Negotiating for the Market

8/14/2019 Negotiating for the Market

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Negotiating for the Market /38

Markets for Ideas

Traditional models of innovation: competition

- Start-ups innovate for entry into product markets and displace

incumbents (Gilbert & Newbery, 1981; Reinganum, 1983)

New Models of innovation: competition

- Start-Ups have options to engage in cooperative commercialisation (e.g.,licensing, acquisitions) rather than compete in product markets (Salant,

1982; Gans and Stern, 2000)

- Advantages in saving on duplicative complementary assets (Teece, 1986)or softening of product market competition

2

Markets for IdeasResearch QuestionLiteratureOutline

IntroductionCompetitionCooperation

Conclusion

Thursday, 11 March 2010


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Sources of Entrepreneurial Rents

3


Source: Thomson Venture/NVCA

Cooperation withestablished firms

Competition withestablished firms


Conclusion



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Sources of Entrepreneurial Rents

4


Source: Disk Drives, Christensen (1997, p.23)


Conclusion



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New Model: Cooperation (Biotech)

5



Conclusion



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Creation without Destruction?

Competition: Technological entrepreneurship can displaceproduct market incumbents

- Entrepeneurship implies creative destruction

Cooperation: Technological entrepreneurship may reinforceexisting market power

- Entrepreneurship leads to creation but no destruction

Key insight: Competition vs cooperation is not a given but achoice ... the result of negotiations between start-ups and

incumbents.

6



Conclusion



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Research Agenda

Builds on research program with Scott Stern (MIT) and DavidHsu (Wharton) ...

To use insights from bargaining theory to understand thecommercialisation choices entrepreneurial start-ups.

Questions:

-

What are the gains from trade between start-ups and established firms?- What impediments exist that might prevent these gains from being

realised?

- What are the welfare consequences of these choices?

7

Markets for Ideas

Research QuestionLiteratureOutline


Conclusion



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This Paper

Consider a dynamic environment.

Understand whether licensing and acquisitions are likely tooccur in a Schumpeterian environment -- that is, competition forthe market is more important than competition in the market.

Characterise the welfare impact of cooperation -- specificallyon the rate of innovation in the industry.

8

Markets for Ideas

Research QuestionLiteratureOutline


Conclusion



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(Bilateral) Gains from Trade

A start-up firm and an incumbent will trade in ideas markets iftheir joint surplus exceeds their outside options

- Outside options: If the start-up can enter the product market (or dealwith another incumbent), then these are their profits under competition

plus sunk entry costs (Teece, 1986)- Joint surplus: Continuation of incumbent position (plus additional value

of innovation)

- Implies gains from trade: avoiding duplicative investments andsoftening product market competition (Gilbert & Newbery)

Long-run: incumbent need not invest as much in R&D capabilities

- Caveat: ability to generate substitute innovations to dampen start-upbargaining power (Gans & Stern, 2000)

9

Markets for IdeasResearch Question

LiteratureOutline


Conclusion



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Impediments to Ideas Trading

Bargaining inefficiency

- Information asymmetries cause inefficient break-downs or delay -- however,we will see attempted trading.

No gains from trade- There are incomplete contracts implying that continued start-up ownership

and control is important. For example, to facilitate the transfer of tacitknowledge (Arora, 1995).

Strategic bypass

- Negotiations may require disclosures that harm the start-ups competitiveposition (i.e., allowing incumbent imitation); so much so that they avoid the

negotiation option -- Arrows disclosure problem (Anton & Yao, 1994).

10


LiteratureOutline


Conclusion


M k f Idi


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Dynamics and Ideas Markets

Static rationale for cooperative commercialisation is strong

Informal strategic concern (esp in teaching cases)

- EMI & the CT Scanner: licensing would be ... selling our bir thright.

- Nucleon: licensing was viewed as mortgaging away the companys future.

- Ecton: Cannon was also concerned about the impact that an acquisition might have on Ectons productdevelopment process. The Ecton founders were worried that if their company were absorbed into a largerorganization after acquisition, their development efforts for next-generation products would get mired Perhaps, they reasoned, their efforts would be more successful in the long run if they remained independentuntil they had a refined product development process that might survive acquisition and integration.

Informal economic reaction:- No problem. Then start-up should build future losses into the price.

