Reports

Working Paper

Building Long-term Firm Value Through Innovation

Alina A. Sorescu and Jelena Spanjol, 2006, 06-122

What innovation strategies and conditions create the greatest long-term financial value for the firm? Here, authors Sorescu and Spanjol assess the long-term economic rents to firms’ aggregate innovation output, taking into consideration competitors’ innovative activity, innovation type (incremental versus breakthrough), and how innovations are deployed across the product categories in which the firms operate.

They hypothesize that incremental innovations, while they do not generate long-term value on their own, play an essential complementary role for breakthrough innovations. Specifically, they hypothesize that greater numbers of breakthrough innovations result in greater long-term value for the firm—but only when the firm also introduces greater numbers of incremental innovations. They also hypothesize that concentrating innovative activity within a few product categories creates more value than having a broad innovative presence across product categories.

They test these hypotheses on a comprehensive database of over 20,000 new consumer packaged goods introduced between 1985 and 2003, using forward-looking stock return measures (long-term calendar-time abnormal returns) as proxies for economic rents. The results indicate that in consumer packaged goods industries, incremental innovations do significantly enhance the rents obtained from breakthrough innovation. They also find that introducing new products only in categories in which a firm can surpass its competition is a winning strategy: firms earn superior rents when they do so. Methodologically, they argue that the calendar-time method they employ offers a better tool for studying the long-term effects of marketing strategies on firm value than previously used metrics such as Tobin’s q or abnormal returns measured using long-term event studies.

They conclude that incremental innovation should be embraced for its role as a complement to breakthrough innovation and that a strategy of aiming for category dominance in innovation will reward firms with significant and sustainable economic rents.

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