Room for User Innovation Before It's Too Late

Although traditionally R&D was performed by the firm, in more and more industries firms are now able to open up their R&D by allowing users to innovate as well. The more users that want to innovate, the more attractive the latter option becomes for firms. However, profit maximizing firms only switch to open innovation when it is "too late". This means that they only open up their innovation when relatively many users are innovating, whereas social welfare would be better served if they do so when a smaller percentage of users are innovating. Therefore, one way that governments can increase social welfare in these industries is to help users become more productive in their innovative efforts.

This conclusion is reached by Alfonso Gambardella (Department of Management and Technology) with Cristina Raasch (TUM School of Management) and Eric von Hippel (Sloan School of Management) in The User Innovation Paradigm: Impacts on Markets and Welfare (forthcoming in Management Science ). In this article, the authors formally model the complex relationships relating to when and how user innovation improves the division of innovative labor, both benefiting producers and increasing social welfare.

In this model, they make three main adaptations to a standard welfare economics model regarding innovation with theoretically novel concepts. In the standard model, producers choose their innovative efforts and consumers decide to buy, depending on variables such as government policy, and producer and consumer characteristics. In this modified model, they added a subgroup of users that have the ability to innovate. These innovating users maximize their utility function, just like in the standard economics model, but there is a difference: They gain utility from creating an innovation. This is called the tinkering surplus, and it might for instance involve the fun, learning, status, or job prospects involved in the process of innovation. A second difference is that the firm can choose to increase this tinkering surplus by helping them make innovations, for instance by providing design tools or by hosting websites that allow these innovating users to share their designs and other members of the community to vote on such designs. Lastly, the model has a mechanic that allows firms to lose profits when users become self-proficient and do not need the firm anymore to produce high quality goods.

Practically both for firms and governance the results obtained from the model with these modifications are also important. The authors have found that if self-proficiency in the industry doesn't become too high, and users can contribute a sizable amount to the innovative process, it is in the best interest of the firm to switch to open innovation when enough users start to innovate. This switch requires a major reorganization of the R&D function, but if they learn how to "direct" users better towards the type of innovation that the firm can profit from, they can achieve a competitive advantage over firms that fail to do so. However, to maximize social welfare, firms should switch when fewer users start to innovate than they do to maximize profits. The policy implication is that in markets where user innovation is possible, to maximize social welfare governments would have to incentivize or subsidize user innovation. Moreover, traditional government interventions such as patents, which incentivize producer innovation may under some conditions even reduce welfare because they encourage a firm-centered R&D process and discourage the division of labor between firms and user innovators.