Formal evaluation

- Requires a dynamic model of successive innovation

11


LiteratureOutline


Conclusion


M k t f IdI t d ti


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Outline

Set-up dynamic model based on Segal-Whinston (2008)

Equilibrium under competition

Equilibrium under licensing

Equilibrium under acquisition

12

Markets for IdeasResearch QuestionLiterature

Outline


Conclusion


I t d ti


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Technological Dynamics

Most models of innovation and ideas markets are static

- Roles of firms in an industry is fixed

-

Single innovation race

Dynamics -- on-going innovation races

- Entrants come in and may become incumbents

-

Incumbents protect against entrants- Licensing may preserve roles in equilibrium but not off the equilibrium

path

13

Introduction

CompetitionCooperation

Conclusion

Model Set-UpEquilibriumRestructuring


Introduction


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Segal-Whinston (AER, 2008)

Model of dynamic technological competition

- SW apply to antitrust practices

- SW consider entrants as competing and displacing incumbents -- on-going change

Here, modifications

- Remove static competition effects to focus on dynamics in

Schumpeterian, winner-take-all or for the market competition.

- Incorporate ideas markets

- Model dynamic capabilities (firms may not be long-lived)

14


Introduction


Conclusion


Introduction


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Firms & Innovations

Discrete time, infinite horizon with common discount factor,

Innovations are sequential- Innovation yields new product of higher quality than previous generation

Incumbent (I)

- There is a single producer of the new product who can earn per period monopolyrents,, until displaced.

Innovation leader

- For each product generation only one firm conducts R&D- Innovation leader drawn from pool of firms including the current incumbent

(ODonoghue, Scotchmer and Thisse, 1998)

- I can be the innovation leader and prolong incumbency

- Otherwise, label leader as entrant orE.

15


Introduction


Conclusion


Introduction


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Innovation Rate

16


Introduction


Conclusion


Introduction


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Innovation Rate

16

InnovationLeaderchosen


Introduction


Conclusion


Introduction


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Innovation Rate

16


E


Introduction


Conclusion


Introduction


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Innovation Rate

16


Choose

E[,1]E


Introduction


Conclusion


Introduction


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Innovation Rate

16


Choose

E[,1]E

I


Introduction


Conclusion


M d l S UIntroduction


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Innovation Rate

16


Choose

E[,1]

Choose

I [,1]

E

I


t oduct o


Conclusion


M d l S t UIntroduction


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Innovation Rate

16


Choose

E[,1]

Choose

I [,1]

No cost to R&D

E

I



Conclusion


M d l S t UIntroduction


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Innovation Rate

16


Choose

E[,1]

Choose

I [,1]

E= 1

No cost to R&D

E

I



Conclusion


Model Set UpIntroduction


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Innovation Rate

16


Choose

E[,1]

Choose

I [,1]

E= 1

I=

No cost to R&D

E

I



Conclusion




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Commercialisation Choices

17



Conclusion




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17

EntrantInnovates



Conclusion


Model Set-UpIntroduction


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17

EntrantInnovates

Competition



Conclusion




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17

EntrantInnovates

I loses

monopoly

profits

Competition



Conclusion



C i i


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17

EntrantInnovates

I loses

monopoly

profits

CompetitionE

becomes I

(earns )

Model Set UpEquilibriumRestructuring


Conclusion



C titi


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17

EntrantInnovates

I loses

monopoly

profits

Competition

Cooperation

E

becomes I

(earns )



Conclusion



C titi


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17

EntrantInnovates

I loses

monopoly

profits

Competition

Cooperation

E

becomes I

(earns )

Iretainsmonopolyprofits



Conclusion



Competition


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17

EntrantInnovates

I loses

monopoly

profits

Competition

Cooperation

E

becomes I

(earns )

Iretainsmonopolyprofits

EremainsE

(earns )

pEquilibriumRestructuring


Conclusion



Competition


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Dynamic Capabilities

18



Conclusion



Competition


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18

Prior Activity



Conclusion



Competition


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18

ProductionOnly

Prior Activity



Conclusion



Competition


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18

ProductionOnly

Prior Activity

InnovationOnly

EquilibriumRestructuring


Conclusion



Competition


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18

ProductionOnly

Prior Activity

InnovationOnly

Production &Innovation



Conclusion



Competition


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18

ProductionOnly

Prior Activity

InnovationOnly


Example



Conclusion


Model Set-UpE ilib i

IntroductionCompetition


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18

ProductionOnly

Prior Activity

InnovationOnly


Example

I not an

innovation leader



Conclusion





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18

ProductionOnly

Prior Activity

InnovationOnly


Example

I not an

innovation leader

E as innovation

leader


Co pet t oCooperation

Conclusion





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18

ProductionOnly

Prior Activity

InnovationOnly


Example

I not an

innovation leader

E as innovation

leader

Merger orI as

innovation leader


pCooperation

Conclusion





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18

ProductionOnly

Prior Activity

InnovationOnly


Example

I not an

innovation leader

E as innovation

leader

Merger orI as

innovation leader

Probability ofbecoming Leader


pCooperation

Conclusion


Model Set-UpEquilibrium



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18

ProductionOnly

Prior Activity

InnovationOnly


Example

I not an

innovation leader

E as innovation

leader

Merger orI as

innovation leader


p [0,1]


pCooperation

Conclusion





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18

ProductionOnly

Prior Activity

InnovationOnly


Example

I not an

innovation leader

E as innovation

leader

Merger orI as

innovation leader


p [0,1]

i[0,1]


