And the Winner is – Acquired.Entrepreneurship as a Contest Yielding Radical

Innovations

Forthcoming in Research Policy

Joachim Henkel, TUM Thomas Rønde, CBS

Marcus Wagner, University of Würzburg

GERMANY IN DANISH BUSINESS RESEARCH

CBS, Nov. 4, 2014

22

Sources of Innovation: Start-ups or Incumbents?

• Schumpeter: – I: entrepreneurs

– II: large incumbents

• Numerous studies, empirical and theoretical:– start-ups ~ radical innovations

– incumbents ~ incremental innovations

• But: – older studies usually assumed

product market competition

– reality: successful start-ups often acquired by incumbents

• Does it matter for innovation if entrants aim for being acquired by an incumbents?

Schumpeter, 1932

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33

Example for Innovation by Acquisition: Cisco

Switching

Storage

ContentRouting WirelessSecurity Voice Optical

Home Networking

Source: Cisco, presentation at TUM, 6/2005

4

• Motivation

• Empirical study: EDA

• Sketch of model and analysis

• Conclusions

4

Agenda

55

EDA Industry

• EDA overall (2006, ca.): $ 5 bn sales, 23,000 employees

• Three large incumbents– Cadence ($ 1.48 bn, 5,200)

– Synopsys ($ 1.10 bn, 5,130)

– Mentor ($ 0.79 bn, 4,230)

• Numerous start-ups (1999: approx. 80)

• Many acquisitions

Quellen: 10-k‘s, A. Sangiovanni-Vincentelli (2003), Report Q3 2006 des EDA Consortiums

66

EDA Industry

• EDA: “Electronic Design Automation”

• Automation of design of computer chips using software

LOGIC CHIP DESIGNEDA

77

EDA Industry

Source of figure: http://www.synopsys.com/products/solutions/dfm.html

EDA software is a system product. Example Synopsys:

Design for Manufacturing Product Family

TCAD from acquisition of Integrated Systems Engineering

1993 founded as ETH spin-off2004 acquired for $ 115 mio.

88

Frequent Acquisitions

The three established EDA firms acquire start-ups at a high and increasing level(1989-2005 = 105)

Sources: Websites, 10k-Berichte

0

1

2

3

4

5

6

7

1989 1991 1993 1995 1997 1999 2001 2003 2005

= 32

0

1

2

3

4

5

6

7

1989 1991 1993 1995 1997 1999 2001 2003 2005

0

1

2

3

4

5

6

7

1989 1991 1993 1995 1997 1999 2001 2003 2005

Synopsys

Cadence

Mentor(11) = 31

= 42

99

Start-ups in EDA: Evidence from Interviews

Start-ups …

A) have to do innovate– “[Innovative technology] is the only thing they sell, so it‘s either make it

or break it.”(2)

B) have to aim for radical innovation:– “... there [in small firms] … has to be a radical core, I would say,

otherwise it is not possible”

• “So they are relying on start-ups, which then are starting from scratch … so they can apply very new methodology with very new techniques without being restrained by all customers or all the methodology”

C) can hardly remain independent in the long run:– “The goal is always to be acquired. […] The more successful we are,

the more urgent it becomes to be acquired.”(3)

Numbers (2, 5, 3) denote the interview patner.

• Motivation

• Empirical study: EDA

• Sketch of model and analysis

• Conclusions

1010

Agenda

1111

Set-up

• One established firm (I) and N entrants

• All conduct R&D to develop a new product

• Firms choose from a given set of possible R&D projects, characterized by their success probability p

• Profit for I from a project, if successful: (p); otherwise: 0

• The function p·(p) assumes its maximum in ]0,1[ at p = p*

• Only the incumbent can market the innovation start-ups aim at being acquired by I

• All firms maximize expected profits:– Entrants: Expected acquisition price

– Incumbent: Expected product market profit minus acquisition price

The Assumptions – Illustration for (p) = 1- p

12

pp*

0

p(p)(p)

1

1313

Timing

time

• Stage 1: firms pick their R&D projects (pI , p1, p2)

• (Nature: R&D outcomes are realized)

• Stage 2: Competition among the start-ups to be acquired by the incumbent

• (Product is sold, profits are realized)

Alternative interpretation: patented inventions are traded in a market for technology

Analysis: Game Theory

• A “Game” is a situation where:

– The “players” have to make decisions

– The payoff is affected by other players’ actions

– The case in setup considered here

• We look for a stable situation (or, “Nash equilibrium”):

– Everybody is expected to behave in a certain way

– All players are doing the best that they can for themselves given what

the other players are expected to do

– Nobody has an incentive to deviate from the expected behavior

The Equilibrium – Illustration for N = 2

15

pp1* pI

*= p*p2*

0

p(p)(p)

1

Intuition

• Entrants choose risky strategies as they need to have the best available technology to be acquired

• Incumbent chooses a safer strategy to have a fall-back option and a good bargaining position in negotiations with a successful entrant

• The more entrants there are, the stronger is the push to pursue radical projects with low success probability/high value:– Success probability of the most radical project undertaken in

equilibrium is decreasing in the number of entrants

• Result is robust to a number of changes:– More entrants, more incumbents, different timing of the game, etc.

16

17

• Motivation

• Empirical study: EDA

• Sketch of model and analysis

• Conclusions

17

Agenda

1818

Conclusions

• Explains focus of start-ups on riskier and, if successful, more radical innovations, based only on their need of being acquired

• Incumbent chooses a safer strategy to have a fall-back option and a good bargaining position in negotiations with a successful entrant

• Parsimonious model with very rich structure

• Model fits well what we observe in EDA– in real life, mixed with other mechanisms (HR, organizational rigidities, focus on

existing customers)

• Industries where model fits are characterized by systems products:– Software, electronics, telecom

• Contribution to understanding sources of innovation and markets for ideas

Thank you