’. This means that autonomous
exchanges are governed by prices in supply-demand equilibrium. The third one, with the lowest degree of internalization,
is hybrid/cooperation, also known as ‘ally’. This means there is a long-term contract relation between parties.
When making ‘make or buy’ decisions, you have to consider some integration options, such as backward , forward and
lateral integration options.
🥵 Horizontal integration = this is the acquisition of another business that operates at the same level of the value chain
in the same industry (offering similar goods and services). Horizontal integration helps companies to grow in size and
revenue; expanding to new markets by buying its competitors.
🥵 Vertical integration = this is when firms expands into upstream or downstream activities in the value chain - to
control different stages of production.
🥵 Backward integration = this happens when a company buys another company that supplies the product or services
needed for production. This is a form of vertical integration (downstream) where the business expands its role up the
supply chain.
🥵 Forward integration = this happens when a business controls business activities that are ahead in the value chain of
the industry. This is a type of vertical integration (upstream). An example is a farmer who sells its crops directly without
Innovation Management FULL summary 3
, selling it to the supermarket first.
🥵 Lateral integration = This is when 2 companies that deal in the sale of similar goods within 1 market merge together.
Make it yourself or outsourcing?
Only when the transaction is recurrent and idiosyncratic to the firm, in-house production should be favored. A firm should
outsource for specialist human knowledge / technological provisions when it is more efficient to do so compared to doing
it ‘in-house’. There are 4 critical dimensions for transactions - that you should ask yourself when considering to take it in-
house or outsourcing it.
Costs are difficult to asses, and therefore 4 variables are used as evaluative mechanisms.
(1) Frequency of exchange (transaction)
This refers to buyer activity in the market or how often the transaction between the parties occurs.
(2) Asset specificity
This considers the extend to which investments are transaction-specific. This can be: site, physical asset or human
asset specific.
(3) Uncertainty
The inability to detail all specifications increases the transaction costs.
(4) Threat of opportunism
Opportunistic behavior of vendors increases the coordination costs of the transactions.
The advantages of a common ownership are to reduce the incentives to sub optimize, resolving differences and more
complete access to relevant information. Advantages are a function os asset specificity and uncertainty.
This graph shows hone to make the product yourself and when to outsource it. On the X-axis it says A = asset specificity
and on the Y-axis is the profit. dG is the governmental costs between internal organizations and the market. dC is the
production costs difference between internal organization and the market. When adding dC and dG together, you have a
line that describes the market advantage. When this is higher than 0, there is a market advantage (buy the asset /
outsourcing). When this is lower than 0, there is internal advantage (produce it in-house) and therefore the business
should integrate backwards (meaning it will produce the asset in-house).
Innovation
Innovation Management FULL summary 4
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