CooperationConclusion





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18

ProductionOnly

Prior Activity

InnovationOnly


Example

I not an

innovation leader

E as innovation

leader

Merger orI as

innovation leader


p [0,1]

i[0,1]

ip max{

p,

i}







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Competition

19






C


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Competition

19

InnovationLeader






C i


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Competition

19

InnovationLeader

I






C ti


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Competition

19

I acquires innovation

and production

capabilities

InnovationLeader

CapabilitiesStage

I






C ti


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Competition

19


and production

capabilities

InnovationLeader

CapabilitiesStage

ResearchStage

I

Iearns and chooses

I in each period until

innovates

qRestructuring





Cooperation


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Competition

19


and production

capabilities

InnovationLeader

CapabilitiesStage

ResearchStage

I

Iearns and chooses


innovates

qRestructuring





Cooperation


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Competition

19


and production

capabilities

InnovationLeader

CapabilitiesStage

ResearchStage

I

E

Iearns and chooses


innovates

or

qRestructuring





Cooperation


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Competition

19


and production

capabilities

InnovationLeader

CapabilitiesStage

ResearchStage

I

E E acquires innovationcapability and Iacquires production

capability

Iearns and chooses


innovates

or

qRestructuring





Cooperation


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Competition

19


and production

capabilities

InnovationLeader

CapabilitiesStage

ResearchStage

I


capability

Iearns and chooses


innovates

Iearns and Echooses E in each

period until innovates

or

RestructuringCooperation

Conclusion




Cooperation


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Competition

19


and production

capabilities

InnovationLeader

CapabilitiesStage

ResearchStage

I


capability

Iearns and chooses


innovates


period until innovatesE replaces I

CompetitionStage

or


Conclusion




Cooperation


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Competition

19


and production

capabilities

InnovationLeader

CapabilitiesStage

ResearchStage

I


capability

Iearns and chooses


innovates


period until innovatesE replaces I

CompetitionStage

or


Conclusion


Model Set-UpEquilibriumR i


Cooperation


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Continuation Payoffs

20

VE= (1

E)V

E+

E( +

iV

I

i+ (1

i)V

I)

VI= (1

E)( + V

I) +

E

pV

E

VIi

= (1 I)( + VIi

) +I( +ipVIi

+ (1ip )VI)


Conclusion


Model Set-UpEquilibriumR i


Cooperation


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Incentives to Innovate

21


Conclusion


Model Set-UpEquilibriumR t t i


Cooperation


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21

E

Restructuringp

Conclusion


Model Set-UpEquilibriumR t t i


Cooperation


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21

+

iV

I

i+ (1

i)V

I V

EE

Restructuringp

Conclusion




Cooperation


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21

+

iV

I

i+ (1

i)V

I V

E

I

E

Restructuringp

Conclusion




Cooperation


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21

+

iV

I

i+ (1

i)V

I V

E

(1

ip)(V

I

iV

I)I

E

RestructuringConclusion




Cooperation


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21

+

iV

I

i+ (1

i)V

I V

E

(1

ip)(V

I

iV

I)I

E E= 1





Cooperation


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21

+

iV

I

i+ (1

i)V

I V

E

(1

ip)(V

I

iV

I)I

E E= 1

I=





CooperationC


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Markov perfect equilibrium

22

VE=

1

c

1 (1) + (i

ip)( )

VI =1

c 1 (1) + (i ip )( )

p

V

I

i=

1

c

1 2 1(1ip)

i( )p( )

c= 1 (1 ) (

ip+ ((1 (1

i) + (1

ip))

p)





CooperationC l i


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Restructuring & Spin-Outs

Would an incumbent innovation leader spin-out its innovating arm?

Not worthwhile if ...

