Innovation and Industry Shakeouts

Many industries were initially populated by a large number of competitors but subsequently experienced a pronounced decrease or shakeout in the number of producers. Such shakeouts are common in manufacturing industries, with the number of producers often dropping by 50% or more during the formative eras of new manufacturing industries [9, 12]. This paper summarizes the findings of a more detailed investigation [ 13] concerning the role of technological change in causing shakeouts. Three recent models of shakeouts featuring technological change were used to guide our investigation. In one theory [ 10], which we label the innovative gamble theory, an initial period of entry is followed by a major innovation or trajectory of innovations made possible by technological developments outside the industry. The major innovations are challenging to develop, providing the basis for the innovative gamble. Some firms may enter if the gamble is sufficiently attractive. Incumbents and entrants that are unable to develop the innovations lose the gamble and exit, contributing to a shakeout. As unsuccessful innovators exit, the rate of exit subsides and the number of firms stabilizes. Entrants during the shakeout have lower survival rates than preshakeout incumbents due to their lesser experience, but over time these differences in survival rates diminish as unsuccessful innovators exit. In the second theory [20], firms initially enter based on novel variants of the product, but subsequent experimentation and investments in complementary goods lead to the emergence of a dominant design for the industry's product. Competition then shifts from product innovation to improving the production process for the dominant design as firms no longer fear that investments in the production process will be rendered obsolete by major product innovations. This leads to a marked rise in process innovation and a decline in product innovation. Entry based on novel product variants becomes more difficult and less able process innovators exit, contributing to a shakeout. Similarly to the first theory, firm exit rates eventually subside as the least able process innovators exit. Also similarly to the first theory, entrants during the shakeout initially have higher exit rates than preshakeout entrants due to their lesser experience, but over time these differences diminish as firms gain experience and the least capable innovators exit. In the third theory [11], shakeouts are not triggered by particular technological developments but are part of a broader evolutionary process in which technological change gives rise to increasing returns. The key idea of this theory is that larger firms earn greater profits from R&D, particularly process R&D, because