How Competition Ups Your Innovation Game

Mike Peña, Stanford University August 22, 2018

The business community’s resistance to over-regulation is a constant gripe. So, when evidence shows that government intervention in the market can spur innovation, it’s worth paying attention.

Take the case of Microsoft, which was sued by the U.S. government in 1998 for allegedly abusing monopoly power by bundling its web-browser software on the Windows operating systems. The government argued that the bundling practice kept other companies from entering the web-browser market, while allowing Microsoft to protect its dominance.

In the early 1990’s, the battlefield was the desktop. Now, it’s the smartphone with Google’s parent company paying a record $5 billion fine levied by the European Union for bundling its search engine and other apps on Android devices.

But do government fines against monopolies actually spur or stifle product innovation?

That’s what two professors who study innovation in the tech industry examined in a new study that won the Best Paper Award at the 2018 Competitive Dynamics Conference hosted by the Smith School of Business at Queens University in Ontario, Canada.

The paper, by Sruthi Thatchenkery, an assistant professor at the University College London’s School of Management, and Stanford Professor Riitta Katila, in the university’s Department of Management Science & Engineering, shows how government can play a positive role in spurring innovation by discouraging monopolies and creating space in the market for healthy competition among firms large and small.

“A broader view of competition in turn boosted innovation by facilitating learning, while minimizing more counterproductive responses to competition, like litigation or technology racing.”

Sruthi Thatchenkery

The Microsoft case was ultimately settled, but, in the years that followed, the new study by Thatchenkery and Katila, shows that competition in the software industry actually increased, and that fueled more product launches among companies seeking to gain share in a market that could once again accommodate more players.

Whether or not the case against Google’s parent company, Alphabet, will have the same effect remains to be seen. Nonetheless, the professors say it follows a familiar pattern in the industry and could make companies more aware of competition and, thus, more innovative in the long run.

eCorner: What does your research help clarify about the relationship between regulation and innovation?

Thatchenkery: The idea that breaking up monopolies can help jumpstart innovation is one of the main motivators behind creating antitrust legislation in the first place. But a lot of classical economic theory focuses on innovation incentives: Does increasing competition also affect a firm’s innovation effort?

We decided to find out, and examined 121 public U.S. infrastructure software firms, the firms they monitored as competitors, and 8,502 product introductions of these firms over an eighteen year period from 1995 to 2012. What was surprising about our research was to see that there are innovation benefits to antitrust enforcement (we specifically focused on the Microsoft trial) that come from changing the way firms think about competition rather than directly changing their incentives.

We were able to demonstrate these indirect effects by taking a “firm-centric” view of competition, where, instead of defining competition at the market-level or industry-level, we look at exactly who firms identify as competitive threats and how that changed in response to potential antitrust enforcement.

eCorner: How does your research explain why companies with overwhelming dominance in a market sector stifle innovation?

Katila: In addition to our statistical analysis of 121 firms, we also went into the field to talk to executives. Our interviews with them suggest several explanations. One is cultural: Startups were worried about stepping on the toes of an 800-pound gorilla (a dominant firm like Microsoft). They wanted to stay away from launching products, or claiming intellectual property in areas that they thought were of interest to the dominant firm, to stay out of its crosshairs. If there is a big monopoly player, it alters the culture of an entire industry. Antitrust enforcement could potentially change that mindset, we find.

Thatchenkery: There’s been other work that looks at the direct effects of antitrust enforcement on innovation. But what our research shows is that there are indirect effects that are also worth considering. Specifically, we find that in the wake of the Microsoft antitrust case, many software firms broadened their thinking about who “counts” as a competitor. They began to see themselves in competition with more firms, and also with firms in other product markets, such as those on the periphery of the industry, and businesses in seemingly unrelated sectors of the market.

This effect was especially pronounced in the firms that were more likely to become targets of antitrust enforcement themselves. A broader view of competition in turn boosted innovation by facilitating learning, while minimizing more counterproductive responses to competition, like litigation or technology racing.

Katila: As Sruthi mentioned, the software firms that felt pressured to pay more attention to competition had the indirect effect of boosting innovation because you have more raw material for innovation, and more templates of different and successful approaches. You can even avoid things that your competitors already tried and failed. So, awareness of competition and awareness of rivals speeds up innovation in the long run.

eCorner: In this study, how much more innovative were companies that cited a larger number of competitors, and how did you quantify that innovation?

Thatchenkery: Our main analysis focuses on brand new software products, basically, anything that is “version 1.0.” The typical firm in our sample releases about two to three new products per year. But firms that pay attention to more unconventional competitors — especially “peripheral” competitors that most other firms ignore — introduce around one to two additional products a year, which is a big jump in productivity!

New product introductions are the lifeblood of software firms in terms of revenue growth and long-term survival. So, our results show that firms that broaden their views of competition beyond the most “obvious” threats can reap some pretty substantial benefits.

eCorner: The $5 billion fine against Google’s parent company for anticompetitive practices is very similar to the antitrust lawsuit brought against Microsoft in 1998. Should we expect to see this issue come up again among tech companies whenever the next digital platform becomes ubiquitous?

Katila: Very likely so. There is an argument that antitrust regulation does not work. Google paid off the fine, and still made $3.2 billion in profit, with no impact on the stock price. So, it barely makes a financial dent.

However, our research points to the long-term benefits of competition. The key point is that the positive effect of these antitrust rulings on innovation comes through their broader impact on attitudes and mindset of companies in the sector in general. They not only change the behavior of one company, but the whole industry. The positive benefits on firm diversity and product innovation can be observed several years down the line.

eCorner: Generally speaking, how necessary is competition for innovation?

Thatchenkery: Competition can give innovation a big boost, but what we show is that firms need to have the right mindset. Focusing on just a narrow number of “obvious” competitive threats, like the one or two biggest firms in the market, can actually be quite stifling.

Instead, firms should reframe competition as a learning opportunity and also pay attention to more unconventional competitors, especially competitors that are flying under the radar on the fringes of the industry. Even if those particular firms don’t become the next big thing, there’s value in learning from a variety of different competitors — especially competitors that are ignored by others — and using that to create something new.

Katila: Competition goes hand in hand with software innovation. When there are only a handful of big players in an industry, there are limited approaches to solving technology problems. When you kill variety, you kill innovation.

Riitta Katila is a faculty member of the Stanford Technology Ventures Program (STVP).
Sruthi Thatchenkery is a graduate of Stanford’s Department of Management Science & Engineering where she studied with STVP.