The “Market for Errors” and the Commercialization of Ideas: A Bargaining Approach

At the level of firms learning must be continuous. Organisational learning is the 
process by which organisations acquire tacit knowledge and experience. Such 
knowledge is unlikely to be available in codified form, so it cannot be acquired by 
formal education and training. Instead it requires a continuous cycle of discovery, 
dissemination, and the emergence of shared understandings. Successful firms are giving 
priority to the need to build a "learning capacity" within the organisation. 
To become knowledge driven, companies must learn how to recognise changes in 
intellectual capital in the worth of their business and ultimately in their balance sheets. 
A firm's intellectual capital - employees' knowledge, brainpower, know-how, and 
processes, as well as their ability to continuously improve those processes - is a source 
of competitive advantage. But there is now considerable evidence that the intangible 
component of the value of high technology and service firms far outweighs the tangible 
values of its physical assets, such as buildings or equipment The difference is its 
intellectual capital. 
Knowledge plays an important role both in a macroeconomic context, for the 
long-term growth, and in a microeconomic framework, being a variable within a firm. 
In any case it is seen as a leading factor for innovation.  
It is quite hard, and sometimes a controversial the organization of the whole 
process of innovation, since many intangible factors and processes are involved and 
each single process has also different features. A general description of this process is 
provided in the present work starting from Imagination, Incubation, Demonstration, 
Promotion and Sustain. 
The main interest as been the focalization in the first step of it: Imagination. This 
process is made up, principally of ideas which, once imagined, must be exploited either 
directly by the same firm, or by another one to which must be transferred. In fact, not all 
firms want to use directly their own ideas, because their discover may derive by the 
chance and consequently a direct production will not lead to positive profits But 
transferring ideas, may happen in different ways,  but  here we are interested in their 
selling.  
The aim of this work is deriving the condition according to which a “Market for 
Ideas” or in particular a “Market for Errors” may exist in other words if Ideas can be 
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commercialized. Its existence is constrained, on one side, on the will of the seller to 
disclose at least part of its discover, and on the other on the behaviour of the buyer. 
 It will be shown that generally there are very low probabilities for this market to 
exist since there are no incentives for both the buyer and the seller to negotiate and 
behave fairly. 
This paper is divided in four chapters. In Chapter one, a general review on 
knowledge and its role in economics will be done starting from growth theory and then 
focalizing on firms’ activities. After that the overall process of innovation will be 
described, taking into account the simplest model of innovation, the linear model and a 
more complicate one, the Chain Link model. Then a more detailed description of the 
different phases of innovation will be provided beginning from the imagination of ideas 
and ending to the commercialization of products. 
Chapter two considers the two different approaches to innovation analyzed in 
literature. It begins with the traditional approach of market failure, that is also the one 
used in this work and then moves to the systemic approach of national innovation 
systems.  
Chapter three goes more in depth with the core of the analysis explaining if it is 
possible to create a market for ideas and according to what condition is it likely to 
happen. This will be examined with the help of game theory and in particular a two 
period bargaining game will be used. 
 Finally Chapter four indicate a possible solution to negotiation of ideas given the 
failure shown in the previous chapter. It focuses first on the role of a sanction, 
explaining why it is not always possible its application to this particular case, and then it 
consider a “referee model” in which a central role in this negotiation is played be a third 
public-owned subject.  
 
 
 
 
 
 
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Chapter 1 
 
 
Knowledge, Innovation and Technology Commercialization 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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1.0 Introduction  
 
In this chapter the literature on knowledge and innovation will be reviewed, in 
particular starting from the role of knowledge it will be analyzed the whole process of 
innovation beginning from “ideas” and ending the final product sold in goods market. It 
will be analysed the role of innovation in both a macroeconomic and microeconomic 
context stressing on this last one being the approach followed in the present work. 
Innovation will be analyzed at firm level and models of innovation will be presented in 
order to understand this complicated process. It is straightforward that this is not an easy 
task being the borders of some processes not so defined sometimes just theoretic and 
that all of them can be carried out within a single firm or across different firms. An 
analysis will be then applied to the transfer of technology and its commercialization. 
Technology transfer may occur within a firm or across firms, and then nationally or 
internationally, all these cases will be reviewed. The final step will be the analysis of the 
overall process of commercialization, describing step by step its development from the 
birth of a simple idea to its selling.   
 
 
1.1 Knowledge as economic resource 
 
The importance of innovation and R&D resides in the fact that it is considered as 
the primary engine for triggering the growth of a country.  
Economics of innovation has important roots, in the work of Polanyi
1
 who drew a 
distinction between tacit knowledge and codified knowledge. He argued that an 
important portion of knowledge individuals posses is tacit by which he meant that it is 
difficult, and sometimes impossible, to communicate and transfer to the others. This 
definition was taken up in Nelson and Winter’s
2
 evolutionary theory, where this 
distinction is placed into a meaningful economic framework by extending it from 
individuals to organizations. They studied how firms and economies grow and the role 
                                                 