23

VI

i VI +VE1(1ip ) i +p

... but spin-outs are always socially desirable asentrants innovate more than incumbents



LicensingRestructuringAcquisition


CooperationC l i


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Licensing

24


and production

capabilities

InnovationLeader

CapabilitiesStage

ResearchStage

I

EE

acquires innovationcapability and I

acquires production

capability

Iearns and chooses


innovates


period until innovates

or

AcquisitionConclusion




CooperationC l i


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Licensing

24


and production

capabilities

InnovationLeader

CapabilitiesStage

ResearchStage

I

EE

acquires innovationcapability and I

acquires production

capability

Iearns and chooses


innovates


period until innovatesEnegotiates with I

NegotiationStage

or

qConclusion






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Negotiations

25

+pV

I

i+ (1

p)V

I+ +

iV

E

Joint Payoff from Cooperation

pVE + +iVIi + (1i )VI

Joint Payoff from Competition

(

p

i) V

I

iV

EV

I( ) 0

qConclusion






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26

VE= (1

E)V

E+

E(+

iV

E)

VI= + (1

E)V

I+

E(+

pV

I

i )

VIi

= (1 I)( + VIi

) +I( +ipVIi

+ (1ip )VI)

qConclusion






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Markov Perfect Equilibrium

27

(p i ) 1 (1ip ) i p( ) 0

Licensing is the unique equilibrium outcome if ...

max

+

pV

I

i+ (1

p)V

I

pV

E( )1

+ iV

E ( +

iV

I

i+ (1

i)V

I)( )

E= 1

I=

qConclusion






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Licensing Equilibrium Outcomes

28

ip

ip

p

i

LicensingLicensing

Competition

CompetitionVI

iV

I+V

E

VI

i


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Licensing Equilibrium Outcomes

28

ip

ip

p

i

LicensingLicensing

Competition

CompetitionVI

iV

I+V

E

VI

i


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Intuition

29

VI

iV

I+V

EIf want an incumbent innovator

p>

i achieve that by keeping I as incumbent (Licensing)

p<

i achieve that by making E the incumbent (Competition)

VI

i

i achieve that by making E the incumbent (Competition)

p < i achieve that by keeping I as incumbent (Licensing)

But welfare maximised by always maximising chancefor entrant innovator

Conclusion


Licensing

RestructuringAcquisition




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Restructuring

30

ip

ip

p

i

Licensing

no gainsfrom trade

Restructuring

CompetitionVI

iV

I+V

E

VI

i


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Negotiations

31

+ipV

I

i+ (1

ip)V

I+




Conclusion


LicensingRestructuring

Acquisition




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Negotiations

31

+ipV

I

i+ (1

ip)V

I+




(

ip

i

)(VI

iV

I

) p

VE



Acquisition




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Negotiations

31

+ipV

I

i+ (1

ip)V

I+




(

ip

i

)(VI

iV

I

) p

VE

1

ip> 1

i

p



Acquisition




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Negotiations

31

+ipV

I

i+ (1

ip)V

I+




(

ip

i

)(VI

iV

I

) p

VE

1

ip> 1

i

p

implies positive externality onpotential entrants



Acquisition




80/93



32

VE= (1

E)V

E+

E

VI= + (1

E)V

I+

E(+

ipV

I

i )

VIi

= (1 I)( + VIi

) +I( +ipVIi

+ (1ip )VI)



Acquisition




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33



Acquisition




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33

E= 1

I=



Acquisition




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33

ip

i

p1 (1 )(1

ip)( ) 0

Acquisition is the unique equilibrium outcome if and only if ...

E= 1

I=



Acquisition




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33

ip

i

p1 (1 )(1

ip)( ) 0


E= 1

I=

Sufficient condition:



Acquisition




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33

ip

i

p1 (1 )(1

ip)( ) 0


E= 1

I=

ip

i+

pSufficient condition:



Acquisition




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Acquisition Equilibrium Outcomes

34

ip

ip

p

i

Acquisition

Competition

VI

iV

I+V

E

VI

i


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Welfare

Acquisition never socially desirable

Significant: commentators suggest that Schumpeterian

competition implies loose merger policy

Here: merger consolidates capabilities to become next leadinnovator in incumbents hands (removes entrant capabilities) --

with reduced innovation incentives.

Merger delays forces of creative destruction

35



Acquisition




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Licensing & Acquisition

36

ip

ip

p

i

Licg

Licensing

Competition

Compn

VI

iV

I+V

E

VI

i


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Extensions

R&D Costs

- Would change little but if rates of innovation the same, the incentive touse negotiations to increase likelihood of incumbent innovator isremoved.

Product market competition

- Increases (static) drivers for licensing

- Licensing involves additional welfare costs

Multiple innovators

- Incumbent still has lower incentives to innovate so conclusion unchanged

37


Extensions

Future Directions


Conclusion


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Future Directions

38


Extensions

Future Directions


Conclusion


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Future Directions

Endogenise capability acquisition

38


Extensions

Future Directions


Conclusion


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Future Directions


Impact of other anti-trust practices under licensing

38


Extensions

Future Directions


Conclusion


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Future Directions


Impact of other anti-trust practices under licensing

Richer space of strategic variables

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Negotiating for the Market

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