Leap of Faith? How Diffusion Dynamics Obfuscate the Commercial Potential of Novel Innovations

Abstract

This study offers a demand-side explanation for why many novel innovations succeed despite initially small observable market sizes. Diffusion theory suggests that the ambiguity of relatively novel product innovations leads potential customers to base their adoption decisions more heavily on others' adoption. As a result, a significant portion of demand only materializes post-diffusion. I posit that this dynamic obfuscates the true commercial potential of novel innovations when estimates are based on pre-launch observable demand. Agent-based simulations support this theory, showing that novel products outperform non-novel ones with similar initial market sizes. I also explore the model's implications for firms' innovation selection processes. The findings complement supply-side strategic innovation theories and highlight the limitations of heavily relying on data-driven, observable market demand in innovation.

Keywords: innovation, demand-side strategy, diffusion, innovation selection, behavioral strategy, data-driven decision-making

JEL Classification: O31, O32, D83, M1, M31, L26