In general terms the innovation process can be understood to involve the sustainable generation, distribution and utilization of new economically-relevant knowledge which continuously accumulates and is recombined in the economy (David & Foray, 1995). The generation of variety is the engine of this evolutionary process and it is recognized to pay clear dividends in economic development.
Saviotti (1991) emphasizes the role of variety, suggesting that the increased net variety of goods and services may be more than a result of the evolution of the economic system; it may be considered a key aspect, closely complementing increased productivity efficiency. Trend growth in variety is associated with a build-up of complementary skills as well as new techniques; it is ultimately associated with changes in the competition landscape in the direction of greater choice and lower prices.
2.1. Heterogeneity and industrial evolution
The question of heterogeneity is central to the key question of how industries evolve. A persistent degree of heterogeneity of organizations is assumed to be desirable in terms of the knowledge-bases, the productive behaviour, and the organization of firms. Together such factors help to promote industrial evolution. Indeed, a variety of social science subpopulations have increasingly studied the contribution of variety in organizations and the economy as a whole. A body of more sociologically rooted work has notably grown up to study different aspects of the population ecology of organizations (e.g. Hannan and Freeman, 1977; Carroll, 1985).
Marshall’s early assertion that, “the tendency to variation is a chief cause of progress” (Marshall, 8th edition, 1922), has attracted renewed interest in economics.40 Such study has especially had emerged in the Schumpeterian tradition, as the emergence of ‘new combinations’ which are crucial to Schumpeter’s story of economic development may be directly linked to the tendency towards heterogeneity. And interest in this fundamental level of industrial dynamics has indeed evolved along a Schumpeterian vein of inquiry into a variety of areas. These include the sectoral composition of the economy, industrial demography and population ecology, stability of firm-size distributions, persistence differences between organizations and of asymmetric firm-performance, etc.41
Such efforts to understand industrial evolution in this sense have at a fundamental level been inspired by evolutionary biology. One central link has been recognized (Melcalfe, 1998; Sloth Andersen. 2004) between the extent and effect of changing firms in industrial evolution and the Fisher theorem of natural selection, especially in Price’s formalized approach. This link about the mechanism of change provides insight into the basic role of heterogeneity in industrial evolution and its link to innovation. According to Sloth Andersen, the Fisher theorem links the pace of evolutionary change directly to variance in the behaviour of a population, where Fisher, “treats selection in terms of what has later been called replicator dynamics or distance-from-mean dynamics.” (Andersen, 1994: 4) Price subsequently (e.g. 1972 and onwards) developed a formalized approach based on measures to trace changes in such population characteristics. The Price equation uses the divergence from the mean in such metrics to partition populations and to trace changes. The equation can be linked to the simple models of Nelson & Winner and in the further efforts to isolate the ‘selection effects’ from ‘innovation effects’ as argued by Andersen (1994).
During the past couple decades this inquiry has improved what is known about the heterogeneity of firms and its implications for different knowledge, competences and learning processes.
40 Marshall (1922, 1966) Economic Principles. Cited in Cohen, W.M. and Franco Malerba (2001).
41 See Malerba (2006) for an overview of this legacy and the field.
48
Industrial evolution involves transformation in underlying knowledge-bases, in technologies, in actors and actor competences, in organization and relationships (e.g. with users), in products and processes, and in institutions. In this setting, the technological regime literature operates on the assumption that the potential for knowledge growth is conditioned by technological specificities (different technologies have different potentials) and by sector characteristics (the technological environment and the dimensions of demand constrain or otherwise shape development paths).
Different technologies have different problem-sets associated with them, and solving these tend to define the ‘routines’ of the firms in the field. (e.g. Orsenigo et al, 1996; Malerba et al, 2002)
This view emphasizes the importance of interdependencies and complementarities in the economy.
The premise is that industrial evolution can be more or less limited by the interaction between knowledge bases, the regime context (including appropriability conditions), and by demand. This dependence on complementarities requires a sufficient heterogeneity in the economy to perpetuate industrial evolution. The concern is getting the creative destructive process to become a ‘creative accumulation’ process (Schumpeter Mode II cf. Pavitt). The concern is to avoid technological mono-cultures which threaten to reduce the learning dividends of a dynamic system.
