Innovation in the New ICT Ecosystem How New

Innovation in the New ICT Ecosystem: How New Knowledge is Endogenously Created in the ICT Sector Martin Fransman Professor of Economics and Founder-Director Institute for Japanese-European Technology Studies University of Edinburgh 1

The challenge facing Europe 1. European companies face increasing competitive pressure through globalised markets from the US on the one hand, and Japan, Korea, China and India on the other. 2. The only viable response is innovation i. e. the creation of new knowledge relating to products, processes, forms of organisation, and markets (Schumpeter’s definition). 3. The low cost option is ruled out by China and India. 2

How is new knowledge endogenously created in the ICT Sector? Paradoxically, even Schumpeter does not provide an answer • Even Schumpeter, the scholar on innovation par excellence, does not tell us how innovation happens. • He does tell us what innovation is (i. e. new products, new processes and technologies, new forms of organisation, and new markets). • He does tell us who the agents of innovation are (i. e. entrepreneurs). • He does tell us about the effects of innovation (i. e. creationdestruction). • And he does distinguish innovation from related events (such as invention, uncertain financing of innovation, and diffusion). • But he does not tell us how innovations happen. 3

How is new knowledge endogenously created in the ICT Sector? 1. One important way (though not the only way) is through the symbiotic interactions between the creators and users of this knowledge. (von Hippel has developed this insight) 2. Other ways include basic or longer term research, where there is no immediate user, in universities and corporate R&D labs, and exogenous change coming from other sectors. 3. But, who are the main creators and users of knowledge in the ICT Sector? 4

How do they fit together as creators and users of knowledge? 5

The Creators and Users of Knowledge in the ICT Sector At a high level of aggregation there are 4 groups of players who create and use knowledge. (1) networked element providers (2) network operators (3) platform, content & applications providers (4) final consumers [NOTE: The first 3 are intermediate consumers. ] 6

A Simplified Model of the New ICT Ecosystem Output of innovative goods and services (from all three layers) Final consumer Global trade Layer 3 Cont. & App. Providers Financial Markets Layer 2 Regulation Converged Networks Global trade Layer 1 Standardisation Networked elements 7

ICT Companies in the FT Top 500 from the US, Japan, Europe and East Asia (Korea, Taiwan and China), 2006 Layer Total number of companies III 9 II 18 I 29 Number of companies by region US 6 Japan 2 Europe 1 US 5 Japan 3 Europe 8 East Asia 2 US 12 Japan 9 Europe 6 East Asia 2 Source : M. Fransman (copyright), calculated from FT Top 500, 2006 8

There are 6 symbiotic relationships between these four players 9

6 symbiotic relationships in the New ICT Ecosystem CONSUMERS 3 3. PLATFORM, CONTENT & APPLICATIONS PROVIDERS 2 5 2. NETWORK OPERATORS 1 6 C O N S U M E R S 1. NETWORKED ELEMENT PROVIDERS 4 CONSUMERS 10

3 Flows within the Symbiotic Relationships 1. Financial flow, emerging from the buyer-seller relationship. This creates financial incentives for knowledge-creation. 2. Information flow, as creators and users get to know more about each other. 3. Material flow, as the creators provide inputs (atoms or bits) for their users. 11

Old and New Symbiotic Relationships Ø The ‘Old’ ICT Symbiotic Relationships (i. e. pre-Internet) Relationships 1, 4 and 6 (In telecoms until circa-1980: a closed innovation system) Ø The ‘New’ ICT Symbiotic Relationships (i. e. post-Internet) Relationships 2, 3 and 5 (An open innovation system, with low-cost entry for existing and new firms) 12

Examples of Symbiotic Relationships Example 1 • Symbiotic Relationship 1 between telecoms operators and their network element suppliers. • While the suppliers do most of the R&D, the operators provide both the investment and user-knowledge feedback (see data at end). Example 2 • Symbiotic Relationship 3 between content & applications providers and final customers. • E. g. web 2. 0 relationships where the consumer is also an innovator and information provider. Example 3 • Symbiotic Relationships 1 & 6 Japan’s overly innovative mobile phone makers who are not internationally competitive • Who provide functionalities such as: digital broadcast (“One Seg”), camera and video, wireless LAN, high-speed data communication, IC credit payment. 13

Mobile Handset Makers: Market Share 14

Symbiosis – example 4 Apple’s i. Phone • Symbiotic relationship 4, between network element providers and final consumers (e. g. great design) • and symbiotic relationship 1, between network element providers and telecoms operators (e. g. AT&T) 15

