Modeling Producer Strategies to Support Free Innovation

In line with standard microeconomic modeling, the focus of Gam- bardella, Raasch, and von Hippel (2016) is on the implications of free innovation for producers as well as on the effects of free innovation and producer innovation on social welfare. I will discuss producer innovation strategies in this section and will turn to the implications for social welfare in the next section. In both sections, I will describe the model variables and modeling results conceptually rather than mathematically. The full mathematical model and findings are provided in appendix 2.

Recall from the above descriptions of four paradigm interactions that two of them are positive for the producer. First, producers' profits increase when free innovators create and diffuse complements that producers do not find it profitable to produce and sell, but that enhance the value of the products or services that producers do sell. Second, producers' costs of developing innovations are reduced when they can adopt designs from free innovators instead of developing designs in-house.

Recall too that one of the four paradigm interactions—free- contested markets—is unalloyedly negative for producers: Free peer-to- peer distribution of products or services by free innovators is a source of competition for producers trying to sell the same thing or a substitute. Just like any other form of competition, competition from participants in the free innovation paradigm decreases the size of a producer's market and/or forces the producer to lower prices. For example, in the mountain biking example discussed earlier, free innovator-developed mountain bike designs were available "for free” to mountain bikers—potential customers—just as they were to mountain bike producers. Individuals who elect to build their own bikes reduce the size of the producers' market by removing themselves as potential customers.

Finally, recall that the fourth interaction is the provision of design support by producers to free innovators. This interaction is under producer control, and it is the path by which the model of Gambardella, Raasch, and von Hippel (2016) envisions that a producer can seek to affect and shape the first three interactions to increase profits.

The model's approach to the interplay of the four interactions is to focus on the fraction of a producer's potential market that is capable of both innovation and self-supply. This is because the profitability of a decision to invest in supporting free innovation development turns out to be centrally affected by that factor. (Innovation design and innovation self-supply generally go together. If you are going to go to the trouble of designing something, you will generally build a copy too as part of the development process. If you are a user, the copy you have made will remove you from the producers' potential market—you have supplied it to yourself.)

Suppose that in a particular market very few individuals in the household sector have the capability to innovate in ways that may be of commercial value to a producer. In that case, the model finds, it would make sense for a producer to stick to in-house development and not invest in developing and supplying innovation design tools to support the efforts of just those few free innovators. The cost per additional free innovation developed would be too high. As the fraction of potential free innovators in the producer's market grows, however, investing a portion of producer R&D dollars in tools to support and increase free innovation becomes more profitable than an exclusive focus on in-house development, even if free innovators both innovate and selfsupply and thereby remove themselves from that producer's potential market.

Eventually, as the share of potential innovators in a producer's market increases still further, investing in supporting free innovators again becomes unprofitable. The loss of potential market associated with self-supply by potential customers becomes so large that the producer's profits are reduced, even though more free commercializable designs are developed. The offsetting effect of customers' self-production is especially dangerous for producers when non-innovating potential customers also gain the ability to make very cheap copies of free innovations. This possibility is a reality today in the case of software and many other information products. Soon, with the increased availability of cheap, personally accessible production technologies such as 3D printers, it also will be a commonplace reality for many physical products.

Of course, this offsetting effect applies only to products that a producer wants to commercialize in competition with peer-to-peer diffusion. In the case of the development of valuable complements that a producer does not want to commercialize, the more free innovation and self-supply the better! For this reason, as we will see in the next chapter, today some producers make heavy investments to specifically encourage and support free innovators' development of complements to the commercial products they sell.

I should note that Gambardella, Raasch, and von Hippel (2016) assume that a natural level of free innovation and self-provisioning by potential customers will be present even without a producer firm making investments to support it. As national surveys show, free innovation is a very widespread phenomenon today, generally without intentional support from producers. This implies a possibility, not included in the model, that the natural level of free innovation and self-supply can already be at a point that is "too high” from the point of optimum producers' profits in some markets. Evidence shows that producers judging this to be the case may then choose to invest in frustrating free innovation rather than supporting it. They may, for example, use legal restraints and/or technical barriers to make their products more costly for potential customers to modify or copy (Braun and Herstatt 2008, 2009).

Finally, independent of the number of potential innovators in a market, a producer's best choice with respect to its corporate R&D investments is never to invest only in providing tools to support free innovators. Free designs can seldom be produced commercially just as they are. A producer therefore must invest internal funds to refine a free design and prepare it for production. In addition, a producer must invest internal funds to develop types of designs that free innovators would not be interested in developing but that are important to the market—for example, designs to make products easier for novices to use. The model therefore addresses the appropriate balance with respect to investments that complement the efforts of free innovators versus investments that substitute for design development activities that free innovators find it viable to make on their own.

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