SECTORAL SYSTEMS OF INNOVATION AND PRODUCTION

Franco Malerba
CESPRI- Bocconi University Via Sarfatti 25 20136 Milan Italy Tel: 39-02-58363391(3397) Fax: 39-02-58363398 E-mail: franco.malerba@uni-bocconi.it

DRUID Conference on: National Innovation Systems, Industrial Dynamics and Innovation Policy Rebild, June 9-12, 1999.

May 1999 This paper is part of the TSER ESSY (Sectoral Systems in Europe: Innovation, Competitiveness and Growth) Project. Stefano Breschi, Francesco Lissoni and Fabio Montobbio have provided very useful comments to an earlier draft.

1. INTRODUCTION

Everybody would agree that sectors differ along several dimensions related to technology, production, innovation and demand. And that they differ in the type and degree of change.

This broad statement is supported by a huge literature of industry case studies, most of them regarding a single industry. Unfortunately, these case studies are done with different methodologies, focus and level of disaggregation. As a consequence, the possibility of comparing sectors with respect to type and role of agents, the structure and dynamics of production, rate and direction of innovation and the effects of these variables on the performance of firms and countries is still very limited.

Indeed, there have been several theoretical studies and a lot of cross sector empirical analyses that have focussed their analysis on specific aspects of sectors. Studies in industrial economics have examined differences in concentration, vertical integration, entry, industrial dynamics, or in the strategic behavior and interactions among firms and have related them to some underlying differences in technology, demand, barriers to entry or other variables related to the sectoral context. Studies in the evolutionary tradition have focussed their attention on differences in knowledge, learning and innovation among sectors and have related sectoral differences to the technological and knowledge environment and to the accumulation of competences by firms. Similarly, the innovation and technological system literature has stressed that in the innovative process the interaction among agents and the role of non-firms organization and institutions differ across sectors and technologies.

Only few of these contributions have expressely focussed their attention on sectors and sectoral differences. Most of them others have made these claims on sectors within broader conceptual and empirical analyses directed to very general issues such as differences in processes of economic dynamics and evolution, or the role of interaction in

the innovation process, without however an explicit and persistent focus on sectors and on their differences. This is the aim of the present paper.

This paper aims at providing an integrated view of what are the main dimensions of sectors and what may account for the differences across sectors in those dimensions, in the within-sector agents heterogeneity and behavioral variety, and in sectoral change and dynamics. In this spirit the concept of sectoral system of innovation and production is proposed and discussed. Why do we need the concept of sectoral systems? First of all, we need to describe the working, structure and dynamics of a sector in its basic functions of developing, producing and selling products and services to a demand composed by users and consumers and the way a sector changes over time. And second, we need to disentangle the relationships between firms learning processes, competences, organization and behavior, non-firms organizations and institutions in a sector. Only by doing that, we can shed light on some key factors that affect firms and countries performance and competitiveness at the sectoral level. And we may be able to find what are the key diversities and the major similarities across sectors in the structure, mechanisms and patterns of change. On this ground it will be possbile to develop public policy indications based on a deeper understanding of the structure, working and dynamics of sectors.

Rather than providing conclusive results and coherent results, this paper is conceptual and methodological. It aims to propose a way to describe a sector, identify the major variables and the main factors affecting structure, agents heterogeneity and change, and lay down the main research questions and the key challenges that lie ahead.

While the concept of sectoral system retains some elements of the traditional industrial organization approach to the analysis of industries (such as the identification of sectors in terms of products and demand and the emphasis on the basic technologies), it draws mainly from the evolutionary and innovation system literature. It is in the evolutionary camp that key concepts such as learning, knowledge, competences and change play a

central role. And it is in the innovation system literature that one may find relationship and networks as key elements of the innovative and production process.

In section 2 the concept of sectoral system is introduced and examined in its main elements. In section 3 a discussion about the working and dynamics of sectoral system is done. Some key issues are discussed in section 4 and challenges and future research directions are presented in section 5.

2. SECTORAL SYSTEMS OF INNOVATION AND PRODUCTION

2.1

A broad definition of a sectoral system

A sectoral system of innovation and production is composed by the set of heterogeneous agents carrying out market and non-market interactions for the generation, adoption and use of (new and established) technologies and for the creation, production and use of (new and established) products that pertain to a sector (sectoral products).

