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10.1 What Is Innovation?

The reduction of transaction costs is a measure as well as a goal of innovation.

Innovation is indispensable to increase sales through matching new market needs and new technologies, in order to revitalize the saturated economy. This is a significant issue shared among the developed countries. However, it is difficult to define innovation because its meaning tends to be taken widely due to its versatile importance. The classic definition of innovation advocated by Joseph A. Schumpeter back in 1934 is used in almost every study on the topic. Innovation, according to Schumpeter, is “a new combination of means of production—that is, as a change in the factors of production (inputs) to produce products (outputs).”Footnote 1 Although production is the main concept here, too, due to the aforementioned background in Chap. 7. it is clear that no change occurs from production per se, and in order to raise a social impact, the sales (usage) of the product are indispensable. In other words, new transactions in large quantity bring a significant change to the society, and the volume of the new transactions determines whether it can be called an innovation or not.

However, the significance of transactions for innovation is more than that. In this chapter, summarizing this book, innovation will be examined through applying the aforementioned concepts. It will come up with the conclusion that promotion of innovation corresponds to the reduction of transaction costs.

There are only two ways to create new transactions for innovation. One is to develop a new product or a new technology that has not been supplied before. And the other is to enable new transactions of existing goods that were not transacted due to high transaction costs despite the fact that the demand and supply have existed.

In Japan, especially where innovation was interpreted as technological innovation, the idea that innovation should be led by new technologies has dominated, which further led to the idea that innovation is the development of new products from new technologies, the former of the two ways above. However, as explained through this book, the core of the globally progressive innovations is the latter, namely, technologies, products, and services that have led to the reduction of transaction costs.

The innovation by the reduction of transaction costs is literally focusing on the reduction of transaction costs per se. As the reduction of transaction costs and the introduction of fixed interfaces have an enormous impact on the society and organizations, huge obstacles are also being raised. During the establishment of interfaces, including social standards, modules, and systems and processes in organizations, vested rights shift, leading to political mechanisms that reject such innovations. As an illustrative example, this explains the failure of the B2B marketplace in conservative industries as well as the rejection of modules in the automotive industry. In other words, achieving innovations is in the double-layered structure, where organizational and/or social innovations are necessary first before creating business innovations. Ultimately, this makes innovation more difficult.

As for the former one, developments of new products and new technologies also correspond to the reduction of transaction costs per se as further explained below.

Metaphors like “Devils River,” “Valleys of Death,” and “Darwinian Seas” are often used to express the difficulties of the process of creating a new business from a new technology—that is, how difficult innovation is. “Devils River” refers to the difficulty of the processes between research and product development. “Valleys of Death” refers to the difficulty of the processes between product development and business development. “Darwinian Seas” refers to the difficulty of the processes between business development and business success.

The common obstacle in the river, valleys, and seas is that ideas leading to innovation are not easily conveyed or disseminated. In order to achieve an innovation success (e.g., great profit from commercialization), an idea needs to be understood by other people who decide that exchanges (transactions) of their resources (investment, effort, and/or introducing personal connections) for the idea (which is expected to lead to compensation or fame in the future) must occur. Furthermore, it has to occur in a sequential manner among all the related parties with different backgrounds, knowledge, and interests. The transaction here consists of each of the transaction elements, such as searching for such parties, presenting/collecting information regarding the idea, collecting information on the parties, negotiating and adjusting for mutual agreement, clearly stating the conditions of the exchange as a contract, carrying out education and support for execution, and monitoring the progress. As for ideas that were judged as unpromising, the transactions will be screened out.

As one’s own resource is to be invested on an idea that will not bring any profit in the short term, this transaction is hardly realized. Since no one knows the future for sure, people do not like to take risk for the sake of new, unknown matters. In addition, as current transactions need to be replaced by the new one in many circumstances, opportunity costs are incurred. During commercialization, the cost of replacing existing fixed interfaces in organizations is added, the result of which increases risks and strengthens oppositions. Even the realization of ordinary transactions is not easy; the transactions for innovation have the difficulty of having to invest on something with uncertain value and further need to be repeated through numerous people. Even if any single transaction among a huge number of such difficult and sequential transactions is missing, one small idea will not constitute a business innovation.

In the first place, most of the ideas claiming to be innovative are valueless. If by any chance there exists a seed of innovation that can actually be realized (thus should be realized), it is important to implement it before the competitors do; then the issue becomes whether the transactions of acquiring necessary resources (including human resources) can possibly be executed or not.

In this way, the reduction of transaction costs is not just the core goal of innovations in the global economy today but also the measure to realize innovations.

10.2 Promotion of Innovation Through Reduction of Transaction Costs

Reasons behind the difficulties of transactions for realizing an innovation are the low frequency and the shift of vested rights.

10.2.1 Difficulties of Innovations from Transaction Perspectives

The difficulties in innovation transactions are due to their low frequency and the shift of vested rights.

