Recent Research: The end of industry disruption?

Disruptive technology, or innovations that radically alter the way consumers, industry, or businesses operate, have long been thought to be the primary way emerging small firms can leapfrog competition and compete against large industry titans. Through innovations such as internal IT systems or logistical improvements, small firms can acquire a decisive competitive advantage over their rivals. Or so the traditional theory holds. In a new paper out of Boston University School of Law, Bessen et al. argue that the way we think about industry disruption and displacement may no longer be an accurate assessment of what is truly going on with significant changes since 2000. Unknown policy implications from their findings relate to possible long-term impacts on regional innovation strategies and American competitiveness.

Declining Industrial Disruption explains that traditionally, when a firm develops a new technology with the goal of utilizing the technology to compete against a larger firm, there is a quick scramble among those in the established industry to adapt and innovate before the small firm carves out a large enough market share to disrupt the industry. Amazon’s release of the Kindle and the Kindle Fire is a prime example of this at the product-level. To compete with the publishing industry, the Kindle allowed users to access a vast digital book library. To compete with the established tablet market, Amazon developed the Kindle Fire with scalable cloud-based technology and an inherent business model advantage by using its own content on the device. Amazon disrupted existing industry through technological innovation and displaced some of the larger long-time industry players. At the industry-level, disruption occurs when a firm, through innovation, creates a new market and value network that outcompetes and outperforms existing firms.

This phenomenon, according to Bessen et al., has experienced a sharp drop beginning around 2000. To demonstrate the decline in industrial disruption, the authors analyzed annual displacement incidents along two measures: how often a leading firm falls out of the top four in its specific industry when ranked by sales, and how often a lower ranked firm leaps into the top four. The shift from rising turnover rates until 2000 to then declining sharply afterward is evident as well for the top 100 firms, reaching lows last seen in the 1970s (see figure 1C in the working paper).

Additionally, through an analysis of the role of different capital stocks (physical, organizational, technology, etc.), the authors found that rising investments in intangibles such as software and R&D among already dominant firms account for much of the decline in displacements and leapfrogs since 2000. To isolate these capital stocks and determine which of them were the most important contributors to dominant firms, the researchers used an extended production function, noting that an analysis involving industry characteristics does not account for individual firm diversity.

The authors also briefly explored the role of acquisitions as a possible explanation for the decline in disruption. They noted, as the rate of acquisitions by the top four firms peaked in the mid-1990s and has been relatively constant at an average of 0.6 firm acquisitions per year (see Figure 4), that this can’t account for the lack of turnover among industry leaders since 2000, and was found insignificant in the modeling. Similarly, lobbying expenses do not appear related to the persistence of top four firms.

What has caused the sharp decline in industry disruption since 2000? The underlying factor contributing to the absence of industry disruption appears to be the ability of well-equipped firms to sink large investments into intangibles, specifically in self-developed software and internal R&D. For example, economies of scale have been identified in large firms’ use of IT. Firms which invest in their proprietary software, big data, and IT capabilities are able to gain advantages over their competitors because of the low marginal cost associated with technological improvements. The economy of scale benefits enjoyed by lager firms (such as the management of highly complex systems) are not realizable by smaller firms. A rapid increase in sunk cost intangible investments has allowed large firms to differentiate themselves and diffuse the benefits of internal innovation throughout their firms at the expense of the smaller firms. This makes upward mobility in sales more difficult for rivals to the dominant companies.

The outcome, the authors conclude, is the rise of “a natural oligopoly” enabled by technology. While technology and innovation were significant contributors to industrial dynamism and disruption in the past, the authors state “now, it seems, information technology allows dominant firms to suppress their own ‘creative destruction,’ decreasing disruption in this particular dimension.” They further postulate a risk of top firms using technology in a more predatory manner or, as phrased in the paper, “with an eye toward ‘business stealing’…. While this technology may deliver productivity benefits today, it is not clear that it will diffuse through the rest of the economy ....”

The authors note the social welfare policy implications of the decline in industry disruption are ambiguous, yet it easy to imagine a world in which low-income consumers and households suffer disproportionately compared to their wealthier counterparts. For example, households with lower income tend to suffer greater welfare losses from lack of competition and displacement in the supermarket industry. Aside from the social implications, anticompetitive behavior also has the capacity to shun new firms from entry, slow job growth, and yield predatory pricing habits. If the trend of declining industry disruption continues, there is a risk of diluting the dynamism of the U.S. economy and the fear of funneling innovation and new ideas through just a few large firms arises.

Besser et al. are not convinced conventional antitrust law can address this unconventional problem. With the insights offered by this paper and other research challenging continued use of  Schumpeterian competition to explain the 21st century economy, policymakers will have to determine the social and economic prices of declining industry disruption and rising oligopolies in globally competitive markets.