The organization of innovation and market dynamics: Managing increasing returns in software firms

Many contemporary markets, particularly markets of information technology products and information services, are characterized by increasing returns, including those resulting from bandwagon and network effects. At the same time, in larger firms, innovation often takes place in distinct units that are semi-autonomous and that have the responsibility for more than one phase in the product development process. In the most extreme case, a separate profit center is created within which research and development (R&D), production, marketing, and related activities are fully integrated and that has its own responsibility for external relations: an internal innovative venture. The central issue in this paper is the relation between the way firms organize their innovative activities and the market dynamics caused by bandwagon and network effects. We focus on the decision-making actors and we propose a categorization of causes of increasing returns and definitions of bandwagon and network effects that are consistent with this aim. We investigate the extent of internal autonomy of the unit, the extent of the integration of R&D, marketing and other activities in the product development process, and the extent of external autonomy. Three cases of projects creating software products, two of them in the same firm, demonstrate that the organization of innovation and the dynamics of the market are mutually dependent. More in particular, we hold that higher autonomy of teams, particularly in managing external relations, is important to cope with and manage bandwagon and network effects.

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