Slide 1 © Carliss Y. Baldwin and Kim B. Clark, 2004 Insights from Agency Theory into User...

Slide 1 © Carliss Y. Baldwin and Kim B. Clark, 2004

Insights from Agency Theory into User Innovation

Carliss Y. BaldwinHarvard Business School

LMU-MIT International Workshop on User Innovation and Open Source SoftwareMunich, Germany, EUJune 21, 2004


Institutions of Innovation—Agenda Goals of our research

– Derive “Institutions of Innovation” from the basic properties of designs

– Users are principals, designers are agents– What do the designs and the users need from the

economic system? Definitions and Basic properties of designs The Problem Domain Agency alternatives

– “Employment”– “Outsourcing”

Conclusions and next steps


First, some definitions/axioms


Designs

Instructions that turn knowledge into things Span all artifacts and human activities

– Tangible, intangible– Transacting, contracting, dispute resolution– Government

The wealth of an economy inheres in its designs


The Great Chain of Design and Production

Architecture Procurement

+ Design + Production Product

Use Users' Willingness to Pay

Competition + Price * Quantity

Market Structure – Cost

– Investment

"Free Cash Flow" Discount for Value

Time and Risk $$$

Rational Investment in New Products and Design Architectures

Finance lives here!Must value everything that is made, including designs

Designs are the start of everything that is made


Design Architecture

Small designs “just get done” by one person or a small team

Large designs require architecture– “The design of the design process”– Forward-looking, future oriented– Analogous to physical architectures

» Create and constrain” movement and search

Major social technology, but not much studied– In engineering or the social sciences


Innovations are NEW Designs

Ex ante: a problem = “the design problem”

Ex post: a solution = “the design”


Users are Principals

Users willingness to pay determines value of a new design


Designers are Agents

A designer may also be a user, But one user-designer can’t solve all

problems!–Remember Wedgwood!


Institutions of Innovation

Aoki => Institutions are equilibrium patterns of interaction

Function is to bring User-Principals and Designer-Agents into a voluntary, productive relationship– User-designers are excluded from this analysis

(will be dealt with later) Institutions are costly—in a free economy,

they must “pay for themsselves”


Our goal

Derive candidate institutions from basic properties of designs;

Compare institutions with different cost structures;

Predict which institutions will be seen in which problem domains


Basic Properties of Designs

Designs are– non-rival

»My use does not prevent yours

– ex ante uncertain;– ex post rankable by outcome; – ex post contingent; – have an architecture

»Modular/integral» indivisible at module level;

– costly


Basic Properties of Designs

Designs are– non-rival (non-exclusive use);– ex ante uncertain;– ex post rankable by outcome; – ex post contingent; – have an architecture

»Modular/integral» indivisible at module level;

– costly


The Problem DomainHypothetical Distribution of Problems

By Number of Users and Value per User

0

0

1

10

100

0 10 20 30 40 50 60 70 80 90 100

Number of Users with Problem, Nj

Value of Solution per User, Vj


Problems on the Same IsoquantHave the Same Total or Social Value

0.01

0.10

1.00

10.00

100.00

0 10 20 30 40 50 60 70 80 90 100



Isoquants in the Domain

Increasing Social Value


Two Agency Alternatives

User = Principal

Designers Specialized Firm

Designers

User employs Specialized Firm Designers employs Designers;

Sells solutions as Products


Coase Theorem—

Frictionless Economy No Transactions or Agency Costs ALL institutions (agency alternatives) are

equivalent

Assume Cost per Solution, C = 5


Under the Coase TheoremCoase Boundary on Problem Solving

Cost per Solution = 5

0

0

1

10

100

0 10 20 30 40 50 60 70 80 90 100



These Problems deserve to be solved

These Problems aren't worth solving!


First thought experiment—Robinson Crusoe

Every user hires designers Cost of hiring = .2*C

– Includes search, mundane, and opportunistic transaction costs


Employment by Robinson Crusoe Users

Robinson Crusoe Problem SolvingCost per Solution, C = 5; Users' Hiring Cost = .2*C

0

0

1

10

100

0 10 20 30 40 50 60 70 80 90 100



These Problems "deserve" to be solved, but won't be—Institutional Opportunity

These Problems aren't worth solving!

These Problems will be solved redundantly


Second thought experiment—Specialist Manufacturers

Upstream Mfrs offer solutions to some problems

Cannot charge more than Users would pay under the alternative employment scenario

Mfrs have costs:– Variable cost per transaction = .2*C– Fixed cost for setup and data = 15*C


Upstream Manufacturers will efficiently solve some problems

Users and Upstream Manufacturers(One Type)

0

0

1

10

100

0 10 20 30 40 50 60 70 80 90 100



Not worth solving!

Solved by Mfrs (efficiently given T-costs)

Solvedredun-dantly

Not solved, institutional opportunity


Third thought experiment—Two Types of Manufacturer

Blue Type has costs (as before):–Variable cost per transaction = .2*C–Fixed cost for setup and data = 15*C

Green Type has lower variable and higher fixed costs–Variable cost per transaction = .01*C–Fixed cost for setup and data = 90*C


Two Mfrs with Different Cost Structures

Two Mfrs with Different Cost StructuresBlue= High Variable; Green= High Fixed

0

0

1

10

100

0 10 20 30 40 50 60 70 80 90 100



Not worth solving!

Solved by Blue (efficiently given T-costs)

Solvedredundantly


Green can Compete


New ScaleTwo Mfrs with Different Cost Structures

Cost per Solution = 5

0

0

1

10

100

0 100 200 300 400 500 600 700 800 900 1000



Not worth it

Solved by Blue or GreenWhich will dominate?


BLUE

Green

USERS


Thank you!

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