Examples of open innovation in which aforementioned transactions are executed successfully and sequentially were given in Chap. 1. The examples show that if transaction costs are small enough, an individual’s information is easily conveyed to others. Then it is spread further to many more with value added. During these processes, one path may reach innovation; the lower the transaction costs are, the higher the probability becomes. On the other hand, if the transaction costs are larger, the probability of the success becomes smaller.

The following two characteristics make the transactions of innovation more difficult than ordinary ones:

  1. (1)

    Frequency of the transactions is low.

    From the definition of innovation, it is characterized by novelty, which corresponds to nothing but low frequency of the occurrence. If the frequency is low, it is difficult to introduce a fixed interface to reduce transaction costs.

  2. (2)

    It replaces existing resources (existing products or related human resources).

    Innovation is explained to create new markets, but in today’s saturated markets, it actually means a replacement of some sort of existing resources. At customers, existing products are excluded, and at companies, the human resources who were in charge of the existing products may become displaced. This comes to the shift of vested rights, political refusal, and oppositions. It is understood as the “dilemma of innovation” especially when the vested rights of a former successful man are enormous in particular; however, in reality, every micro innovation results in refusal and oppositions.

If all the sequential transactions from ideas to commercialization are executed smoothly and efficiently, the probability of innovation increases. However, all the transactions are difficult with frictions due to the reasons above and become even more difficult than the individual transactions explained in Chap. 9. Thus, precise interface designing is indispensable.

Two cases—social transactions with a focus on promoting venture start-up companies: organizational transactions within a company developing new products and new business—will be discussed below.

10.2.2 Improvement of Transactions: Venture-Related Innovation in the Society

Venture start-up companies will be developed with the improvement of the related transactions.

10.2.2.1 Transactions of Financing

Funds are indispensable prior to commercialization. Most of the necessary resources can be acquired if a company has enough funds. If the transaction interfaces of financing commercialization are prepared, the probability of successful venture-related innovation increases significantly.

The establishment of financing systems of risk money (venture capitalists, angel networks, project finance, and diversified financing methods) is important among companies. As for fixed interfaces to reduce the transaction costs of the finance, matching platforms between the investors and the start-up companies and information transmission on each transaction element should be standardized (e.g., standardized presentation of business plans).

10.2.2.2 Transactions of Resources Procurement

Although most of the necessary resources can be procured with enough funds, funds are extremely limited in most cases. In order to appeal to expensive skilled employees when launching a business, in particular, establishing a transaction interface of trust as an emotional solicitation method such as enthusiasm and dreams becomes necessary.

However, many fixed interfaces that assist in the procurement have been appearing on the Internet. For example, LinkedIn standardized human resources’ database/network and has increased its popularity worldwide. Whether they know each other in advance or not, various job offers and job-hunting information are widely shared. Because the information is accurate and abundant, it has contributed greatly to human resources procurement.

Also, transactions of procuring business support functions such as lawyers, patent attorneys, certified tax accountants, overhead operations (e.g., accounting, general affairs, and IT), and various consultants became easier through various online matching websites. AnnaLee Saxenian asserted in her previously cited book Regional Advantage (Saxenian 1994) that networking was the key success factor of Silicon Valley companies in the 1990s. Interfaces have become stratified on the network and have advanced significantly from that time.

10.2.3 Transactions for Business Innovation Within a Company

Innovations within a company may be promoted by improvements of the related transactions.

Seeds of technological innovation in a company are usually developed by an R&D department. The significant issue here is how to manage the balance between freedoms in inspiration (allowing any subject one desires) versus limits from marketability and feasibility in order to facilitate innovations. Thus far, there exists a general tendency of ignoring the marketability and feasibility due to the difficulty to evaluate them (effectiveness). However, the number of valueless researches has increased excessively from such lack of management and interference, while the freedom of such researchers has become a part of vested rights. The decision on objectively screening off projects that have lower possibility of innovation becomes important for promoting successful innovations. As for marketability and feasibility, an information-sharing interface between each researcher and the director based on the viewpoints of potential market size, expected penetration, expected own market share, and cost prediction can be useful, namely, Pro Forma. In addition, fixed interfaces of project management that monitor and manage the progress of technology development should be shared (e.g., the phase gate model).

Also, as resource efficiency in commercialization increases when the seeds of innovation from R&D match the needs of business divisions, the establishment of matching interfaces between R&D and business divisions is effective. For example, business divisions may fund seed projects in R&D that match their market needs and, in return, R&D accepts their requests derived from their business development.

Recently, in addition to seed development in R&D, companies have increasingly introduced business development systems focusing on marketing ideas-driven innovations such as new business plan contests and intrapreneurship systems. When the cost expenditure on these trials increases, the probability of innovation occurrence also increases obviously. However, it does not imply simple increase in amount, of course; rather, it is a significant managerial decision for the investment trade-off between current operations and innovation.

