Global innovation and economic value

India Studies in Business and Economics Vijay Kumar R.P. Sundarraj Global Innovation and Economic Value India Studies in Business and Economics The Indian economy is considered to be one of the fastest growing economies of the world with India amongst the most important G-20 economies Ever since the Indian economy made its presence felt on the global platform, the research community is now even more interested in studying and analyzing what India has to offer This series aims to bring forth the latest studies and research about India from the areas of economics, business, and management science The titles featured in this series will present rigorous empirical research, often accompanied by policy recommendations, evoke and evaluate various aspects of the economy and the business and management landscape in India, with a special focus on India’s relationship with the world in terms of business and trade More information about this series at http://www.springer.com/series/11234 Vijay Kumar R.P Sundarraj • Global Innovation and Economic Value 123 Vijay Kumar Faculty of Management Studies PES University Bengaluru India R.P Sundarraj Department of Management Studies Indian Institute of Technology Madras Chennai India ISSN 2198-0012 ISSN 2198-0020 (electronic) India Studies in Business and Economics ISBN 978-81-322-3758-7 ISBN 978-81-322-3760-0 (eBook) https://doi.org/10.1007/978-81-322-3760-0 Library of Congress Control Number: 2017948612 © Springer (India) Pvt Ltd 2018 This work is subject to copyright All rights are reserved by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed The use of general descriptive names, registered names, trademarks, service marks, etc in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use The publisher, the authors and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication Neither the publisher nor the authors or the editors give a warranty, express or implied, with respect to the material contained herein or for any errors or omissions that may have been made The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations Printed on acid-free paper This Springer imprint is published by Springer Nature The registered company is Springer (India) Pvt Ltd The registered company address is: 7th Floor, Vijaya Building, 17 Barakhamba Road, New Delhi 110 001, India Preface The task seemed daunting The world outlays billions of dollars on innovation, but there has been no holistic assessment of its outcome Do we have the answer to the question: have investments in innovation paid off? Outlays are not outcomes This book is a study aimed at providing a comprehensive asses sment of the impact of innovation and should count as a pioneering effort How does this book provide a wholesome appraisal of value created by innovation? It captures the societal value that innovation delivers to humanity, the economic value that it endows to nations and the financial value that it provides to innovating firms Each of these values must be positive to conclude that innovation pays The book has a truly global canvas and accentuates innovation in the Technology and Pharmaceutical sectors, the two largest bastions of innovation Big data and analytics underpin the development of the material used Datasets include 86 million patent records and million financial records This is one of the largest datasets analysed for developing a book Such rich data drawn globally, annulls region-specific idiosyncracies and make the findings robust Anecdotal examples of innovation point to value accrual America spends the most on innovation which partly explains why it is the wealthiest nation in the world IBM’s IP licensing is worth more than $1 billion TI fully exploited the DSL patents that they acquired almost three decades ago The Gillette shaver protected by a fortress of 57 patents has a dominant 75% market share Apple’s recent design patents have enabled them to become the most valuable company in the world With cumulative sales of more than $120 billion, Pfizer’s IP protected Lipitor was the biggest selling branded drug ever; when the patents expired in November 2011, sales dropped a whopping 42% the next month The ‘One-click-ordering’ patent catapulted Amazon to become a leading e-commerce company A whole new industry was born when Xerox patented the photocopying technology Equally important has been the creation of societal value of innovation (decreased infant mortality due to new medicines, for example) and economic value (such as increase in per capita income and productivity due to innovation) The book is replete with real-world examples of innovation creating value, a recurring theme that runs through the book The book is developed in the backdrop of the period 1990–2016, v vi Preface a period of frenzied innovation and economic distress which saw the disruptive advent of Internet, an upsurge in mobile communication and a paradigm shift in personal computing Chapter deals with the various facets of Innovation The evolving global innovation theme over the last 25 years bring in useful insights Innovation as a creator of intangible assets and its ability to create value are discussed The two bastions of innovation, Technology and Pharmacy, are profiled, while we take a peek into innovation at the Silicon Valley Chapter is focused on the economic impact of innovation Studies have established that innovation-intensive industries create highly skilled jobs, have higher wages, are more productive, lead exports and enhance competitiveness through thick and thin of business cycles The link between innovation and economic growth and the effect of innovation on productivity and income has always