1
 Polanyi (1966); 
 
2
 Nelson and Winter (1982); 
 
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of technical change as one of the leading forces behind this process. They posit that 
firms are repositories of a complex set of knowledge bases, competences, and skills, 
which are embodied in the so called “organizational routines”. Given the often 
unintentional way in which routines are conducted, they create organizational 
knowledge and capabilities that are tacit, and therefore difficult to transfer and to 
imitate by organizations. In contrast, codified knowledge can be transformed into 
patents, blueprints, white papers, journal articles and so on. Winter
3
 noted that corporate 
knowledge must go further than the distinction between tacit and codified knowledge. 
According to his ideas what matters is the extent to which knowledge can be transferred 
or imitated. He articulated the distinction of knowledge more and more, distinguishing 
among: articulable or tacit, teachable or unteachable, articulated or non-articulated, 
observable or non-observable, simple or complicated; system independent or system 
dependent, context independent or context dependent, monodisciplinary or 
transdisciplinary. The first element of each pair denotes forms of knowledge that make 
it easier to transfer across individuals or organizations, while the second makes 
transferability more difficult. He argued also that tacitness and codification are not 
inherent properties of knowledge. According to him, the counter part of tacit knowledge 
is not codified knowledge but “articulable” knowledge, suggesting that knowledge can 
be articulated and made easy to transfer. The nature of knowledge can make it difficult 
to articulate, i.e. when knowledge is complex or cannot be observed in use. However, 
the important point is the extent to which knowledge is codified, or more generally, the 
extent to which it is easy to transfer is an economic decision rather than an inherent 
property of knowledge. Winter also explains the reasons why individuals and 
organizations may want to invest in making their knowledge codified. In fact, the fear 
that rivals may use a firm’s knowledge encourages the firm to keep it in forms that 
reduce the risk of spillovers. Another contribution is that of Kogut and Zander
4
 who 
argued that markets for technology may not exist for reasons other than the classical 
market failure problem, because the fact that knowledge or technologies are embedded 
into organizational routines seriously constraint the choice to transfer them to other 
agents.  
                                                 
3
 Winter (1987);  
 
4
 Kogut and Zander (1992); 
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Up to this point, we have just distinguished between tacit and codified knowledge, 
but another important issue concerning knowledge is the appropriability and the fertility 
of R&D results. The chief outcome of R&D is just ideas and as such they can be used 
by many firms at the same time. If research is fertile then a firm will have more 
incentives to spend on R&D, but the fertility is determined by many factors interacting 
among them. First of all, the fertility of research hinges on the successful interactions 
between basic research (the search for general principles and results) and applied 
research (the application of basic research to specific uses and the development of new 
products). Basic research does not lead alone to technological progress, but the success 
of applied research depends on the “goodness” of the former.  
The issue of appropriability has been widely studied by Saviotti
5
 who developed a 
general approach to the analysis of the appropriability of tacit and codified knowledge. 
He started from the fact that firms and organizations need knowledge to create 
innovations. This knowledge is generated in a number of ways, which can generally be 
described as a mechanism of learning which varies depending on the type of knowledge 
considered, and on the institutional setting in which learning takes place. As already 
mentioned above, a common distinction is between hard and soft science, between basic 
and applied research and so on. In particular Saviotti focuses on disciplinary knowledge 
created within academic disciplines. In fact, not all knowledge is created and 
transmitted within academic disciplines; for example there are various types of tacit 
knowledge that are not learned within an academic context and are not governed by the 
same rules as academic disciplines. However the growing R&D intensity of most 
processes has stressed the importance of disciplinary knowledge. Here search activity is 
a kind of “learning by not doing”. Learning by not doing means replacing of one kind of 
activity (production) with another activity (search) with the latter faster, simpler and 
less costly than the others. As a consequence search activities reduce the uncertainty 
and the cost involved in the development of innovations by lowering the number of 
trials required. During search activities no real production process takes place, but at 
best simulated at a much lower scale. On the other hand, the learning takes place by 
doing occurs without any explicit search, but only as a result of the repeated 
performance of the production process. Two extreme forms of learning can now be 
                                                 
5
 Saviotti P.P.(1998)  
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contrasted: learning by doing, without any search, and learning by searching, without 
doing.  To sum up: knowledge is cumulative, tacit or codified and it has a limited 
appropriability. The cumulative character of knowledge implies path dependence and 
the creation of barriers, as established participants in given technologies accumulate a 
differential advantage with respect to potential entrants. Knowledge in firms and 
organizations has a collective character, that is, it is not simply the sum of pieces of 
knowledge “owned” by the individual members of the organization. In this sense we 
can define knowledge base of a firm the collective knowledge that the firm uses for its 
productive purposes. 
 
1.2  Codified Knowledge and Tacit Knowledge 
  
In the previous paragraph the distinction between tacit and codified knowledge, 
was barely sketched here this issue will be analyzed more in depth since it plays a 
crucial role in innovation. 
Knowledge is rarely completely tacit or completely codified; in most cases 
knowledge is in the middle of these two extremes. Knowledge is not created codified on 
purpose. Knowledge is at least partly tacit in the minds of those who create it. The 
process of codification is required because knowledge creation is a collective enterprise 
that requires communication. Reducing costs of communication is important since the 
probability of communication is inversely proportional to the cost of communication 
and directly proportional to the similarity of transmitter and receiver. Both the 
transmitter and the receiver must know the “code”. In this case, codification can be 
thought of a process rather than an intrinsic property of a piece of knowledge. The 
process of codification for a given subject is gradual and not evenly distributed. 
Moreover as a new discipline proceeds, the oldest part s become codified, the newer 
parts, which are often considered the frontiers are less codified. Each researcher 
explores simultaneously with other researcher these frontiers, but given the individual 
character of discovery, each researcher can have different intuitions, use different 
variables and discover correlations within different set of variables. To ensure progress, 
the result of each researcher have to be communicated through the standardization of 
concepts and definitions. Hence a process of selection takes place, by means of which 
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