Morgan Williams and Dr. David J. Bryce, Department of Organizational Leadership and Strategy

Substantial friction exists in markets when sharing new innovation or realizing the gains that arise from innovation. This friction may create suboptimal outcomes for broader society because it can lead to situations in which the best innovations are not widely shared. For example, it is well-known that large, well-resourced technology firms often patent far beyond their target product markets in efforts to stave off competition from new or upstart entrants. Some of these incumbent firms also engage in alliances with innovative smaller firms with the explicit intent to suppress or exploit innovations emerging from the alliance. This has negative consequences for society because it means that the best ideas may not be brought to market in a timely way.

Often, small firms are unaware of these hazards. This paper clarifies the theoretical tensions at play to identify a set of conditions that help to resolve some of this market friction. In particular, this project will specifically seek to answer the following question: Under what conditions is it beneficial for a small firm to partner with a stronger firm or rival for new innovation? An analysis of empirical and scholarly research yields little guidance or direction for small firms in this partnership dilemma. We present an analysis of the differing economic incentives for large and small firms during collaboration and the implications for profit appropriation.

Due to fear of expropriation, small firms may actively avoid technology partnerships with large firms, which may result in the suppression of Schumpeterian competition, economic loss to society, and in limited partnerships between large and small firms. We intend to supply theoretical arguments to explain the conditions under which small firms may benefit or suffer from alliances with larger partners. The weight of evidence suggests that incentives for forming research and development licensing agreements are misaligned except in three unique cases, which will be outlined later in this paper. The arguments surrounding the forming of technological partnerships have strong strategic policy implications; our research will serve as a guide for small firms in their economic decision making and advancement.

The scope of this paper does not allow for an examination of joint-management conditions or regulatory conditions brought about by a partnership with private equity or government. Instead, we examine the primary source of capital: other corporations. The small firm may be attracted to the capital of the large corporation; however, this capital often comes with conditions which may ultimately prove costlier than the benefits attached to it. Unfortunately, the difficulty in accruing capital, expertise, and experience often drives small firms to discard the innovation through license or sale. However, conditions exist where it is strategic and profitable to partner with another firm.

A small entrant firm faces far greater challenges from incumbent rivals and marketplace constructs, including predatory behavior and unenforceable patent law. Within the technological marketplace, a large, established firm has greater access to capital and developmental resources. This allows the firm to engage in a strategy of information capture, erecting barriers to protect market share. These barriers can be erected when innovation safeguards are ineffective, or when it is too costly for the small firm to pursue litigation against the larger firm for infringement. In addition, with plentiful resources to battle legal reprisals, a large firm could copy the innovation directly without fear of legal repercussion. Alternatively, the large firm could imitate the innovation by information that is gleaned from near-observation. In all, the evidence suggests that large firms often suppress the diffusion of information to protect market share.

In this exchange the small firm is at an inherent disadvantage. As indicated by Arrow’s Paradox, a small firm often must reveal its innovation in exchange for partnership with a large firm. The small firm is often reluctant to show the idea, but the other party is unwilling to go forward without seeing it; this is essentially a condition where Arrow’s Paradox holds true. Without sufficient protection this sharing is risky for the innovator; the idea could easily be copied or held hostage by the stronger rival. In addition, only a temporary period of patent/confidentially protection exists. If the small firm has reason to doubt the strength of the patent protection for its innovation, it will be less likely to patent and bring the idea to market.

Considering all of these difficulties, when would it be worthwhile for a firm to partner with a larger rival? The history of the American marketplace does not evidence the sustainability of a few ever-dominant firms. Incumbent corporations have not been the exclusive holders of all intellectual capital through time. Instead, scholars affirm that the disruptive nature of the “entrepreneurial imperative” has powered American business success. In other words, “good ideas are not the province of the privileged few” (Bryce 2). Despite all of the precarious difficulties that exist, history suggests that small firms still partner with larger rivals; therefore, unique cases do exist in which profitable and effective partnerships can be formed between large and small firms.

Businesses do not exist in a static, defined world, and in certain cases, the incentives of large and small firms will align. This can occur for several reasons. First, a small business can profit from collaboration when the nature of its knowledge or innovation advantage can be easily copied and cannot be protected by a patent or other barrier. This advantage may only hold, however, for a brief period of time before it is trumped by another market player. In the development of ethanol products, for example, the industry does not utilize one exclusive supplier. Using corn as the primary input, the industry has attracted many suppliers and producers of this increasingly popular energy source.

Second, a small and large firm could benefit through partnership if market efficiency is in play and other firms are “rushing to market” to develop a similar product. Collaboration would be beneficial to facilitate a first mover advantage, and an alliance would likely form due to the profit incentive for the two firms at the expense of others in the market. The small firm would need the distribution channels and other resources of the larger firm in order to beat the competing firms to market.

Finally, if the product is truly unique and is adequately protected by law, the small firm could safely share the innovation with potential partners. Evidence suggests, however, that this occurs only in certain industries, and primarily only in which a distinct product or prototype can be developed.