The Industrial User As Product Innovator: Markets, Hierarchies and Patterns of User-Initiated Innovation

Gordon R. Foxall, University of Strathclyde
ABSTRACT - User-initiated product innovation occurs when a firm that has invented a novel device first invests in its internal application as a process innovation and second seeks returns from its general marketing. Three modes of user-initiated product innovation and users' roles in them are distinguished and three explanations of the functional locus of innovation are examined in order to understand better the observed pattern of user-initiated product innovation: the appropriability of benefit, appropriability regimes, and transaction costs theories.
[ to cite ]:
Gordon R. Foxall (1988) ,"The Industrial User As Product Innovator: Markets, Hierarchies and Patterns of User-Initiated Innovation", in NA - Advances in Consumer Research Volume 15, eds. Micheal J. Houston, Provo, UT : Association for Consumer Research, Pages: 286-291.

Advances in Consumer Research Volume 15, 1988      Pages 286-291

THE INDUSTRIAL USER AS PRODUCT INNOVATOR: MARKETS, HIERARCHIES AND PATTERNS OF USER-INITIATED INNOVATION

Gordon R. Foxall, University of Strathclyde

[The empirical research was grant-aided by the Economic and Social Research Council, London.]

ABSTRACT -

User-initiated product innovation occurs when a firm that has invented a novel device first invests in its internal application as a process innovation and second seeks returns from its general marketing. Three modes of user-initiated product innovation and users' roles in them are distinguished and three explanations of the functional locus of innovation are examined in order to understand better the observed pattern of user-initiated product innovation: the appropriability of benefit, appropriability regimes, and transaction costs theories.

INTRODUCTION

The sensitivity of producers of new products to the detailed requirements and behaviors of their potential customers is a crucial determinant of the effective marketing of innovations and their rapid, extensive diffusion. In user-initiated product innovation, the potential for such close understanding is immense. The term refers to a firm's exploitation of an internally-invented device by (a) investing in its application as a process innovation within that firm's own productive system, and (b) benefiting additionally from its marketing and diffusion as a product innovation. In the first phase,.user-initiated process innovation, the firm gains from the enhancement of its output as a result of the improvement of its production methods; in the second, user-initiated product innovation (which is not an automatic progression), from the fees or royalties accruing from leasing or licensing its technological know-how, or the profits deriving from the direct marketing of the new product. Based on detailed case histories of user-initiated innovation at the Warton Unit of British Aerospace (BAe) in Lancashire, England, this paper describes several styles of user involvement in innovation and examines critically theories which elucidate the functional locus of innovation.

The paper relies on precise definitions of process and product innovation, and of user-initiated innovation itself. Process innovation involves the application of capital equipment that is installed by an industrial producer as part of his productive capacity and from which he expects to gain commercially via the economic and/or technical improvement of his output. Product innovation occurs when a new good or service is sold in a consumer or industrial market, from which the supplier gains commercially through increased profits or sales revenues. It follows that the same item can be both a process innovation and a product innovation at different times. User-initiated innovation is a feature of firms rather than households or individual final consumers since it involves at some stage the user-initiator's investment in his invention, i.e. as a capital or producer good which is intended to enhance the efficiency of his operations. Final consumers sometimes suggest new product ideas, e.g. the 'Chopper' bike, but this docs not constitute user-initiated innovation as the term is understood here.

USER-INITIATED INNOVATION

Industrial firms perform dual roles in the course of their business: they are not only suppliers of products and services but also customers for the products and services of other firms. Accounts of industrial product innovation have traditionally emphasized the role of the producer, to whom they attribute responsibility for the entire procedure - from idea generation and market exploration, through product development and testing, to commercialization and post-launch management. A decade ago, von Hippel (1978) contrasted this prevailing view of industrial innovation, the manufacturer-active paradigm (MAP), with situations in which users initiate new product development. The customer-active paradigm $AP) describes situations in which user-firms develop their own ideas, designs or prototype innovations (usually when their usual suppliers cannot quickly provide solutions to urgent technical problems) and subsequently approach a manufacturer with a request to produce and supply the device on a regular basis. The manufacturer may, having explored the market and further developed the innovation, produce and market it for users in general (von Hippel 1978).

