How do you kickstart innovation? Here are some pointers

Beyond the law of supply and demand, one of the few things that most economists and policymakers agree on is that innovation is a very good thing. Most authorities acknowledge that the tremendous gains in lifespan and living standards made over the past 300 years have been largely the byproduct of human ingenuity.

The question is: how do we get more of it? Here the consensus breaks down. In some places, deep state involvement has helped. In others, benign neglect seems to have made all the difference. Culture, systems of capital formation, and the technology in question have all had varying impacts on innovation and its diffusion. But there do seem to be a few things that almost always help generate more innovation.

Build an Entrepreneurial University System

Universities tend to have an outsized impact on innovation, not so much directly—although major research universities do produce a steady stream of patents—as indirectly, largely because they tend to lead to communities that are home to a steadily replenishing supply of the kind of highly educated young people who are useful for research-intensive businesses.

At the top of the charts is Stanford University. A 2011 study of 143,482 alumni by Sequoia Capital found that Stanford alumni have founded 39,900 companies, which are collectively worth roughly $5.4 trillion. If they could somehow band together, these Stanford-parented companies would be the 10th-largest economy in the world—and that’s not counting the founders of some of the largest companies founded by Stanford alums, including HP, Cisco and Google, who did not respond to the survey.

Despite its unusual degree of success, Stanford remains a useful example, because a number of factors seem to have gone into its success as an engine of innovation. One, a lot of the professors have been entrepreneurs at some point. Two, the university has long cultivated ties with the community around it, through extensive internship programs and joint projects with industry and entrepreneurs. And three, for a long time, the university has sponsored new business competitions and classes on how to start up a business. Forty percent of alumni respondents who went on to found businesses said they had participated in one or more of these programs.

Policymakers everywhere have taken note of the outsized number of business innovations produced by Stanford and other leading universities—particularly in China. In a 2011 presentation, Lou Jing of China’s Ministry of Education, noted that the country was working to develop a knowledge innovation system that is “business-based, market-oriented, and comprised of industry, academia, and research”. The evidence suggests that the government is following through on creating a system with plenty of interchange between the public and private sector: 40% of all research at China’s fast-growing universities is now funded by business, according to Lou.

Think Small

Although major enterprises sometimes come up with important new ideas and have the scale, for instance, to undertake major research projects the way IBM has, for instance, with its massive Watson supercomputing system, a number of studies suggest that innovation tends to be inversely correlated with the size of the firm.

One recent Stanford study, for example, found that companies tend to file more patents before an IPO than after. After analyzing and rating the quality of 40,000 patents filed by companies that either had an IPO or planned to have an IPO between 1995 and 2003, Assistant Professor of Finance Shai Bernstein found that companies experienced, on average, a 40% decline in patent quality after the IPO.

If innovation is most prevalent in small firms, then the thing to do might seem to be to encourage more small firms. Yet in the developed markets at least, labor market laws tend to encourage workers to prize employment with a large firm rather than a small firm, creating a kind of disconnection between what society needs and what the legal structures support.

Ton Wilthagen, a professor of labor law at the University of Tilburg in the Netherlands, argues that one important step would be the creation of more supportive institutions for small and medium-sized enterprises. The “SME United” system he proposes would make it easier for companies to share employees and offer shared services that would make it easier for small companies to expand without increasing their administrative overhead.

At the same time, such programs might be used to reinforce a region’s growth, by helping to give it a single identity. “Networked companies are in general the future, so why not label them and present them more specifically that way?” asks Wilthagen.

Big firms have tried to respond to the disadvantages of their scale in several ways. One is by partnerships with venture funds, as a way to gain insight into new ideas. Another is that large companies have become increasingly good in recent years at essentially harvesting start-ups and incorporating their best people and best ideas into their own company. Such acquisitions have become so routine in technology for big companies that some observers now argue that it’s inaccurate to think of many start-ups as start-ups any longer.

Venkatesh Rao, a Seattle-based tech commentator, recently suggested that you can even look at most of today’s tech entrepreneurs as “the new labor”. He argues that “the balance of power between investors and entrepreneurs that marks the early, frontier days of a major technology wave (Moore’s Law and the Internet in this case) has fallen apart. Investors have won, and their dealings with the entrepreneur class now look far more like the dealings between management and labor (with overtones of parent/child and teacher/student).”

Finally, many companies have tried to create opportunities for “intrapreneurs” to start new ventures internally, but set apart from the rest of the company. Google gives its workers this kind of creative autonomy, by allowing its technical talent to spend 20% of their time working on projects of their choice. Look For an Unfair—But Not Too Unfair—Advantage.

