Diffusion Shortfall in Free Innovation

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In the preceding chapter I identified innovation pioneering as an important inbuilt difference between innovation development activities carried out within the free innovation paradigm and the producer innovation paradigm. In this chapter I identify an important inbuilt difference between the two paradigms with respect to innovation diffusion. By doing so, I further illustrate the research and practical utility provided by the free innovation paradigm.

The diffusion-related matter I will focus on is a systematic shortfall in free innovators' incentives to invest in diffusion of free innovations. I present evidence for that shortfall, and then argue that it is caused by the absence of a market link between free innovators and free-riding adopters. In a discussion at the end of the chapter, I suggest ways to address this situation.

“Market Failure" in the Free Innovation Paradigm

The value of free innovation to society comes in part from free innovators' satisfaction of their own needs via the innovations they develop. Social value is increased further if others also adopt and benefit from those same developments. Of course, to realize this second form of value, free innovations must diffuse from their developers to free adopters.

In chapter 2 we saw that more than 90 percent of innovators in the household sector do not attempt protect their designs from adoption by free-riding peers or producers. We also saw that most are quite willing to have their innovations diffuse for free to others. However, simply being willing to allow free riders to adopt a design if they wish to do so is by no means the same as investing to support diffusion to free-riding adopters.

Investment in diffusion by free innovators can increase social welfare because it is often the case that even relatively small investments can greatly reduce search and adoption costs for many free riders. For example, if I, as a free innovation developer, would invest just a little extra effort to document my open source software code more clearly, I could greatly reduce the time that perhaps thousands of adopters would require to install and use my novel code. Intuitively, it would seem that there would be a net increase in social welfare if I were to expend just that small extra effort.

To determine the optimal level of spending on diffusion in this case more exactly, it is useful to view the free innovation developer and the pool of potential free-riding adopters as a combined "system” for which we are seeking to maximize benefits. Assume that investments in diffusion of free innovations will lower adoption costs for free riders. Assume also that additional investments will lower adopters' costs at a declining rate. (For example, the first hour I spend improving my software code documentation might help clarify things a lot for free adopters, the second hour would contribute somewhat less additional clarity, and so on.) System benefit is then maximized at the point where an additional dollar of investment in diffusion by the free innovator—or anyone else in the system—reduces adoption costs by a dollar across all free adopters.

The question then is how to get to this optimal level of investment? The problem is that free innovators have to bear the costs of investments in diffusion, while free adopters get all of the benefits and do not share those costs. There is no market link that would enable a more appropriate allocation. Situations like these are described in economics under the heading of "market failure.” With his evocative metaphor of an "invisible hand,” Adam Smith described how pursuit of self-interest leads purchasers (whom he called "demanders”) and producers jointly participating in a market to produce "always that precise quantity ... which may be sufficient to supply, and no more than that supply, that demand” (1776, 54, 56). A market fails when it does not get this balance right, and when the interaction of purchasers and producers fails to allocate resources efficiently (ibid., 55). Stated in present-day terms, a market failure exists when another possible outcome can make a market participant better off without making someone else worse off (Krugman and Wells 2006). Market failures, in turn, are regarded as a form of inefficiency, especially of information and resources, that calls for government intervention and remedy (Bator 1958; Cowen 1988).

The absence of a market link and resulting market failure affect only the free innovation paradigm. In the producer innovation paradigm, in contrast, there is a built-in direct market connection that rewards investments in diffusion. When customers buy a product for which the producer has monopoly rights, they transfer part of the benefit they derive from adopting the innovation to the producer in the form of a price higher than marginal cost. This gives the producer a monopoly profit that both motivates and rewards investments in diffusion to gain more sales. (However, as I will note at the end of the chapter, a different diffusion problem affects the producer innovation paradigm.)

The difference in levels of diffusion incentives within the two paradigms just described is not always so stark. It can be partially or even fully offset in cases where types of self-rewards that increase with diffusion are valued by free innovators. For example, presumably the selfrewarding "warm glow” of altruism experienced by a free innovator increases as the number of people who adopt his or her free innovation increases. One could say the same for self-rewarding pride of accomplishment. Reputation enhancements can also fit: at least sometimes, the greater the diffusion of an innovation, the greater the reputational gain for the developer.

Given all these factors, is there, in practice, a general shortfall in diffusion effort by free innovators? We do not have very good data on this matter yet but, as we will next see, the available evidence does point toward such a shortfall (de Jong, von Hippel, Gault, Kuusisto, and Raasch 2015; von Hippel, DeMonaco, and de Jong 2016).

 
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