In this module, we will focus on innovation and firm boundaries. That is, we'll consider questions of when and how much should firms innovate internally versus how much do they look outside of the firm for new ideas and other firms to collaborate with. As such, we'll build upon a foundational strategy concept of vertical integration. That is, which activities are needed to get a product to market and which of these activities does the firm own or control? Throughout much of the 20th century, most large firms were fully integrated and controlled most, if not all, aspects of innovation, from in-house R&D to manufacturing, to marketing and sales. Classic examples include pharmaceuticals, automobiles, and consumer electronics firms that competed with each other to sell products to end consumers. A key strategic decision for many of these firms was which activities to perform in-house versus which to buy through markets from suppliers. Decisions about the boundaries of the firm. We refer to this as the megabuy decision. The emphasis is on evaluating the transaction costs of negotiating with other firms to buy inputs through markets versus the coordination costs of making them in-house. However, today, for many innovating firms, being vertically integrated as limiting as many valuable ideas and technologies are created outside of the fun boundaries. In addition, sometimes new innovations resulting from a firm's own R&D may not fit with the firm's product portfolio, and these ideas can sit unused within firm boundaries. In other words, these firms have a closed innovation model with respect to firm boundaries. New ideas don't get in, an unused ideas can't get out. In listen decades, however, we've seen a shift towards open models of innovating, whereby firms are less integrated and they look outside firm boundaries to buy, sell, or co-develop innovations with other firms. The implications of firm boundaries are more open and pose, which not only has enabled firms to innovate faster, but it has also facilitated new business models, greater innovation through entrepreneur activity and firms focusing on specialized activities rather than being fully integrated. Let's look at an example from the pharmaceutical industry. Historically, pharmaceutical firms were fully integrated, controlling all activities from early stage drug discovery through drug development, manufacturing, and sales. However, there's considerable uncertainty in whether early drug discoveries will actually work in treating disease and improving health. As a result, firms would invest millions of dollars in R&D with only a few drugs making it to market. This uncertainty makes it challenging for pharmaceutical firms to ensure that they have a steady pipeline of new drugs to save the patients. In the early 1800s, we began to see a shift as breakthroughs and new drugs emerging from universities were being commercialized through venture back startups. This allowed incumbent pharmaceutical firms to find new drugs originate outside their own R&D to fill their drug pipelines. As a result, they begun investing less than their own internal R&D and looking more towards licensing from or acquiring biopharma startups. Today we see the same phenomenon in many industries, especially where there's a rapid rate of innovation and many new ideas and technologies coming from different sources. As a result, not only are firms looking outside their boundaries for new ideas to buy, but they're also provides them with new business models for innovating firms to capture value that is no longer the innovating firms need to vertically integrate to sell a product to end-users, but instead they can sell their innovations to other firms in technology markets. Let's return to our pharmaceutical industry example and think about this from the perspective of a biotech-startup that is commercializing a new drug discovery. They no longer need to vertically integrate into late-stage clinical trials, manufacturing, marketing, and sales to sell the drug to patients. But instead they can realize value from their innovations by either licensing their technology or by being required by pharmaceutical firms. They have the financial resources and specialized capabilities in marketing and sales to realize the most value from the drug. That is, for innovating firms, especially startups, a key strategic decisions today is whether to compete in a product market by vertically integrating and selling to end-users or whether to compete in a technology market whereby they license partner or sell their technology to other firms. Today, the pharmaceutical industry is far less integrated than it once was. We see are many specialized firms performing specific activities along the value chain. Startups focusing on drug discovery in early-stage drug development, large clinical research organizations like IQVIA and Labcorp, conducting clinical trials, and low-cost contract manufacturers who make many of the drugs. Big pharmaceutical firms like Pfizer and Merck either acquire or contract with these other firms and focus themselves on marketing and selling the drugs. Underpinning open innovation and technology markets are the mechanisms by which firms capture value from their innovations. That is, how do innovators prevent other firms from imitating their ideas and ensuring that they can realize the greatest returns to their innovations. In this module, we will also learn about these different mechanisms with a particular emphasis on patents, as well as firms specialized assets and capabilities, which are the things that they either owned or can do that are unique from other firms and provide a competitive advantage. In the recent videos, Raj will provide a deep dive in the first two videos into understanding open models of innovation, followed by a video on how to become an innovative leader. I hope you enjoy.