A sectoral system has a knowledge and a technological base, and key links and complementarities among products, knowledge and technologies, which greatly affect the creation, production and use of the sectoral products.

The agents composing the sectoral system are individuals and organizations. These organizations may be firms (such as users, producers and input suppliers) and non-firm organizations (such as universities, financial institutions, government agencies and so on), as well as organizations at lower or higher levels of aggregation (such as consumers, R-D departments or industry associations). Agents are characterized by specific learning processes, competences, structures and behaviors. They interact in a market and non market way through processes of communication, exchange cooperation, competition and command, and their interactions are shaped by institutions (rules and regulations).

A sectoral system changes over time through coevolutionary processes.

This broad definition of a sectoral system highlights several points, that sharply contrast with the standard definition of a sector. The industrial organization definition of a sector would start from defining sectoral boundaries as given and static. It then would concentrate on firms as the main actors. These firms would use similar types of technologies, inputs and techniques, supply goods that fulfil specific functions to customers, and be engaged in market exchange, transactions and strategic decisions regarding competition, cooperation and command (vertical integration). The definition of sectoral system proposed above would highlight a different set of points.

First, a sectoral system perspective pays attention to knowledge and its structure as a key element in a sectoral system. The knowledge base may greatly differ across sectors and affects the innovative activities, organization and behavior of firms within a sector.

Second, and related to the first point, it focusses on key aspects of firms such as learning processes, competences, behavior and organization. The emphasis on identifying the degree and determinants of agents heterogeneity and behavioral and organizational variety within sectors is a characteristics of the sectoral system approach.

Third, it gives importance to links and complementarities at the input and demand levels. These complementarities are both static and dynamic and include interdependencies among vertically or horizontally related sectors, the convergence of previously separated final products or the emergence of demand from the existing one. Thus

interdependencies and complementarities define the real boundaries of a sectoral system. They may be at the input or at the demand level and may concern innovation, production and distribution.

Fourth, it places emphasis on the role of non-firm organizations such as universities, financial institutions, government, local authorities and of institutions and rules of the games such as standards, regulations, labor markets and so on. Non-firms organizations

and institutions greatly differ across sectors and affect the innovative, and productive activities of firms.

Fifth, it pays attention to the relationships among agents. Agents are examined as involved in processes of market and non market interactions. As a consequence, also demand is seen as composed by agents with specific attributes and knowledge, that interact with suppliers in various ways.

Sixth, it focusses on the dynamics and transformation of sectoral systems. In particular, it emphasizes coevolutionary processes involving firms and non-firm organisations, knowledge, technology and demand.

Some methodological remarks have to be advanced with respect to the above definition of sectoral system. Since the definition is a broad one, it may be appropriate also to talk about a sectoral innovation system, a sectoral production system and a sectoral distribution system, which could be related more or less closely. In addition, sectoral systems may have different levels of disaggregation, depending on the specific goal of the empirical analysis. So the sectoral products examined may be very broad, such as computer hardware and software, or much more narrow, such as computer software. Finally, when the actors of a sectoral system are considered, this definition may run into a unit of analysis problem. In the above definition, we have mainly remained at the firm level. However agents at a level of disaggregation lower than firm-such as a division of a firm, an R-D laboratory, or even single inventors- may be the key actors in a sectoral system.

In the following pages, a more in-depth examination of these various elements will be presented.

2.2 Sectoral Products and Basic Technologies

Two of the dimensions in which sectors differ are products and the related basic technologies. This is something strongly emphasized also by the industrial organization literature on sectors from Bain(1956) to Scherer(1990) to Sutton (1991,1998). Actually, differences in the equilibrium structure of industries have been identified as determined by the underlying patterns of technology and demand, in addition to the type of sunk cost.

Moreover these two dimensions have allowed the industrial organization literature to delimit the sector in terms of similarity in techniques or similarity in demand (substitutability), in addition to strategic interdependence. In this case we have the standard industrial economics definition of sectoral boundaries in terms of similarity of production processes (technological similarity) or of cross demand elasticity and functions that the product satisfies (functional similarity of products). Within this sectoral context, firms would follow different strategies in terms of pricing, R-D, advertising and would face organizational choices such as specialization, vertical integration, diversification and so on.