2.2. Heterogeneity and the firm
42But what are the mechanisms at the firm-level that spur diversification of their activity within a country? Firm level innovation processes are recognized to be shaped by an interaction between factors internal to the firm, such as strategy, physical resources and capabilities, and factors outside its boundaries. Diversity in the contextual aspects for example makes inter-country comparisons difficult (Smith, 2001). A major element of the external factors is the institutional conditions which enable and which restrict certain activities: such factors shape the way firms manage their resources.
In general, the process of differentiation stems from enterprises attempt to distinguish what they sell from rivals in markets that are less than perfect. Schumpeter’s emphasis on “technological competition” (Schumpeter, 1942; 1975) indicates that firms develop products and/or services that are new and stand out next to those of rivals: firms develop new processes and new techniques that improve the quality of what they sell: or firms explore new channels of distribution or new ways to influence consumer demand. Instead of focusing purely on efficiency, firms may take risks by investing in distinct and new product/process/service that, if successful, will allow them to charge more for what they sell without direct threat of competition.43
42 This section is based on Iversen (2003)
43 In this setting, risk-taking agents compete through an expensive search process to commercialize new technologies on unsaturated markets with correspondingly high profit-margins.
Of course, many markets tend to blend the cost component, the technological component and the taste component. The importance ascribed to each will differ not only according to the main type of market (commodity, product or service) but also, to a certain degree, according to the maturity of the relevant product or service market. Mature markets characterized by little innovation will tend to behave more like commodity markets in which rivals compete principally on price (i.e. price-oriented competition), while the innovative aspect will be more important in emerging markets (technology-oriented competition).
Notwithstanding, three modes of competition can be distinguished. In competitive markets, firms can attract buyers by making what they sell:
• Distinct in terms of price
• Distinct in terms of technological performance
• Distinct in the eyes of the consumer
• Distinct in a variety of ways that overlap the above categories.
In instrumental terms, competitive position depends on the firm’s internal capabilities related to purchasing, finance, production, conducting R&D, marketing, distribution, sales and other functions important to its business. Organizational elements are also important, not least the firm’s competitive strategy. Internal capabilities are necessary but not sufficient to establish and defend a firm’s competitive position. Since competition is essentially a relational phenomenon, there will necessarily be factors outside the firm that will condition its position. Two general types of external factors can be distinguished. First, there are general aspects about the firm’s competitive environment that are important and to which it has to be attuned and responsive. These are aspects that confront the firm but which are difficult to observe. They include aspects of market-structure both on the supply and demand side, aspects such as the dynamics of demand, cost conditions, the existence of economies of scale, the size of capital requirements, etc. A second set of external factors involves potential links the firm can develop with its surroundings. One important element is the role that access to public infrastructure and aspects of the regulatory framework play in shaping the competitive environment. The availability and quality of the ‘economic infrastructure’, regulatory conditions and climate, and the nature and extent of institutional support are some of the external factors that are important (Guerrieri and Tylecote, 1994). Together internal and external factors contribute to the balancing of generation, selection, and accumulation processes of new knowledge.
2.3. Heterogeneity and Institutions
The role of institutions is important here, not least in relation to small firms whose limited resources might nip innovative activities in the bud (c.f. Johnson, 1988). In general, it can be said that institutions hold three basic functions in relation to innovation. They can reduce uncertainty by
50
providing information, they can help to manage conflicts and they can provide incentives for example to promote R&D investment (Edquist and Johnson, 1997). In general, IPRs have a role to play in this
‘economic infrastructure’ in organizing knowledge production, in promoting new R&D, in promoting further utilization as well as coordinating use of new knowledge, while avoiding underutilization losses. 44
At the firm level, the assumption is that IPRs can augment the position of a firm by helping it to protect the distinctiveness of its products and/or services both in terms of the underlying technological originality— notably through patents and utility models—and in terms of their distinctiveness in the eyes of the customer —notably through trademarks and industrial designs. The use of relevant types of IP-protection can potentially aid the competitive position of the firm by affording it the room to cultivate its distinct qualities without threat from direct competition from imitations. This suggests that IPRs may play important roles in managing IP in cases of technological competition. In terms of the economy as a whole, the way IPRs do this implies both costs and benefits for different actors. On the one hand, IPR-protection brings with it social costs in the form of higher prices (monopoly pricing): on the other, IPRs provide the economy with an incentive to innovate (based exactly on the prospects for the innovative firm for monopoly pricing). The monopoly profits provided by IPRs may have the added advantage for the economy as a whole if it is ploughed back into higher levels of production and innovation.