The interfaces of the cross-functional team, introduced in Chap. 1, cover most of the transactions that occur during the process of commercializing the seeds of innovation, which include “how to propose an idea of innovation,” “who should evaluate it and how,” “how to organize the team in charge,” and “who authorizes the implementation and how.” If a company puts emphasis on innovation rather than current operations and fixes these interfaces properly, then the numerous transactions in the commercialization process become smooth and efficient, resulting in significant increases in the success probability.

10.3 Structure of Innovation Breakdown

Innovation is doomed to breakdown. Without the capabilities to solve the structure, it is impossible to overcome it.

In spite of the significance of innovation, most of it does not lead to expected results. In order to realize it, numerous transactions need to be completed within the long process of taking an idea to commercialization. Those are the aforementioned sequential transactions, each of which is by far more difficult to execute than ordinary.

First of all, if the quality of the idea (i.e., the expected value in the future) at the beginning is unpromising, the transaction is hardly executed (should not be executed). Also, the planning capability, execution capability, enthusiasm, physical and mental strength, problem-solving capability, and the learning ability of the person who claims his idea will lead to a successful innovation are scrutinized. In reality, most of the proposed transactions will be unqualified to this point; a diamond in the rough must be searched for among enormous piles of sand.

Current businesses may have resulted from the success of an innovation in the past, but luck and coincidence must also account for a large share of the cause. It is hard to say that a company will be as lucky as it was in the past when it achieved a successful innovation to create its current business. It is quite possible that although the total amount of available resources may have increased by far, things that have been lost are more influential than the increased resources. Namely, organizations have lost enthusiasm, desire, self-motivation, critical thinking, and a problem-solving capability, which are indispensable for the innovation needed for growth and expansion and were possessed by the founders. This is because of the organizations’ history; people who followed fixed interfaces have been selected; people who questioned or proposed new methods were excluded because they interfered with efficiency during the process of growing in scale. It had been necessary for the companies to invest in artificially fostering the culture where the employees were conscious about creating innovations even in their day-do-day operations and challenging to development of necessary capabilities.

Assuming that a person with high capabilities and desire made the proposal of promising seeds for innovation, this is the point where the real difficulties of innovation start.

As for the seeds with a high possibility of success, the allocation of resources (capital, competent human resources, channels, and so forth) is necessary. However, this leads to depriving resources that belong to current vested right holders. It is hard to earn the compliance of the current vested right holders, who had succeeded in their innovations in the past. It is easy for them to assert that the seeming diamond in the rough is a grain of sand because effectiveness cannot be evaluated objectively; someone should deal with unreasonable interference from them. Without very powerful leadership, it is impossible to raise the seeds of uncertain innovation when considering these power political relationships.

Interest oppositions that are hard to solve logically occur invariably with innovation. Interest oppositions within organizations are solved smoothly if there is strong leadership (even though it accompanies risk of dictatorship), and it is basically impossible to solve under unanimous solution system. In Chap. 6, it was explained that predominating leaders are unfavorable in village communities and changes are rejected, as it leads to heterogeneousness. This is one of the biggest reasons why Japanese society is weak at innovation. The issue which has been preexisting from the past has just been manifested under the growing global competition. The decline of the Japanese economy is synchronously proceeding with the phenomenon, which includes globalization by digitalization, intensified competition by globalization, and increased significance of innovation for intensified competition.

The forte of the Japanese village community was the gradual improvement, which functioned in an environment where everyone could agree on the direction, such as when catching runners up front and the only necessary consensus building is fine adjustments. When nobody raised an objection, changes on a small scale could be processed quickly, which functioned extremely well in simple transactions of production such as production cost management, quality control, and inventory control, even without IT utilization. However, on the other side, it is safe to say that the organizational techniques for handling major changes on a large scale that accompanied shifts of resources from vested rights holders to emerging forces have never been developed. As for such complicated and large-scale transactions, customs and tacit knowledge that have managed fixed interfaces spontaneously are no longer enough.

In village communities, the capability of managing fixed interfaces is very limited. Too much time must be expended for the new developments or modifications to reduce transaction costs, the consequence of which makes it impossible to process innovations, which require the most difficult transactions in sequence. These days, Japan seems to prostrate not just revolutionary innovation but also even extremely small changes along with loss of vitality.

The growing tone of nationalistic argument in the media and academia, such as “what we need is only encouragement,” “make greater use of our strength,” or “current situation is nothing wrong,” may contribute to short-term escape from the reality, forgetting about the currently accumulated problems. However, following the global movements, understanding indispensable changes, and flexibly complying with them are essentially required.

Substitutionability of transaction partners was included in the definition of degree of modularity in Chap. 4; one of the major functions of interfaces is facilitating transactions of substitutes. When interfaces are established, people try to earn their positions, and people try not to be deprived of their power. In other words, competition is promoted; efforts, growth, change, and innovation are revitalized.