A sectoral system perspective would not deny the key role of product demand or technologies in defining a sector and in affecting the type of firms activities. It adds however other key elements - such as knowledge, complementarities and agents heterogeneity - that play a major role in the innovative performance and competitiveness of firms and countries.

2.3

Knowledge

Knowledge plays a central role in innovation and production. This point has been strongly emphasized by the evolutionary literature (Nelson,1995; Dosi,1997;

Metcalfe,1998) as well as by the literature on the knowledge based economy (Lundvall,1993; Lundvall-Johnson,1996; Cowan-David-Foray,1998). In these

contributions, knowledge encopasses both tacit and codified elements, and is closely related to the problem solving activities of firms.. The knowledge base underpinning firms activities becomes highly idiosincratic at the firm level. Knowledge does not diffuse automatically and freeley among firms, but it has to be absorbed by firms through their differential abilities accumulated over time.

In addition, the evolutionary literature has proposed that sectors and technologies differ greatly in terms of the knowledge base and learning processes related to innovation. Knowledge may first of all differ across sectors in terms of domains. One knowledge domain may refer to the specific scientific and technological fields at the base of innovative activities in a sector. (Dosi,1988; Nelson-Rosenberg, 1993). The second refers to the type of knowledge regarding the applications, users and demand of sectoral products.

Other dimensions of knowledge may be relevant for explaining innovative activities in a sector. First, knowledge may have different degrees of accessibility (MalerbaOrsenigo,1998) i.e. opportunities of gaining knowledge that are external to firms. This knowledge may be internal to the sector (thus favouring imitation) or external to the sector (thus affecting the availability of technological opportunities to incumbents and new firms). In both cases greater accessibility of knowledge decreases industrial

concentration. Greater internal accessibility means lower appropriability: competitors may gain knowledge about new products and processes and, if competent, imitate those new products and processes. Accessibility of knowledge which is external to the industry is related to scientific and technological opportunities, both in terms of level and in terms of sources. Here the external environment may affect firms through human capital with a certain level and type of knowledge or through scientific and technological knowledge developed in firms or non-firms organizations such as universities or research laboratories. The sources of technological opportunities markedly differ among sectors. As Freeman (1982) and Rosenberg (1982) among others have shown, in some sectors opportunity conditions are related to major scientific breakthroughs in universities. In other sectors, opportunities to innovate may often come from advancements in external R&D, equipment

and instrumentation. In still other sectors, external sources of knowledge in terms of suppliers or users may play a crucial role. Not all external knowledge may be easily used and transformed into new artefacts. If external knowledge is easily accessible, easily transformable into new artefacts and exposed to a lot of actors (such as customers or suppliers), then innovative entry may take place (Winter,1984). On the contrary, advanced integration capabilities are necessary (Cohen-Levinthal,1989) if the industry may be concentrated and formed by large established firms.

Second, knowledge may be more or less cumulative i.e. the degree by which the generation of new knowledge builds upon current knowledge. One can identify three different sources of cumulativeness. The first is source is the learning processes and dynamic increasing returns at the technology level. The cognitive nature of learning processes and the past knowledge constrain current research, but also generate new questions and new knowledge. The second source is related to organizational capabilities. These capabilities are firm-specific and can be improved only gradually over time. They implicitly define what a firm learn and what it can hope to achieve in the future. A third source are the feedbacks from market. Such as "success-breeds-success" processes (like those used in Nelson and Winter (1982) models). Innovative success yields profits that can be reinvested in R&D, thereby increasing the probability to innovate again. From this discussion, it follows that cumulativeness may be observed at various levels of analysis. One is at the technological and the firm level. Here high cumulativeness implies an implicit mechanism leading to high appropriability of innovations. In case of low appropriability conditions and knowledge spillovers within an industry, however, it is also possible to observe cumulativeness at a more aggregate level, such as at the sectoral level. Finally, cumulativeness may be present at the local level. In this case high cumulativeness within specific locations is more likely to be associated with low appropriability conditions and spatially localised knowledge spillovers. Cumulativeness at the technological and firm levels creates first mover advantages and generates high concentration. Firms who have a head start develop new knowledge based on the current one and introduce continuous innovations of the incremental type.

