Soft but Strong: Software-Based Innovation, Product Market Competition, and Value Creation in the IT Hardware Industry
46 Pages Posted: 10 Jan 2019
Date Written: December 31, 2018
The emerging dominance of software as a differentiating factor within the manufacturing sector has received some attention in the literature but the specific pathways by which this occurs is still unclear. In this paper, we examine the pathways by which software-based innovation provides value for information technology hardware firms in the U.S., specifically through the mechanism of software patents and their influence on product market competition. Using the data of over 159,000 patents by 459 public IT hardware firms in 1996-2006, we first show the value-creating role of software-based innovation: patents that incorporate or build on software intellectual property are more frequently cited and more likely to be renewed for legal protection. Consequently, firms that possess patent stocks with greater software intensity achieve greater market value, measured by Tobin’s Q. In terms of mechanisms, we find that the greater software-based innovation within the firm is associated with less competition in product markets: increases in software intensity correlate with significant reductions in the similarity of product offering relative to that of rivals and the number of effective competitors in the market. This software-based differentiation benefit accrues disproportionately more to specialized hardware firms, relative to diversified firms. This differentiation effect appears mostly with software patents that are embedded within hardware products or devices, so as to reinforce their functionality. Our research contributes to the emerging literature on software-based innovation and the pathways by which software continues to transform other industry sectors, specifically through product differentiation.
Keywords: sotware, patents, innovation, information technology, hardware, product market competition, specialized firms, diversified firms, econometrics
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