The by which innovation destroys existing firms and

The Schumpeter’s Effect:Joseph A. Schumpeter an Austrian-born American economist and political scientist who became known for his contributions to economic theory in the area of innovation and entrepreneurship. This entry introduces Schumpeter’s philosophy as well as his theoretical construct of creative destruction. He is often credited for starting modern growth theory that is based on the inevitable by-product of the process of development and innovation. Schumpeter’s description of the innovation process and its diffusion continues to be characteristic in the contemporary knowledge- and technologically driven global economy. Schumpeter’s creative destruction and three firm reactions to innovation:• Exit, • Switch and• The Sailing Ship EffectCreative destruction was Schumpeter’s term during 1943 for the process by which innovation destroys existing firms and their technologies.

It includes the process of substitution of a new technology for an existing technology for some defined market. Schumpeter had nothing to say about the possible reaction of the established firms to this process, but we know from work in the management area that there sometimes is an active response to the threat of creative destruction (Cooper and Schendel 1988, Cooper and Smith 1992, Foster 1988). From this literature we can identify three generic strategies of response to the process of substitution, which can be referred to as exit, switch (to the new technology) and the sailing ship effect (the acceleration of innovation in the old technology in response to the threat from the new). Before we analyse this last we should say something of the other two.

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‘Exit’ may of course be a forced outcome of creative destruction, via liquidation. However, it is a strategic response if the incumbent firm anticipates problems from future innovation and elects to exit the threatened market early and to its advantage over ‘forced’ exit.The decision to ‘switch’ from the old to the new technology is particularly interesting and has been the focus for the papers cited above, especially Cooper and Smith 1992. This paper examines eight product lines that experienced substitution effects; these range from ball point versus ink pens, to diesel-electric versus steam locomotives.

Much of the analysis concerns the behavior of 27 established firms, selected by Cooper and Smith for their dominant market position in the old technology. All of these entered the new technology, but few managed to establish as dominant a position in the new technology as they had in the old. A diverse range of problems faced those wishing to switch; these included the problems of internal groups which recognized that the advancement of the new technology threatened their expertise and power; to the problems of judging how the new technology would develop and which old competencies could be retained and which should be shed.Technology S-curveThe technology life cycle which is concerned with the time and performance of developing the technology, the timeline of recovering cost, and modes of making the technology yield a profit proportionate to the costs and risks involved.

The four phases of the technology life-cycle:1. Research and Development (R) phase:  when incomes from inputs are negative and where the prospects of failure are high2. Ascent phase when out-of-pocket costs have been recovered and the technology begins to gather strength.

3. Maturity phase when gain is high and stable i.e. the region going into saturation 4.

Decline phase of reducing fortunes and utility of the technology.

Author: Rita Johnson


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