How Start-Up Firms Innovate: Technology Strategy, Commercialization Strategy, and their Relationship

Abstract

A successful start-up firm makes two important strategic innovation choices during its early life. It must decide upon a 'technology strategy' -- whether to specialize or generalize in the allocation of its research and development efforts -- and a 'commercialization strategy' -- whether to cooperate or compete with incumbents to secure the investment it will need to commercialize its inventions. In this paper, I advance a 'system vs. components' theory of innovation, which supposes that technological products are based on systems of complementary components. A pattern of specialize-and-cooperate and generalize-and-compete then occurs naturally as entrepreneurs maximize their expected profits given both the available technological opportunity and the state of technology in their industry. I derive measures of technology strategy for patent-holding start-up firms, and use the choice to sell the firm in an acquisition or to raise investment through an initial public offering (IPO) as prototypical examples of cooperate versus compete commercialization strategies. I then show that measures of technology strategy Granger-cause commercialization strategies in cross sectional analyses. I also address the endogeneity issue that arises because forward-looking start-up firms chose their technology strategy in anticipation of their commercialization strategy by using the introduction of the 2002 Sarbanes-Oxley Act (SOX) as a shock to the relative costs of an IPO. I provide evidence that successful start-up firms altered their technology strategies to favor component specialization following the introduction of SOX.

Keywords: Start-up Firm, Patent, System vs. Components, Complement, Substitute, Initial Public Offering, Acquisition, Sarbanes-Oxley, Venture Capital

JEL Classification: O3, O12, M2, L2, G34, G38, D2, G24