In both MAP and CAP, it is the manufacturer who acts entrepreneurially with respect to product innovation. The CAP makes clear that the manufacturer, not the user, is alert to the gains to be made from marketing the innovation widely. The user-initiator of the device fulfills the roles of inventor and process innovator; his main concern is to find a manufacturer who can guarantee reliable supplies and, although the user may receive some royalties or fees, he is not concerned to benefit maximally from the marketing and diffusion of his novel device as a product. But the CAP does not describe the full range of user involvement in industrial new product development. There are instances in which users seek entrepreneurially to benefit as fully as possible from the wider exploitation of their process innovations as products by performing some or all of the functions involved in the later stages of NPD that are ascribed in both MAP and CAP to manufacturers. A third paradigm (Foxall 1986) acknowledges that some user-initiators go on to test and develop the innovation in order to enhance its attractiveness to prospective buyers; some engage in market exploration and research in order to strengthen their bargaining positions vis-a- vis the manufacturer who will eventually produce and distribute the new product; and some assume the entire burden of NPD functions from the idea generation to commercialization and beyond. Such user-initiators are no longer indifferent to the general marketing of the invention and the commercial gains available from its diffusion, but actively engaged in benefiting as fully as possible.

To explore the nature and scope of this third pattern of industrial NPD, detailed case histories have been compiled of user-initiated product innovation in five firms. The following discussion is based on two of these since they provide an overview of the entire scope of user-initiated innovation in a single organization and illustrate the strategic development of a major industrial company's role as both process and product innovator. The cases concern (i) the operations of the Business Development Group at BAe, Warton; and (ii) the development of control software for flexible manufacturing systems (FMS) by BAe in joint venture with the U.K. General Electric Company (GEC).

BAe, Warton relies heavily on its expertise in the economical deployment of advanced manufacturing techniques (AMT). Its engineers often collaborate with external firms to design, develop or produce process innovations. Such collaboration resulted on occasion in the intellectual property rights to the jointly-produced innovations being secured by the external partner: Warton obtained continued supplies of the device, but the co-developers received commercial benefit of its general marketing. Therefore, Warton established a business Development Group (BDG) to protect its property rights in order to benefit directly from its commercial diffusion.

BDG identifies internally generated and applied innovations with commercial potential, and locates firms that can co-develop, manufacture and market the resulting products. It assesses market demand in conjunction with the personnel responsible for the invention and its process innovation, noting the device's unique qualities and user benefits in order to conclude a profitable licensing agreement with an external manufacturer. BDG then negotiates, monitors and polices the licensing of the innovation.

TABLE 1

USER-INITIATED INNOVATION

Research led to a tripartite classification of manufacturer-user interactions in industrial innovation: manufacturer-initiated innovation (MII) in which the manufacturer is responsible for the entire NPD process and which broadly corresponds to the MAP; user-initiated process innovation; and user-initiated product innovation. It uncovered three forms of the last of these: (i) that in which the user is largely passive and having invented the innovation brings it to the attention of a manufacturer but yields the initiative for its commercial exploitation as a product innovation (broadly the CAP); (ii) that in which the user seeks entrepreneurially to gain from the commercialization of his process innovation as a product, trying to gain maximally from its marketing by licensing it profitably to a firm that undertakes its manufacture and distribution; and (iii) that in which the user carries out all of the tasks involved in the new product development process: having invented and internally applied the innovation, going on to produce and market it. Explanation was sought why user-initiators choose specific modes of user-initiated product innovation. The following section discusses three potential sources of understanding of the functional locus of innovation and analyses the typical examples summarized in Table 1 in terms of their concepts and explanations. The three explanations are summarized in Table 2.

EXPLANATIONS

Appropriability of benefit (AB): Von Hippel (1982) predicts the functional locus of innovation based on the differential ability of manufacturers and users to benefit from sales of output-embodied innovation knowledge. There is only a remote chance of innovators benefiting from non-embodied innovation knowledge (i.e. as licensed information rather than products or processes): patents afford little protection because obtaining redress is costly and slow, and competitors can 'invent around' the patents; nor do trade secrets ("knowhow") provide protection for long: other firms may independently discover the technology, obtain it by accidental disclosure or reverse engineering'. The alternative is to gain from output-embodied knowledge, its use as a process or product component, and the consequent enhancement of output. The innovator s ability to benefit from output-embodied knowledge requires setting up a quasi-monopoly, either at the industry level so that competitors share his knowledge but he (as possessor of dominant market share) benefits; most; or at the firm level so that the innovator alone benefits;. The former is probable when industry members are protected by entry barriers; the latter when the innovator can benefit through patenting, know-how, or (more usually) the long time period required by an imitator to market a similar product or apply a similar process . During such 'response time', the innovator enjoys a temporary quasi-monopoly and gains from increased profit margins or market share.

TABLE 2

COMPARISON OF EXPLANATIONS

Based on limited examples, von Hippel concludes that, in all but one circumstance, it will be the user who benefits;, for he can maintain the secrecy of innovation by using it in his factory without revealing it to competitors. The exception occurs when a manufacturer of process machinery establishes a quasi-monopoly based on improved methods of construction and expects; to produce and sell enough machines to achieve substantial experience economies.