been under intense gaze The raging debate on the impact of automation on employment is discussed Chapter is an analysis at the firm level That innovation impacts firm performance is not widely disputed Several examples of successful IP deployment strategies adopted by global companies point to wealth creation The paradox of India, while being low on innovation but high on firm performance, is seemingly counter-intuitive The vital societal value created by pharmaceutical innovation is discussed in Chap Drug innovation has had a profound effect on human life The impact of new medicines on mortality and the control of endemic diseases and their attendant economic gain buttresses the gains from medical innovation The impact of disruptive innovations (Internet, Social media, Internet of Things, Autonomous driving) in the digital world is discussed in Chap The consumer surplus generated by the ubiquitous mobile phones in the connected world is staggering, while the social media platform has become a way of life The overwhelming impact of IoT to connect all inanimate things (and human beings) has become truly transformative Finally, the disruptive nature of autonomous vehicles and their ability to create social upheaval is examined Chapter is devoted to an empirical study of value created by the process of Schumpeterian creative destruction The study examines whether innovation patterns explain firm performance and investigates whether innovating firms are better in withstanding economic stress Given the turbulent business environment that is here to stay, the moot point is whether innovating firms can cope better with adversarial business periods I must mention people who helped me in the preparation of this book Prof Krishna Sundar of IIM-Bangalore helped me with research material which has clearly enriched the book that much more I am grateful to Vasanta Kottapalli, a senior professional in the Silicon Valley, who had the difficult task of reviewing the raw version of the book I am deeply indebted to her I am equally thankful to Vinayak who also went through the first version of the book and helped me clean up the contents My wife Rekha and daughter Malavika watched me banging on my laptop with trepidation, wondering aloud whether I would ever finish the book (it has taken years), but shared my joy when the book was completed Preface vii Writing a book on innovation is a double-edged sword; while one admittedly deals in cutting edge, the canvas is so large that one faces the risk of being pilloried for not covering specific aspects of innovation In my humble defense, I submit that this book is focused on answering the question: has it been worth it (investing on innovation)? Bengaluru, India Vijay Kumar Contents Facets of Innovation The Idea of Innovation The Value of Innovation The Spark of Innovation Global Innovation Who’s Spending on Innovation? Innovation Trends The Dominance of Technology Innovation Innovation in the US A Special Place—The Silicon Valley Chinese Innovation References 10 15 19 23 29 36 41 44 The Economic Impact of Innovation The Economics of Innovation Innovation and Productivity Income Rises with Innovation Innovation Improves Standard of Living Impact of Automation on Employment Is the Impact of Innovation Waning? References 49 53 57 64 70 74 84 89 Monetizing Innovation The Rise of Intangibles Patenting and Value Creation Extracting Value from IP Are Patents Detrimental for Innovation? R&D and Value Creation 95 97 100 109 121 123 ix x Contents Innovation Pays Off at Apple 126 The Curious Case of India—Low on Innovation, but High on Performance 130 References 141 The Societal Value of Pharmaceutical Innovation Societal Value of Medical Innovation Infectious Diseases Chronic Diseases Economic Impact of Pharmaceutical Innovation Life Expectancy Is Correlated with Income Has Pharmaceutical Innovation Been Financially Remunerative? The Evolving European Pharmaceutical Innovation References 147 156 157 162 170 173 176 181 183 The Value of Disruptive Innovations The Internet The Economic Impact of the Internet The Consumer Surplus Generated by the Internet Sectoral Impact of the Internet The Value of Mobile Internet The Oligopoly in the Internet Social Technologies Facebook Internet of Things (IOT) The Economic Impact of IOT The IOT Landscape Autonomous Vehicles The World of Driverless Vehicle Fewer Accidents, Saving Lives Collateral Impact of Autonomous Vehicles The Economic Impact of Autonomous Vehicles References 189 191 192 198 201 205 211 213 220 223 224 229 236 237 242 244 247 251 The Economics of Creative Destruction Is Creative Destruction a Better Value Creator? Preceding Studies Theory and Hypotheses Firm Performance Measures The Link Between Innovation and Firm Performance Schumpeterian Patterns and Innovation-Firm Performance Models Coping with Turbulent Times Data 257 261 263 265 265 267 270 272 274 292 The Economics of Creative Destruction for the M-II for each of the firm performance measures was tested The results in Table indicate that the Schumpeterian effects are significantly present for all the three measures (H5a, b, and c) (Table 6.10) It is, therefore, concluded that the Schumpeterian effects are significantly present in each of the three regression models The results strongly indicate that the Schumpeterian innovation patterns have a discerning influence on each of the firm performance measures In other words, the way innovation patterns influence profitability, stock returns and market value in M-I is significantly different from the way the patterns’ influence is felt in M-II firms Second, the difference in firm performance between M-I and M-II is tested This is done using a dummy variable