The Environmental Context of the Knowledge -Creating Symbiotic Relationships • Knowledge is always created locally within specific contexts (e. g. Antonelli (2008). • There are 4 sets of influences on the symbiotic relationships, as shown in the next slide. 16

Symbiosis is Environmental Context-dependent COMPETITION FINANCIAL INSTITUTIONS 6 Symbiotic Relationships REGULATION & COMPETITION LAW OTHER INSTITUTIONS e. g. legal standardisation universities 17

The Innovation Opportunity 1. The set of factors identified in the previous slides define opportunities for innovation. But, will they be constructed as opportunities or not, and who will see them? 2. It is precisely here that the Schumpeterian Entrepreneur enters, whether through a small firm or a large, established company. 3. A key issue is the incentives that the system provides the entrepreneur (e. g. Metcalfe (2004), Baumol et al (2007) 18

4 Implications for Government Policy-Makers 1. They should establish prioritised outcome objectives for their national ICT systems. 2. They should establish performance indicators in the prioritised areas and use them to benchmark their system against a) the global leaders and b) several comparable countries. 3. On the basis of the indicators they should identify the strengths and weaknesses of their national system. 4. They should propose action to be taken by identified players in the national system to improve performance. (Governments will differ in terms of what they think can and should be done. ) All the information in 1 -4 should be made public and subject to analysis and debate. 19

3 Implications for Regulators 1. A better understanding of the innovation/knowledge-creating process will allow regulators to take a more dynamic approach, complementing their often static regulatory tools. Antonelli (2007): “Regulators should care for the dynamic properties of the economic systems they want to regulate…. The dynamics of the system can be understood analysed only when the localized context of action – and innovation – of each agent, both on the demand the supply side, is taken into account. ” (Communications & Strategies, No. 68, 2007, p. 15. ) 2. Regulators have correctly emphasised competition and acted against the abuse of significant market power. However, although competition is an important component of innovation, competition is not sufficient to produce internationally-competitive innovation. Institutions and entrepreneurship are also necessary. 3. Regulators should try and take greater account of innovation dynamics in making their regulations. 20

Benchmarking Performance of National Innovation Systems International Competitiveness of Incumbent Telcos and Cable Companies in Broadband Speed (OECD, 2007) 21

Global Comparison of minimum Broadband Prices (OECD, 2007) 22

Broadband technology diffusion by country 23

Problems regarding governance by telecoms regulators The Dominant Regulatory Paradigm in Telecoms (DRPT) • The mindset of telecoms regulators has been shaped by neoclassical economic theory which teaches that social welfare is maximised under conditions of intense competition (i. e. perfect competition). • Accordingly, regulators have seen the creation of competitive conditions as one of their main tasks. • A major focus has been on bottleneck infrastructure where significant market power (SMP) and dominance may be exercised. This has justified ex ante, sector-specific regulation. 24

What is wrong with DRPT? (1/2) • The economic theory underlying DRPT tends to be static and does not take account of the process of innovation. • Accordingly, the causal link between competition and the output of the ICT Ecosystem – i. e. more innovative goods and services – is inadequately explained and dealt with by policy. • Apart from competition (see below), the performance of the ICT Ecosystem also depends on co-operation (c. f. the 6 key symbiotic relationships) and a range of institutional drivers of performance. • The institutional drivers of performance include: financial institutions and markets (c. f. Telecoms boom and bust); legal institutions (c. f. role of litigation in frustrating US Telecoms Act, 1996); standardisation (c. f. success of GSM); and universities (c. f. university research on ICTs, role of Stanford U. in incubating entrepreneurs of Yahoo!, Google, etc). • In short, DRPT does not deal adequately with the process of innovation which is the main driver of growth, productivity and new goods and services. 25

What is right with DRPT? (2/2) • The DRPT is right to attach high priority to competition. • But it does so for the wrong reason, tending to assume implicitly that competition will automatically result in maximum social welfare. (In economic theory, perfect competition logically implies – i. e. is the same thing as – optimisation of social welfare. ) • However, in a world of innovation, change and uncertainty, the determinants of globally superior performance are far more complex than this theoretical approach acknowledges. • The DRPT is right to be concerned about bottleneck infrastructure, the existence of SMP and dominance, and the possibility that this may lead to anti-competitive behaviour. • Competition is a key driver of the process of innovation, which in turn is THE key driver of the performance of the ICT Ecosystem. But if innovation is a key ultimate objective it is necessary to go beyond these concerns. 26