Accessibility and cumulativeness are two key dimensions of knowledge which could be related to the notion of technological and learning regime, which differs across sectors. The notion of technological regime dates back to Nelson and Winter (1982) and provides a description of the knowledge environment in which firms operate. More generally, Malerba and Orsenigo (1996 and 1997) have proposed that a technological regime is composed by opportunity and appropriability conditions; degrees of cumulativeness of technological knowledge and characteristics of the relevant knowledge base. More specifically, technological opportunities reflect the likelihood of innovating for any given amount of money invested in search. High opportunities provide powerful incentives to the undertaking of innovative activities and denote an economic environment that is not functionally constrained by scarcity. In this case, potential innovators may come up with frequent and important technological innovations. Appropriability of innovations summarises the possibilities of protecting innovations from imitation and of reaping profits from innovative activities. High appropriability means the existence of ways to successfully protect innovation from imitation. Low appropriability conditions denote an economic environment characterised by the widespread existence of externalities (Levin et al., 1987). The properties of the knowledge base relate to the nature of knowledge underpinning firms innovative activities. Technological knowledge involves various degrees of specificity, tacitness, complementarities and independence and may greatly differ across sectors and technologies (Winter, 1987).

Malerba-Orsenigo(1997) and Breschi-Malerba-Orsenigo(1999) have linked technological regimes to differences in the sectoral patterns of innovation. This difference in the organization of innovative activities at the sectoral level may be related to a fundamental distinction between Schumpeter Mark I and Schumpeter Mark II models. Schumpeter Mark I is characterized by "creative distruction" with technological ease of entry and a major role played by entrepreneurs and new firms in innovative activities. Schumpeter Mark II is characterized by "creative accumulation" with the prevalence of large established firms and the presence of relevant barriers to entry for new innovators. This regime is characterized by the dominance of a stable core of few large firms, with limited entry. High technological opportunities, low appropriability and low cumulativeness (at the

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firm level) conditions and a limited role of generic knowledge lead a Schumpeter Mark I pattern. On the contrary, high appropriability and high cumulativeness (at the firm level) conditions and a generic knowledge base lead to a Schumpeter Mark II pattern.

Recent research (see Klepper 1996) has clearly shown that during the evolution of sectors industries changes may occur in Schumpeterian patterns of innovations. According to an industry life cycle view, Schumpeter Mark I pattern of innovative activities may turn into a Schumpeter Mark II. Early in the history of an industry, when knowledge is changing very rapidly, uncertainty is very high and barriers to entry very low, new firms are the major innovators and are the key elements in industrial dynamics. When the industry develops and eventually matures and technological change follows well defined trajectories, economies of scale, learning curves, barriers to entry and financial resources become important in the competitive process. Thus, large firms with monopolistic power come to the forefront of the innovation process (Utterback-Abernathy 1975, Gort-Klepper 1982, Klepper, 1996). On the contrary, in the presence of major knowledge, technological and market discontinuities, a Schumpeter Mark II pattern of innovative activities may be replaced by a Schumpeter Mark I. In this case, a rather stable organisation characterised by incumbents with monopolistic power is displaced by a more turbulent one with new firms using the new technology or focusing on the new demand (Henderson-Clark,1993; Christensen-Rosenbloom 1995). The empirical evidence (Malerba-Orsenigo,1996) suggests also the existence of differences across sectors and of similarities across

countries in the patterns of innovative activities for a specific sector, thus providing support for the relevance of technological regimes in determining sectoral invariances in the patterns of innovative activities. This is so as long as opportunity, appropriability and cumulativeness conditions are rather similar across countries. On the contrary, the ability to generate and exploit opportunity conditions is less similar across countries. This ability is related to the level and range of university research, the presence and effectiveness of science-industry bridging mechanisms, vertical and horizontal links among local firms, user-producer interaction and the types and level of firms' innovative efforts (Nelson, 1993).

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Breschi and Malerba (1997) have enriched this discussion by providing some simple sectoral examples and introducing also a spatial dimension. Traditional sectors

composed by many innovators, geographically dispersed with no specific knowledge spatial boundaries are associated to technological regimes with low degrees of opportunities, appropriabilities and firms cumulativeness with a knowledge base partly embodied in equipment and materials. Mechanical sectors located in industrial districts, with many innovators, geographically concentrated with local knowledge boundaries are associated to technological regimes of medium opportunities, low appropriability and high firms cumulativeness and a tacit and specific knowledge base. The car sector, with few innovators, geographically concentrated with local knowledge boundaries is associated to technological regimes characterized by high cumulativeness at the firm level and a system type of knowledge with some tacit components. Computer mainframes with few innovators, geographically concentrated with internal global knowledge boundaries are associated with technological regimes characterized by high opportunity conditions and a limited degree of potential variety, with both tacit and codified knowledge. Finally the modern microelectronics, software and micro computer sectors with many innovators, geographically concentrated with both local and global knowledge boundaries is associated with very high opportunity conditions and a wide variety of potential technological approaches (Breschi-Malerba,1997).

