Benefiting from Rivals’ Breakthroughs

A company's market value actually increases when its known rivals innovate.

Common sense would dictate that a competitor’s breakthrough is bad news for a company. But the company’s investors might think otherwise. Anita M. McGahan, Everett W. Lord Distinguished Faculty Scholar and professor at Boston University’s School of Management, and Brian S. Silverman, J.R.S. Prichard and Ann Wilson Chair in Management at the University of Toronto’s Rotman School of Management, studied U.S. patent filings by 4,168 companies from 1975 through 1999 and subsequent moves in the capital markets. As expected, they discovered that when a company files a patent that is important — a breakthrough that is cited by many subsequent patent filings — its investors are enthusiastic. But they found that a company’s investors are also upbeat when one of its established competitors files an important patent. The company’s “Tobin’s Q” — the ratio of its financial market value (think stock market capitalization plus outstanding debt) to the replacement value of its assets — tends to increase when those filings are announced.

So to the extent that investors’ sentiments include rational expectations of how the company can generate commercial value from its assets, an innovative competitor is a good thing. A breakthrough could lead to lucrative new market segments, areas in which a company might find new growth, even if it is not the initial leader.

On the contrary, when innovation is introduced into an industry from outside its circle of recognized competitors, it sends an entirely different message. Outsiders — whether they are university researchers, tinkerers in their garages or corporate research and development centers — have more potential to turn market dynamics upside down, it would seem. New telephone technologies like cellular phones and Voiceover Internet Protocol telephony, for example, threaten the business model of existing telecommunications providers. Thus, investors aren’t so keen when a new player owns an important piece of intellectual capital, be it a technology or a business method.

But outsider innovators don’t always have the upper hand. “Industry structure is critically important to who wins from innovation,” says McGahan. “The relationship among industry structure, market power and innovation is something we need to understand better.”

Industry structure includes the importance of patents and of complementary assets, the authors explain in their 2006 paper “Profiting from Others’ Technological Innovation: The Effect of Competitor Patenting on Firm Value,” a paper that has been accepted for publication in Research Policy.

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