Regime of Appropriability (AR): Teece (1986) asks why the economic returns to technological innovation may accrue not to the innovator but to an imitator. He argues that (i) the strength of the 'regime of appropriability' surrounding the industry, (ii) the stage of development of industrial dominant designs, and (iii) the availability of complementary assets, determine whether the innovator or a competitor gains. 'A regime of appropriability refers to the environmental factors, excluding firm and market structures, that govern an innovator's ability to capture the profits generated by an innovation'(p.287). Its precise nature depends on the technology involved and the extent to which legal measures protect the innovator's intellectual property. At the preparadigmatic stage of the development of an industry (before a generally accepted product design has emerged) the innovator risks investing heavily only to find that imitators benefit by establishing the industry standard (Abernathy and Utterback 1978). Once the dominant product design is established, however, the profitable commercialization of a core innovation technology depends on the use of complementary assets such as marketing and after-sales service that are essential to the exploitation of the core technology which the innovation uses. The more specialized these complementary assets are to the core technology, the greater will be the need for the innovator to control them.

Tight appropriability regimes occur only on rare occasions when patents or trade secrets preclude imitation. If production depends upon specialized assets, the innovator should integrate manufacture and distribution in order to avoid their loss as a result of a partner's possible withdrawal from the contractual agreement. During the paradigmatic stage, effective manufacture and marketing depend on economies of scale, the core technology becomes increasingly imitable, and commercial exploitation of the benefits of the innovation requires control and skillful management of specialized complementary assets such as implementation and use knowledge.

Transaction Costs (TC): Transactions cost analysis is concerned to ascertain the governance structures appropriate to the planning, completion and monitoring of productive tasks. It rests upon two behavioral assumptions: (i) the bounded rationality of decision-making arising from uncertainty, and (ii) the opportunistic behavior of one or other transacting party, specifically when small numbers of competing sellers make it advantageous to be first to market ('nontrivial first mover advantages'). The internalization of transactions which would otherwise occur in the marketplace is justified and impelled by increases in transactions costs deriving from (l) uncertainty, (2) the frequency of transactions, and (3) the transaction-specificity of assets. The impetus to internalize decisions, substituting 'hierarchical, intra-firm control based on sequential, adaptive decision-making' for market exchange based on 'contingent claims contractual bargaining' (in jargon-free terms, to make rather than buy) is predicted to increase directly with these three factors (Williamson 1975, 1981). Once the costs associated with these factors reach a certain level, vertical integration provides a more economical governance structure than market transacting by its provision of incentives and controls, and the facilitation of organizational information processing.

Transactions cost reasoning applied to industrial innovation must acknowledge (i) the complexity of technological innovations which is predicted to increase directly the complexity of the organizational structure in which it is developed and produced, and (ii) the possibility of intermediate forms of integration for the development of particular novel technologies (Globerman 1980). For market contracting to occur it must be possible to specify the market's technical requirements, and the number of suppliers of the technology must be relatively large. Contingent contracting is the apt governance structure in this case because the costs it imposes are lower than the potential costs of administering integrated organization. But when the development of technology is exploratory and few firms can supply it, first mover advantages make opportunism more likely; integrated R&D/development/production/ marketing becomes more probable. Often quasi-vertical integration is sufficient to ensure that divulgence of information by one party to the development/bargaining process will not allow the other to independently produce the technology.

Integration is also more probable, the more discontinuous and complex the technology under development. Hence competitive bidding is the most probable governance structure when precise specification of the required performance and features of the technology is possible; when such specificity is less easy, quasi-integrated contracting is probable; and when breakthrough technology which serves a particular user's needs is under development, the probable governance structure will impose a degree of hierarchy or ownership-based integration, quasi or full.

ANALYSIS

The purpose of the analysis is to understand better the observed patterns- of user-initiated innovation using the concepts and general predictions of the three explanations (Table 3).

User-Initiated Process Innovation (UII1)

BAe cannot benefit from non-embodied innovation knowledge (AB): there is no market for the final product (because of technical drawbacks in use) and thus none for the licensed know-how. The user alone can benefit by applying the innovation in his own production system. Patents grant little if any protection and are in any case irrelevant given lack of external demand. The AR approach does not lead to clearcut predictions. In the absence of a market, the user alone stands to benefit and there is no question of an imitator gaining advantage. Both asset specificity and uncertainty (TC) are high. The governance structure is predictably vertical integration since no question of external transacting has arisen.

Passive User-Initiated Product Innovation (UII2)

The cutting tool was open to reverse-engineering and capable of only minimal patent protection. But there is a response time advantage for the first firm to market based on the period needed by imitators to respond and large potential demand. AB reasoning suggests that this is likely to be the manufacturer rather than the user: the former has existing productive capacity and marketing expertise and can achieve significant experience economies more quickly than the user (otherwise the user would not have sought quasi-vertical integration at all.)