Although rather archetipical, this analysis points to the direction of emphasizing differences across sectors in some key factors related to differences in knowledge and learning regimes. Much more work has to be done first to develop a finer grained analysis of the relationship between knowledge and innovative activities at the sectoral level, and second to enlarge the scope of the analysis from sectoral innovation systems to sectoral production systems and sectoral distribution systems.

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2.4 Key links and dynamic complementarities

Sectors may have a lot of links and complementarities that span out of the static boundaries of a given demand and basic technologies. A sectoral system is thus composed by an internal structure and by boundaries related to key links and dynamic complementarities among artifacts and activities. These links may be of a quantitative and static type as input-output links are. On the contrary dynamic complementarities take into account interdependencies and feed-backs, both at the demand and at the production levels. Links and complementarities greatly affect firms strategies, organization and performance, the rate and direction of technological change, the type of competition and the networks among firms and among firms and non-firms organizations.

The emphasis on key links and dynamic complementarities is not novel. First, the notion of filiere has highlighted the role of major vertical links among sectors in production activities. Second, the notion of development blocks introduced by Eric Dahmen (1989) has stressed the idea that investments often are closely interrelated and span over different technologies or activities, and that they may originate tensions and virtuous cycles among related products in the process of economic development. Dynamic complementarities among artefacts and activities thus provide force and trigger mechanisms of growth and innovation.

Two examples may show that links and complementarities have to be taken into account for an understanding of the working and dynamics of sectoral systems. In multimedia, the convergence of different types of demand and technologies has originated a new sector with continuously expanding boundaries and in which new entrants come in from each of the industries constituting the new multimedia sector, using new strategies more in tune with the new features of multimedia. In computers until the 1980s dynamic complementarities and key linkages have kept hardware and software highly interdependent and have consequently affected the vertical organization and strategies of several computer firms. Later on, some of the dynamic complementarities have become

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less strong and standard interfaces have emerged, thus leading to the creation of strategies of specialization in computers hardware or in software.

2.5 Heterogeneous agents connected by market and non market interactions

One of the key aspect of a sectoral system view is the focus on the within-sector heterogeneity of agents in terms of types, competences, behavior and organization. And a related major point is that sectors differ in the extent and kinds of agents heterogeneity.

What are the major types of agents in a sectoral system? First of all the key actors in a sectoral system are the firms involved in the innovation, production and distribution of sectoral products, and in the generation, adoption and use of new technologies. These firms are characterized by a technological, productive or market specialization; have specific beliefs, expectations, competences, and organization and are engaged in processes of learning and knowledge accumulation. Competencies correspond to specific ways of packaging knowledge about different things and therefore they have an organisational content. These aspects have been greatly emphasized by the evolutonary view of the firm. (Nelson-Winter,1982; Dosi-Marengo-Fagiolo, 1998, Malerba,1992, Teece-Pisano,1994, Metcalfe,1998).

Firms include also users and suppliers who have different types of relationships with the innovating, producing or distributing firms. The role of users is extremely important in several sectors, such as agro-food or instrumentation as Lundvall (1993) and Von-Hippel (1988) have forcefully pointed out. The focus on users puts a different emphasis on the role of demand. Demand is not seen as an aggregate set of similar buyers, but as composed by heterogeneous agents with specific attributes, knowledge and competences who interact in various ways with producers. Similarly, also suppliers of components and subsystems play a major role in affecting the competitiveness of downstream sectors. They are characterized by specific attributes, knowledge and competences, with a range of more or less close relationships with producers. The role of suppliers varies across sectors. It is enough to compare the market and non market relations between

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microelectronics suppliers and information technology producers with the close relationships between producers of advanced machineries and donwstream user industries in the Italian industrial districts (Pavitt 1984; Malerba,1993).