Problems regarding governance by policymakers • The main problem is fragmentation. • The ICT Ecosystem is the responsibility of: telecoms regulators, ministry of trade & industry, competition authority, ministry of science and technology, perhaps a separate ministry of communications (e. g. MIC in Japan), to name just the main ones. • Each has their own perspective on the system; none has a holistic conceptualisation of the ICT Ecosystem as a whole. • This can lead to a lack of co-ordination and inconsistency. 27

Data • The database, from which the following graphs come, is based on the 157 top global companies (by market capitalisation) • The data comes from Thomson Financial, UBS Investment Research, DTI R&D Scoreboard, and individual company reports. • For further details see Fransman, M. (2007). The New ICT Ecosystem – Implications for Europe, chapter 4. 28

R&D is done primarily in Layers 1 and 3 R&D to Sales Average Ratio per Layer (2002 -2006) R&D Expenditures Distribution between Layers (2002 -2006) 29

Investment in the New ICT Ecosystem comes largely from Telecoms Operators in Layer 2 CAPEX to Sales Average Ratio per Layer (2002 -2006) CAPEX expenditures Distribution between Layers (2002 -2006) 30

Profitability and Returns are higher in Layer 3 than in Layer 2 31

This raises a potential problem for the ecosystem • To the extent that capital is allocated by financial markets according to returns, it may turn out that Layer 2 is relatively deprived of investment funds. • In turn – via the symbiotic relationship – this could deprive Layer 1 companies who are dependent on network operators for revenue… • …and slow the development of the Internet platform provided by Layers 1 and 2 on which Layer 3 depends. 32

Do European telcos have more market power than their US and Asian counterparts? Answer: There is little evidence to support this argument (to the extent that market power is reflected in profitability). In 3 of the 5 years European telcos have been outperformed by US and/or Asian (Japanese and Korean) telcos. 33

Company data classification 34

Companies in our Database : Layer 1 35

Companies in our Database : Layer 2 36

Companies in our Database : Layer 3 37

Selected Bibliography • • • • Antonelli, C. and Baranes, E. (2007). ‘The Design of Communication Systems’, Communications and Strategies, No. 68, 4 th quarter, 2007. Baumol, W. J. , Litan, R. E. and Schramm, C. J. (2007). Good Capitalism, Bad Capitalism and the Economics of Growth and Prosperity. New Haven: Yale University Press. Fransman, M. (ed) (2006) Global Broadband Battles: Why the US and Europe Lag while Asia Leads, Palo Alto: Stanford University Press. Fransman, M. (2007). ‘Innovation in the New ICT Ecosystem’, Communications and Strategies, No. 68, 4 th quarter, 2007. Fransman, M. (2007). The New ICT Ecosystem: Implications for Europe. Edinburgh: Kokoro. Malerba, F. (ed. ) (2004). Sectoral Systems of Innovation: Concepts, Issues and Analyses of Six Major Sectors in Europe. Cambridge: Cambridge University Press. Metcalfe, J. S. (2004). ‘The entrepreneur and the style of modern economics’, Journal of Evolutionary Economics, Vol. 14, No. 2, May, 157 -176. Nelson, R. R. and Winter, S. G. (1982). An Evolutionary Theory of Economic Change. Cambridge MA: Harvard University Press. Schumpeter, J. A. (1943). Capitalism, Socialism and Democracy. London: Unwin. Schumpeter, J. A. (1954). History of Economic Analysis. New York: Oxford University Press. Schumpeter, J. A. (1934). Theory of Economic Development: An Inquiry into Profits, Capital, Credit, Interest and the Business Cycle. New York: Oxford University Press. Schumpeter, J. A. (1966). Capitalism, Socialism and Democracy. London: Unwin. Von Hippel, E. (1988). The Source of Innovation, Oxford University Press. Von Hippel, E. (1998). ‘Economics of Product Development by Users: The Impact of ‘Sticky’ Local Information’, Management Science, 44(5): 629 -644. 38

Book and Related Website The New ICT Ecosystem – Implications for Europe First part of the book, and a summarising power point presentation, are freely downloadable, and the whole book can be purchased (at a lower price than Amazon’s), on the accompanying website (go to general section): http: //www. web 2 foryou. com/home. htm 39