TABLE 3

SUMMARY OF UII EXAMPLES

The manufacturer is likely to control complementary assets (AR) on which the commercial exploitation of the core technology depends. Specific knowledge about the use value of the innovation gained during its development is equally available to user and manufacturer but the latter has general marketing expertise and distribution skills. The lack of competitive supply and the nontrivial first mover advantages predict opportunism on the part of the manufacturer (TC). The user provided the codeveloper sufficient information to make himself superfluous. The dynamic continuity of the innovation, the moderately high asset specificity involved in developing it, and the large market which motivated the user-initiator to seek quasi-vertical integration equally made the manufacturer's opportunism probable.

Active User-Initiated Product Innovation (UII3).

The AB approach neither predicts nor explains this mode. It suggests that to benefit from the leasing-out of technological knowledge is rare. The innovator cannot protect his non-embodied knowledge by patenting or trade secrets. Moreover, the user-initiator is forced to reveal his technical (and market) knowledge. Yet, contrary to the AB prediction, UII3 is a reality.

The concept of complementary assets (AR) is a useful key, however, to understanding the user's different role and experience in UII3 compared with UII2. The user in UII3 develops a quasi-vertically integrated relationship with the manufacturer by exploiting the information he uniquely possesses about the implementation and productive application of his process innovation. When the product is launched by the manufacturer, the user understands better than any other firm can the problems and potential of investing in the new technology. The manufacturer, who requires maximal response time advantages in the product market, also relies on this information as a complementary asset to assist his marketing of the core technology. The user can prevent the opportunism of the manufacturer by controlling the release of this complementary asset (TC/AR); sustained quasi-vertical integration is attractive to the manufacturer as well as the user. The user, as a representative of the market in general, acts as a lead-user (von Hippel 1986), providing insights into market needs. The user enjoys a response lime advantage not predicted by the AB theory and benefits from the exploitation of non-embodied innovation knowledge. The manufacturer is not opportunistic despite the high asset specificity, technological uncertainty, small numbers and nontrivial first mover advantages, all of which lead to the accurate (TC) prediction of an intermediate degree of integrated control.

Vertically-Integrated User-Initiated Product Innovation (UII4)

The AB theory is not well-equipped to predict the situation in which a user becomes manufacturer and marketer of his own invention, but some aspects of its reasoning are relevant. BAe and GEC established a quasimonopoly at the level of two horizontally integrated firms based on the response time required by imitators. This in turn stems from the implementation and use knowledge which they uniquely share. But the AB approach deals in distinct roles of user and manufacturer and is not applicable to this situation in which a hybrid appears. The AR stress on complementary assets is again valuable. The hypothesized tendency to full vertical integration when firms seek to establish a dominant product design is also accurate. (At least the subset of the industry which sought to obtain the FMS control software even before it was commercially available was willing to accept the BAe/GEC product as fulfilling the industry standard). Having developed the basic software, the two firms marketed it separately on the basis of individual expertise in applying it, strengthening the vertically integrated frameworks in which subsequent products were produced and marketed. This tendency to vertical integration is also predictable on TC reasoning: technical and market uncertainty was high because of the discontinuity of the software under development. Asset specificity was very high notably with respect to the human resources involved, and there were enormous first mover advantages, which suggested opportunism on the part of any external manufacturer/marketer would be large.

CONCLUSION

Several patterns of user-manufacturer involvement in industrial innovation, from the entirely manufacturer-dominated (MII) to the entirely user-dominated (UII4) have been identified. The res arch extends the MAP/CAP dichotomy and necessitates reexamination of the roles traditionally ascribed to users and manufacturers. The observed patterns of user-initiated innovation transcend not only the user's assumed role in the MAP but also the CAP assumption that the customer is an inventive user rather than a product innovator.

Elements of all three explanations are needed to account for the spectrum of user-initiated innovation presented. While TC analysis offers the most general understanding, its insightful behavioral assumptions and powerful explicatory concepts can still be supplemented usefully by certain AB and AR concepts. The notions of response time and complementary assets are particularly explicit in clarifying the quasi-vertical integration attempted in UII2, achieved in UII3, and the managerial behaviors of user and manufacturer. An important consideration that is beyond the scope of the present study is the problem of marketing new technological products to direct competitors who may suspect the motives of the rival-vendor (Foxall, in press). BAe's customers are not necessarily competitors - the products are in demand in industries far removed from aviation/aerospace - and even direct rivals cannot reject the possible competitive advantages of adopting a technological innovation simply because it is offered by a competitor. This is one of several themes for further research. In the meantime, the analysis begun in this paper confirms the need for studies of industrial diffusion based on novel explanations of discontinuous high technology innovations in competitive contexts (Robertson and Gatignon 1986).

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