on pooled data to discriminate between the overall M-I and M-II firm performance in the generic equation firm performance ẳ b0 ỵ b1 dummySchumpeterian The results in Table indicate that there is a significant difference in all the firm performance measures (p < 0.01), thereby validating Hypotheses 4a, b, c (Table 6.11) Hypotheses H6a, b, c H6a: Difference in Profitability between stress and non-stress periods of M-II firms is significantly greater than the difference in Profitability between stress and non-stress periods of M-I firms H6b: Difference in Stock returns between stress and non-stress periods of M-II firms is significantly greater than the difference in Stock returns between stress and non-stress periods of M-I firms H6c: Difference in Market value between stress and non-stress periods of M-II firms is significantly greater than the difference in Market value between stress and non-stress periods of M-I firms The process for testing the stress hypotheses was done in two steps First, one regression for each combination of innovation pattern and performance measure was run separately for M-I and M-II (i.e six regressions in all); this was done to check whether the performance during stress was worse than that during the non-stress period Performance measure ẳ b0 ỵ b1;I Dummy Performance measure ẳ b0 ỵ b1;II Dummy ẳ for stress time-frameị for MIị ẳ for stress time-frameÞ ðfor MIIÞ Next, the Chow’s F-test is conducted to check whether b1,I = b1,II in the above regressions The results of the stress tests are consolidated in Table 6.12 Results, Analysis and Interpretation 293 The first set of regressions (columns A and B of Table) provide interesting results in that while profitability coefficients are negative (i.e profitability declined, but 10 times more in the case of M-I firms) during the stress period for both M-I and M-II classes, the coefficients for both market value and stock return are all positive, indicating that, despite stresses, these measures improved for both M-I/M-II Further, Chow’s test indicates that the change for M-II was ‘better’ Each of the Fvalues from the Chow’s test is significant (at least p < 0.05-last column of Table), thus supporting Hypotheses 6a, b, c and indicating that M-II firms were much better in coping with stressful times Also, analysis of other value measures (Revenue and patent counts) in Table provides further proof that M-II firms did handle the stress better The revenues increased substantially and the innovation (patent) output amplified significantly The intangible assets created by the innovation activity in Mark II firms seem to act as a bulwark in stressful times Additional Validation for H4a–H4c (M-I, M-II Firm Performances Are Different) This section provides additional evidence to support the conclusion reached earlier that firm performance in M-II firms was better than M-I firms Mark II Ave profitability 4.7% Mark I Ave profitability -5.1% 294 The Economics of Creative Destruction Profitability: The difference in the average profitability is close to 10% as indicated in Table between M-II and M-I firms Figure further confirms that M-II firms were consistently more profitable than M-I As can be seen in Figure, the average profitability differential between Mark-I and Mark-II firms was close to 10% While Mark-I firms were in the red during the last two decades (except between 1994 and 1997), Mark-II firms were always in the positive territory in period (except 2002) Is there a profitable innovation range? The answer to this question would be very useful to managements of tech firms who are constantly required to make R&D investment decisions that will yield positive returns Figure shows the plot of profitability with patent counts The first part of the plot is occupied by the Mark I innovators, characterized by low patenting and negative profitability The next range is the profitable range occupied by Mark II innovators, with enhanced innovation activity (represented by the skyscrapers) and increasing profitability From the plot, it is observed that there are a few M-II innovators which are loss making, while M-I firms (marked by low patenting) are seen right across, implying that there are profit-making and loss-making (albeit fewer) M-II firms It appears that an approximate range of 1000–2000 patent counts per year is associated with a profitability range of 0–6% To ramp up to this level of patenting, M-I firms have the arduous task of being consistent patentees for several years, perhaps even decades and grow revenues as well (patent counts and firm size are correlated) For managers of M-I firms, however, it is comforting to know that it is possible to be an M-I firm and still be profitable even at low levels of patenting Thirty-percent of the 400 tech companies in this study’s dataset have not patented at all, while 50% of firms have less than patents M-I firms which seek to create value through innovation can look at profitable innovation levels in M-I An analysis of the M-I firms reveals that in the patent count range of 30–40 (presumably still within the M-I range, as it is conceivable that creative accumulation will start happening beyond 50 patents), profitability is at its peak at 9.4% with two-thirds of firms operating in this range being profitable From the above figure (at the right extreme), it may be seen that firms with low patent counts are profitable as well, and in fact, highly profitable This throws up the question whether innovation drives profitability across all tech firms It does appear that the shareholder value created in many tech firms is not due to innovation, but due to non-innovation strategies pursued by them Additional Validation for