Finally, other types of agents are non-firm organizations such as universities, financial institutions, government, local authorities. They support in various ways innovation, diffusion of new technologies and production of firms within a sectoral system, but again their role greatly differs among sectors. Think of the role played by the university in sectors such as biotechnology, the local government in machine tools, the military in the early days of the semiconductor and computers and venture capital in software, biotechnology and multimedia.

An important role in sectoral systems is played by new agents- both new firms and nonfirms organizations-. For example new firms bring in the innovation and production processes a variety of approaches, specialization and knowledge, and contribute to the major changes in the population of agents and in the trasformation of technologies and products in a sector. As examined by Audrestch (1996) and Geroski (1994) and others, the role of new firms differ drastically from sector to sector both in terms of rate of entry and in term of composition and origin, and thus has quite different effects on the features of the sectoral systems and their degree of change.

The previous discussion has put a lot of emphasis on firms and non-firms organizations as the main types of agents in a sectoral system. As mentioned earlier, however, the firm is not always the most appropriate unit of analysis for specific sectors. In fact, in some sectors agents may be examined at a different level of disaggregation, either lower or higher. In biotechnology for example, a key unit of analysis is the university department, the research laboratory, and even the individual scientist. In electronics the network of firms with its alliances and close relationships is often a more appropriate unit of analysis for competitive process.

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The evolutionary literature however has stressed agents heterogeneity not only in terms of types but also in terms of behaviour and organization (Nelson,1995; Metcalfe,1998; Dosi,1997). In addition it has placed emphasis on the variety of beliefs and expectations, affected by previous learning and experience and by the environment in which agents act (Fransmann,1994). Different firms know how to do different things in different ways. As such, knowledge and competences constitute one of the major sources of both the heterogeneity among firms and their differential competitiveness.

From these remarks, it is possible to advance two claims. The first one is that within sectors heterogeneity is a key element in sectoral systems. A higher or lower degree of agents heterogeneity in terms of types, beliefs, competences, behavior and organizations may stem out of differences in a set of factors: knowledge base, technology, demand, links and complementarities, history, experience, learning processes as well as the amount of change and uncertainty that characterize a sector. The second is that sectoral systems greatly differ in the extent and type of agents heterogeneity.

Within sectoral systems, heterogeneous agents are connected in various ways through market and non-market relationships. Traditionally, agents have been examined as involved in processes of exchange, competition and command (such as vertical integration). Recently also processes of formal cooperation or informal interaction among firms or among firms and non-firm organization have been examined in depth, as one may see from the literature on tacit or explicit collusion, or hybrid governance forms or formal R-D cooperation. This literature has analyzed firms with certain market power, suppliers and users facing opportunistic behavior or asset specificities in transaction or firms with similar knowledge and facing appropriability and indivisibility problems in the R-D process. However the evolutionary approach and the innovation systems literature have stressed the diversity in knowledge and capabilities among agents, the relevance of trust and the range of informal interactions and relationships among agents. (See Lundvall,1993, Edquist 1997; Nelson,1995, Teubal M. 1991). In addition, it has emphasized that the relationships between firms and non-firm organizations such as universities and public research centers is a very important source of innovation and

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change in several sectors such as pharmaceuticals and biotechnology, information technology and telecommunications (Nelson-Rosenberg,1993). In sum, in uncertain and changing environments networks emerge not because agents are similar, but because they are different. In this way networks may integrate complementarities in knowledge, capabilities and specialization.

Again, these networks are specific to different sectors. For example, it is enough to compare the case of biotechnology and pharmaceuticals in which networks of large pharmaceutical companies, new biotech firms, universities and venture capitalist are sources of innovation, with the machinery sector in which networks are composed by producers, users and local banks.

And in some sectors these networks may constitute local (regional) systems of innovation and production. In fact in several cases, such as machinery, some traditional industries, but also information technology, the sectoral system is highly localized and defines the specialization of a whole regional or local area. For example, machinery is highly concentrated in highly specialized regional areas. Similarly, sectoral specialization and local agglomeration overlap in Route 128 for minicomputers and in Silicon Valley for personal computers, software and microelectronics (Saxenian,1994).