Success in business tends to be built upon some kind of unfair advantage: you own better land than the farmer next door. Your guild has knowledge of some kind of hard-to-master expertise. Your burgers have a secret sauce.

Success in building an innovative society seems to work in a similar way, by building on earlier expertise. In China, as in Europe, many of the most important industrial clusters have roots that stretch back centuries. Zhili Township in Zhejiang, for instance, has been an important weaving center for hundreds of years—it even means “weaving town” in Chinese. Innovations happen in places likes Zhili as firms compete against each other, and because over time they themselves begin to constitute a market with specialized needs, and suppliers grow up around them to fill those needs—who again begin to specialize.

Comparative advantage tends to be at the root of most innovation success stories in the developing world, according to Jean-Eric Aubert, a retired innovation specialist for the World Bank Institute. “These advantages may result from natural endowments (a wine-friendly climate in Chile), human resources (a cheap, educated labor force in Vietnam), or market positioning (Romania’s proximity to East European markets),” he writes.

New infrastructure can serve a similar role too, by creating the context for a new ecosystem, such as a highway, a cellphone network, or the Internet.

Paradoxically, the companies and individuals who are best at innovation are also best positioned to kill it or at least slow it down. As they gain more control over the market, they become increasingly well positioned to constrain their competition, particularly when they are backed up by strong intellectual property laws. “IP was invented to encourage innovation and as you know it worked,” says Cedric Manara, Associate Professor of Law at EDHEC Business School, Paris.

Manara argues that the system in Europe has gone too far. For example, where a book could once be protected for a few dozen years, copyright protection in Europe extends now for 70 years after the life of the author—despite the fact that the average economic life of most books is no more than 14 years.

At the same time, the increasing breadth of patents creates constraints on innovation as well. In France, a recipe for a salad has been patented. In the US, business processes, such as Amazon’s ‘one click’ purchasing, can be patented.

Such extensions essentially serve as a kind of tax on newcomers, Manara says, by inhibiting new innovations. Increasingly, there are even people who would collect vague patents in areas that will conceivably develop, then sue for infringement when a workable invention does come along.

Such “patent trolls” or “patent pirates” had become a kind of cottage industry in the US in recent years, until a 2011 patent reform act clamped down on the litigation. The “trolls” would open an office or a post office box in east Texas, to establish jurisdiction in an area presided over by a federal judge known to favor patent-holders’ rights, and sue deep-pocketed tech companies in the hopes of a settlement, “routinely doling out megamillion-dollar verdicts to patent holders.”

Even now, however, some companies are pursuing strategies that involve buying up patents not for use, but to force a license down the line. Intellectual Ventures, for instance, a company co-founded by Microsoft alum Nathan Myhrvold, reportedly continues to pursue this controversial strategy, which as Open Innovation theorist Henry Chesbrough has told CKGSB Knowledge, makes the firm “very close to a ‘patent troll’, if not a patent troll.”

In a world where IP protection can sometimes have such perverse outcomes, some observers have questioned whether it stunts more innovation than it encourages.

Manara, for one, isn’t sure if the end of IP rights would be the end of the world, and cites the example of Linux software language and the Android operating system, both of which can be used free by anyone, as examples of an alternative model.

What would happen if this were a more general model? “Maybe it wouldn’t be an earthquake,” Manara concludes.

China has seen successful examples of companies that began as copycats and later evolved into innovators in their own right. Tencent, for instance—recently named China’s most innovative company by US tech magazine Fast Company—grew to prominence allegedly through “shanzhai”, or copying many leading Internet sites and services.

One reason is that your competition may be able to copy things just as well as you do: Ganji.com, a Craigslist knockoff, for example, had to make a number of changes to the founder’s idea of emulating Craigslist, the free American listings site, in order to build a defensible niche in the Chinese market–and fend off 2,000-3000 other large and small copycats at the same time.

In some circumstances, in fact, intellectual property protection may actually discourage more competition.

History does offer at least one example of the advantages of weak IP rules. German historian Eckhard Höffner has argued that Germany caught up with Britain technologically by the end of the 19th century in part because unlike Great Britain, which had a copyright law beginning in 1710, Germany had no general copyright law until well into the 1840s.

The result, he theorizes, was not that people stopped writing, but that they published more and sold more copies at lower prices. In 1843, for example, Germany published about 14,000 different titles—mostly technical and scientific papers—at the same time as Great Britain published 1,000. As a consequence, innovations were adopted much faster in Germany than Britain.

From a societal point of view, the German example would suggest that the royalty on the idea matters less than the dividend. Or as the French avant-garde filmmaker Jean-Luc Goddard puts it, “It’s not where you take things from—it’s where you take them to.”

(Image courtesy: Flickr user Zetson’s photostream)