Why companies need inventors, not just their ideas

Why companies need inventors, not just their ideas

By Peter Gwynne May 13, 2013

Peter Gwynne is a former science editor of Newsweek and a freelance writer who covers science, technology and business.

According to an early and frequently quoted aerodynamic model, bumblebees cannot possibly fly. Of course, any entomologist or gardener knows that the fuzzy insects make it into the air with great success; the model simply had it wrong.

As with bees, so it is with business. Researchers have long held the conceit that innovative entrepreneurship is impossible. “They assert that ‘entrepreneurs can’t do anything new in the economy,’” says Daniel Spulber, a professor of management and strategy at the Kellogg School.

This is because established firms have several advantages when it comes to taking inventions to the market. “They have all kinds of assets that are complementary to innovation,” Spulber says, including established corporate structures, marketing channels, an existing customer base, and access to capital. To go it alone, on the other hand, the inventor must undertake the cumbersome effort of setting up a new firm and dealing with the uncertainty that any new invention faces in the market. Even Joseph Schumpeter, perhaps the greatest advocate of entrepreneurs, suggested in his classic book Capitalism, Socialism, and Democracy that only large companies have the resources and market power necessary for innovation.“Yet we see innovative entrepreneurs all the time—Larry Page and Sergey Brin at Google, Pierre Omidyar at eBay, Mark Zuckerberg at Facebook, and Jeff Bezos setting up Amazon.com,” Spulber points out. Plainly, then, the negative view of entrepreneurship’s contributions to the economy has as little credibility as early bumblebee aerodynamics. “So if you have a great idea that would result in an innovation in the marketplace—why not just transfer it to an existing firm?” Spulber asks rhetorically. One reason may be tacit knowledge: the fundamental understanding that inventors possess about their own creations.

The Entrepreneurial Advantage
As part of a broad project to discover why we need innovative entrepreneurs, Spulber applied game theory to model the economic importance of tacit knowledge. Such know-how “is difficult to transfer to others,” he says. “I conclude that tacit knowledge can be an explanation for why inventors become entrepreneurs.” Just as composers can often conduct their own works with more authority than professional conductors, entrepreneurial inventors can translate their own findings into marketable products more effectively than established organizations that buy or license the rights to the findings.

“The main idea is that the inventor and the existing firm have to choose to compete or cooperate,” Spulber explains of his model. In the first of three stages, “inventors invest in R&D and produce an invention. Existing firms may themselves invest in invention, but they also invest in capacity to absorb the inventions of others.” In the second stage, he continues, “inventors decide whether they want to share that invention through licensing or sale of patents. Existing firms have to decide whether they want to stick with what they’ve got or buy ideas from others.” In the third stage, collaboration or competition commences. The model attempts to specify how much inventors will invest in developing their tacit knowledge and how much existing firms will invest in absorbing the knowledge of others.

“The inventor’s tacit knowledge is important because it can overcome the competitive advantages in technology implementation that existing firms derive from complementary assets,” Spulber writes. That is, the difficulty of transferring tacit knowledge puts the existing firm at a disadvantage, and however effective the transfer, existing firms cannot possibly know as much as the inventors about their inventions.

And there are other benefits to an innovative entrepreneur. Says Spulber, “having entrepreneurship available means that inventors will invest more in developing inventions, because they may be able to develop them themselves.” He continues, “This persuades them to invest more in the entire effort of inventing. It is the payoff from more original invention.”

In addition, innovative entrepreneurship tends to result in greater returns on increasing R&D investments. This is because the innovative entrepreneur must cut prices to compete with existing firms, thus driving up sales. Greater sales then lead to greater returns from improved products and more efficient production processes.

Finally, Spulber’s research indicates that the character of any particular invention determines the route it takes to the market. “If you have a very high-quality invention”—that is, one with great market potential—“and the associated tacit knowledge is very difficult to transfer, you’re more likely to become an entrepreneur,” he explains. “Lower-quality inventions are more likely to be transferred for a given amount of tacit knowledge.” The development of online book sales, for instance, exemplifies a high-quality invention. “Jeff Bezos must have contemplated the possibility of working with traditional booksellers Barnes & Noble or Borders,” Spulber speculates. “But he struck out on his own and created Amazon.com.”

Implications for Public Policy and Management
Spulber, who is completing The Innovative Entrepreneur, a book slated for publication next year, notes that his work has public policy implications. “The important purpose of patent systems is to provide inventors with the right to exclude access to their invention in return for asking the inventor to disclose details to others,” he says. “Recognizing the tacit knowledge of the inventor indicates that patents don’t contain everything. That fact makes patents even more important. By protecting inventors’ intellectual property, we want to encourage them not only to disclose their knowledge in the patent but also to commercialize their invention and hence share their tacit knowledge, or apply it through entrepreneurship. Entrepreneurs benefit from patent protection.”

Corporate executives should also take note. Spulber refers to Shuji Nakamura, the engineer who invented blue, green, and white light-emitting diodes (LEDs) and the blue laser. Nichia Corporation, the small Japanese company that employed him, gave him very little help. “Nakamura purchased the machine needed to manufacture the LEDs, took it apart, and reconfigured it until he made it do what he wanted it to do,” Spulber points out. “He achieved what many others with more funding and personnel were unable to do. The information he published—even though his company did not want him to—had a lot of value. But his effort must have involved a lot of tacit knowledge known to him alone.”

Then, after Nichia gave him a bonus of just $180 for his invention, Nakamura not only sued the firm, eventually settling on a $9 million payment; he also decamped to the University of California, Santa Barbara. “Tacit knowledge can be quite important to corporations,” Spulber observes, “as this ‘asset’ has legs.”

That example carries a message for companies that encourage ‘intrapreneurship’—entrepreneurial behavior within the corporate environment. “Companies need to understand that just having access to products invented by their employees is not the whole story,” he says. “Talented employees have plenty of knowledge in addition to the inventions they make available to their employers. Employers should consider involving those employees in the process of developing their inventions rather than just taking the inventions and running with them.”

Reproduced with permission of the Kellogg School of Management and Kellogg Insight. © Kellogg School of Management at Northwestern University.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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