One final remark has to be advanced. The key role played by networks in a sectoral system leads to a meaning of the term sectoral structure different from the one used in industrial economics. In industrial economics, structure is related mainly to concentration and vertical integration. In a sectoral system perspective, on the contrary, structure refers to links among artefacts and to the relationships among agents: it is therefore far broader than the one based on exchange-competition-command. We can say that a sectoral system is composed by webs of relationships among heterogeneous agents with different beliefs, competences and behavior, that affect their actions and that are rather stable over time.1
1

A business scholar such as Porter has clearly understood these problems and issues. In his analysis of business strategies, Porter has quite early abandoned the traditional concept of industry and market. It has attempted to enlarge it in various ways. In Competitive Strategy (1980) he discusses firms strategies in industries and provides a description of industry boundaries that move away from similarity of technical

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2.6 Institutions

Finally sectoral systems differ with respect to their typical institutions. Institutions include norms, routines, common habits, established practices, rules, laws, standards and so on that shape agents cognition and action and affect the interactions among agents (Edquist and Johnson,1997; Coriat-Dosi,1995; Nelson-Sampat,1998 ). A key issue to be address by current research refers to the emergence of sectoral institutions either as a result of deliberated planned decision or rather as evolving out of not predicted consequences of agents interaction.

Institutions may affect sectoral systems in two ways. The first one refers to the sector specific effects of national institutions. In fact national institutions such the patent system or antitrust regulations may have different effects on the different sectors due to the features of technology and knowledge and the type and features of agents. The second refers to the role of sectoral institutions such as sectoral characteristics of the labor market or sector specific financial institutions. Think for example of institutional settings such as disclosure agreements and standards in software or the regulations in the modern pharmaceutical sector.

The analysis of the role of institutions on the innovation production and distribution in sectoral system is only at the beginning. A lot of work has to be done in this respect, and will face present a formidable analytical challenge, also because institutions may be more or less formal (such as patent laws or specific regulations vs. traditions and conventions) and their effects more or less binding on agents actions.

processes or substitutability in demand, by considering also suppliers and buyers, and the threat of products or services substitutes. Later on in discussing how nations can affect the way industries compete on the international scene he stresses the role of factor conditions (skilled labor, infrastrucure and so on), demand conditions and related and supporting industries (in addition to firm strategy, structure and rivalry) (The competitive advantage of Nations, 1990). Finally in his last work Clusters and the new economics of competition (Harvard Business Review, 1998) Porter focusses on local knowledge, trust and relationships and culture as the basis of competition: better access to employees and suppliers; access to specialized information; complementarities of various kinds; coordination with local companies; access to institutions and public goods (pool of skills, reputation and technology) and better motivation.

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3. THE WORKING, DYNAMICS AND EVOLUTION OF SECTORAL SYSTEMS

3.1 The basic relations among variables and the basic processes

The working of a sectoral system is based on the relationships among the various elements of a sectoral system. Recently progress has been done in this respect but a lot of ground has still to be covered.

First of all, knowledge base, complementarities, and learning processes greatly affect the kinds of competences and the viable behavior and strategies of firms in a sector. A lot of case studies in the managerial and economic history literature are trying to shed light on this aspect. Think for example of the different types of competences in sectors such as computers, auto or pharmaceuticals which are related to the type of knowledge and learning processes of these sectors (Iansiti,1998; Iansiti-Clark,1994; Henderson,1994) As a first approximation, it is possibile to link basic behavior and strategies to some differences in the underlying knowledge and learning regime. An exercise in this respect has been done by Malerba and Orsenigo (1993) by linking the specific learning regimes in terms of opportunity, cumulativeness and appropriability of innovations, to the type and range of basic innovative behavior (radical vs innovative vs imitative behavior) in sectors such as computers, biotechnology and semiconductors. As previously mentioned knowledge and complementarities, together with firms idiosincratic experience and competences, also affect agents beliefs, visions or cognitive representations of the sectoral context in terms of basic economic processes, technology, demand, users, suppliers, competititors and so on. For fascinating examples about this aspect see Fransmann (1994) and Langlois on computers (1998).

Also differences in demand conditions play a major role in affecting sectoral differences in firms competences, behavior and organization. Porters (1977) broad sectoral

taxonomy of demand conditions and its effect on firms organizations and strategies

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clearly illustrate this point. And, when demand conditions are coupled with some basic features of knowledge and technology, the effect on firms behavior and organization could be significant. For example, empirical and theoretical analysis of the evolution of the computer industry show complex relationships between demand, technology,

knowledge base and the boundaries of firms (Bresnahan-Malerba,1999; Malerba-NelsonOrsenigo-Winter,1999b).