H4a–H4c (M-I, M-II Firm … 295 Stock returns: The stock returns were significantly different between M-I and M-II innovators Further, Figure suggests that M-II firms provided better returns to investors Those who invested in M-II firms saw their investments multiply more than times in 15 years, while investments in M-I firms multiplied less than twice during the same period 296 The Economics of Creative Destruction Figure (Figure source: Thomson Reuters) plots the stock returns for the period 1995–2009 which clearly indicates that M-II firms consistently gave much higher returns than M-I firms Also, Mark II innovators outperformed the broader S&P 500 index by a wide margin and has been at par with the technology index since 2002 Market value: From Figure (Figure source: Thomson Reuters), it can be observed that the difference in market value between M-II and M-I innovators is significant, with the market value of M-II firms being consistently higher than M-I firms throughout the period of 1990–2009 The broader technology sector, though, Additional Validation for H4a–H4c (M-I, M-II Firm … 297 enjoyed considerably higher valuations than M-II innovators, but this differential narrowed sharply after the dot.com crash The upshot is that the Schumpeterian patterns are significant implying that M-II firms are better than M-I firms in creating wealth and consistently at that Additional Validation for H6a–6c (Economic Stress Analysis) This section provides additional evidence to support the conclusion reached earlier that M-II firms coped with stressful times much better than M-I firms M II firms not only managed stress better, but also appeared to improve their performance The profitability differential between Mark I and II firms consistently increased during the stressful period indicating M-II’s better performance during adversity Given the inevitable economic turmoil that has come to stay, innovators are likely to survive and even thrive during these upheavals and this is a bigger contributor of innovation than its ability to increase short-term profitability In fact, the profitability differential between Mark I and II innovators increased consistently during the stressful period Figure above shows the plot of the differential against cumulative YTD years The profit differential between M-I and M-II firms during the stress period is more than any other time in the non-stress period 298 The Economics of Creative Destruction As further evidence of the better performance of Mark II innovators during stressful times, it is observed that the relationship between patenting activity and profitability for Mark II innovators (Figure left) while being negative during the first decade reverses and turns significantly positive during the second decade (stress period) due to higher innovation activity Implications of the Findings Research Implications The Table summarizes the findings obtained through the empirical analysis, as well as a comparison with some key papers in the literature First, in line with previous research studies [21–23, 25, 27], the results provide general support to the association between patent count and firm performance, although it must be pointed out that the measurements in the literature have partially considered firm performance (in the sense that they pertain only to a single value-measure) and shown significance Second, while the RDI moderation observed herein agrees, in a broad sense, with those in the literature, the particular results are different: while Kotabe [43] moderation-result concerned the association between multinationality and performance, in the case, RDI’s moderating role pertains to a different relationship involving innovation-output measures (e.g patent count) As for the Schumpeterian patterns, the observations extend those of earlier studies [33, 35]: unlike these works (wherein a single innovation is sufficient to classify a firm as an innovator), the M-I sample chosen for the analysis can also be considered as innovators, since they have an average of 10 patents Despite this Implications of the Findings 299 somewhat strong test, M-II firm’s performance was better than M-I firms Further, regarding the sparse literature on Schumpeterian moderation, in a very general sense, the results agree with those in Castellacci and Zheng [28]; however, while those researchers have considered technological regimes and performance (as given by productivity), patent activity and financial performance measures are considered Finally, the stress-tests findings largely align with [31], although the focus is on the tech sector, and further use patent statistics (instead of a survey in Archibugi) Managerial Implications The significant relationship between patent count and performance brings out the importance of innovation to tech firms and builds up the case for increased patenting activity in tech firms When one looks at profitability, one considers information provided in the balance sheet and income statements, and hence these measures provide the viewpoint of how patents affect the accounting perspective of the firm On the other hand, the significant association between patents and market value indicates how investors view a firm’s innovative activity Next, to interpret the findings with RDI, the equations are re-arranged as follows: Profitability = Market Value = M-II M-I (2.61 − 23.46 * RDI) * Log(WPC) 11.8 * RDI + [0.81 − 1.56 * RDI] * Log(WPC) (4.35 − 42.55 * RDI) * Log(WPC) 2.21 * RDI + [0.41 − 1.27 * RDI] * Log(WPC) The italicized part of the first equation above suggests that RDI has a direct negative impact on profitability for both M-I/M-II classes, and furthermore, unless the RDI values are quite low (