New technology creates opportunities as well as adjustment costs.
Product innovation can create a new or improved offering; process innovation can reduce resource use or improve production. Research and development is uncertain and uses resources before gains are assured. Technological disruption can introduce new competitors or make an incumbent's assets, skills or business model less valuable. Competitive pressure can encourage innovation, while market power may supply funds but also reduce the pressure to improve. The balance depends on whether the firm can keep enough of the innovation's benefits rather than lose them to copying, as well as finance, rivalry and the type of innovation; no market-structure label guarantees the outcome.
- Product innovation
- A new or improved product changes what the firm offers buyers.
- Process innovation
- A new production method changes how output is made; for example, software may reduce the time needed for each job.
- Uncertainty
- Research and development (R&D) investigates and develops new ideas. It uses resources before success is known, and adopting a technology can require training and installation.
Apply the distinction
Disruption
New technology can alter entry barriers and demand or reduce the value of existing assets.
Incentive versus ability
Competitive pressure and potential rewards affect incentives; finance and skills affect ability. Market structure alone settles neither.
Worked example: Will new software repay its cost?
A document-printing firm considers software that automates job preparation. Installation and training cost $4,000. If successful it saves $600 of relevant cost each month for ten months, with sales and other costs unchanged. There is also a possibility of savings of only $250 per month. For this simple comparison, add the monthly savings directly without adjusting future money for when it is received.
- Under the successful forecast, savings total 10 x $600 = $6,000. After the $4,000 outlay, the gain over ten months is $2,000. This sets aside discounting: adjusting future amounts to a value today.
- At $250 monthly savings, the total is $2,500 and the project loses $1,500 relative to the alternative.
- The firm should investigate compatibility, staff training and actual workload rather than assume automation always pays for itself.
- A rival online service could also reduce demand for printed output, changing the value of the investment. Lower processing cost does not guarantee enough future sales.
Watch out for this
Only firms with monopoly power can innovate.
Finance and incentives matter, but small or competitive firms may innovate too. Specify the barriers and opportunities in the case.
Check your understanding
With a $4,000 outlay and ten months of $600 savings, what is the net gain over the stated undiscounted comparison?
- $6,000.
- -$1,500.
- $2,000.