Large firms, small firms, and innovation

A recent response by Nicolai J. Foss to one of my posts about Nelson & Winter gave me food for thought. I think this is a critically important discussion for innovation scholars. I agree that Nelson and Winter (N&W) do not directly talk about large or small firms. Their work is primarily about routines, that adjust sluggishly. In his book, David Audretsch appeals to N&W when he talks about “search” vs. “routinized” innovation, tracing the former to small startups and the latter to large firms. If you accept the N&W argument about the fundamental role of routines, the following logical chain is a direct implication:

·       Large firms typically are older and with time, routines become entrenched.

·       Large firms typically have successful products that generate cashflows and profits, that would be destroyed by radical innovation.

·       Large firms are political bureaucracies (March, 1962 - https://www.jstor.org/stable/2128040) within which power is wielded by divisions that have the greatest current cashflows and profits, precisely the divisions that are most threatened by radical new products.

·       The incentive of the powerful divisions in large firms is to channel the organization’s resources toward making their current products better – incremental innovation – and away from radical innovation that threatens their intra-firm power.

·       In short, large firms are bad at radical innovation because they have a lot to lose from it. They have what Julian Birkinshaw has called the "corporate immune system" that works to kill it.

In contrast:

·      Routines in small startups are new and still malleable.

·      They have no products, cashflows, or profits that would be destroyed by radical innovation.

·      In short, small startups are good at radical innovation because they have nothing to lose and everything to gain from it.

This is precisely what we find when we examine the 3,596 New Molecular Entities (NMEs) approved by the US FDA between 1993 and 2008. Over 70% of these were developed by SMEs. Even the 30% overstates the role of large firms since many of their NMEs entered the firm through the acquisition of startups.

Of the 102 blockbuster drugs marketed by the pharma majors between 1980 and 2012, only 25 were developed internally (https://www.mydigitalpublication.com/publication/?m=46092&i=683607&p=90&ver=html5).

As we argue (Mudambi & Swift, SMJ 2014), large firms only invest in exploration when the returns to exploitation fall low enough, late in the product life cycle. https://onlinelibrary.wiley.com/doi/abs/10.1002/smj.2097

Large firm CEOs are well aware of all this, and this underlies their enormous emphasis on CVCs, as well as JVs and other partnerships with startups and universities.

Most recently, the COVID-19 vaccines provided further evidence for this model – the radical innovations originated in small firms like BioIntech, universities like Oxford, or government-funded initiatives. They were scaled up, commercialized, and brought to market by pharma giants like Pfizer, AstraZeneca, and Moderna.

Lastly, as someone who has studied patents for the last several decades, I agree that it is well-known that an enormously high percentage of the global patent stock is assigned to large firms. However, the raw number of patents means very little. A huge percentage of patents filed by large firms are roadblocks and patent thickets funded to strategically protect their extant products. What matters is breakthrough patents and here large firms have a much smaller presence.