In particular, sectoral differences in the level and type of entry seem to be closely related to differences in the knowledge base, the level, diffusion and distribution of competences within a sectoral system, the presence of non-firms organizations such as universities and venture capital and the working of sectoral institutions (such as regulations or labor markets). (Audretch,1996; Malerba-Orsenigo,1999; Geroski,1996).

Finally, the type of knowledge, the learning processes, the distribution of competences, the key links and the dynamic complementarities affect the type of networks among heterogeneous firms and non-firm organizations. Think of the change in the underlying knowledge base in the switch from old drug discovery in the pharmaceutical industry to modern biotechnlogy, which has created new types of networks and a different type of relations among firms, non-firms organizations (such as universities and venture capitalists) and institutions (such as regulations) (Henderson-Orsenigo-Pisano 1999; Orsenigo et al. 1999). And compare it with the knowledge base of the machinery sector which is related to completely different types of networks and relationships between firms (users and suppliers), non-firm organizations (such as local banks and industry associations and government) and institutions (local trust). Or relate it to the type of knowledge and networks in complex system industries such as flight simulation (MillerHobday-Leroux Demers-Olleros,1995)

At the base of the degree of heterogeneity within sectoral systems lie the interplay between two key evolutionary processes that may differ from sector to sector: the process of generation of heterogeneity and the process of selection (Nelson,1995; Metcalfe,1998).

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These two processes greatly affect industrial dynamics and account for its differences across sectors.

Processes of generation of agents or behavioural heterogeneity are related to a variety of mechanisms: entry, R-D and innovation, adaptation and change in organizations and so on. Even the emergence and growth of new sectoral institutions and organizations such as new specialized departments within universities, new scientific and technological fields and new types of education increases variety and can be associated to the emergence of new technologies and new knowledge. See for example the general discussion of Rosenberg and Nelson (1993) on the role of universities in several fields of science and technology and the case of the chemical industry on the emergence of new departments and engineering degrees in universities in response to new technological developments in industry (Arora-LandauRosenberg, 1999). Sectoral systems differ extensively in the processes of generating heterogeneity.

Processes of selection play the key role of reducing heterogeneity. Selection may be more or less intense and frequent and affects the growth and decline of the various groups of agents and the range of viable behaviours and organizations in a sector. Selection processes greatly differ across sectoral systems. While theoretical work on selection has been successfully done at a very general level (see Metcalfe,1998), however, a finer grained analysis of selection and the factors affecting it at the sectoral level still has to be developed.

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3.2 Transformation and coevolution

Change is a distinctive feature of sectoral systems. Change does not mean simply a quantitative growth of the variables of a sectoral systems. It means transformation and evolution.

Recent research has clearly shown that during the evolution of sectors changes may occur in the technological and learning regimes and in the patterns of innovations. Over time, changes in regimes may turn a Schumpeter Mark I pattern of innovative activities into a Schumpeter Mark II. Early in the history of an industry, when knowledge is changing very rapidly, uncertainty is very high and barriers to entry very low, new firms are the major innovators and are the key elements in industrial dynamics. When the industry develops and eventually matures and technological change follows well defined trajectories, economies of scale, learning curves, barriers to entry and financial resources become important in the competitive process. Thus, large firms with monopolistic power come to the forefront of the innovation process (Klepper,1996 and 1997). On the contrary, in the presence of major knowledge, technological and market discontinuities, a Schumpeter Mark II pattern of innovative activities may be replaced by a Schumpeter Mark I. In this case, a rather stable organisation characterised by incumbents with monopolistic power is displaced by a more turbulent one with new firms using the new technology or focusing on the new demand (Henderson-Clark,1993; ChristensenRosenbloom 1995; Ehrnberg-Jacobsson 1997). More specifically, within the same industry the knowledge at the base of innovative activities may change in two different ways: an evolution towards a dominant design and a drastic change. In the first case the growth of concentration and the rise of large dominant firms takes place and concentration increases (Utterback,1994). In the second case, new types of competencies may be required for innovation. As a consequence, major industrial turbulence and entry of new firms occur and industrial leadership has a major turnover (JovanovichMcDonald,1984; Tushman-Anderson,1986, and Henderson-Clark,1990). Finally changes in demand, users and applications represent another major change in the context in which

22

firms operate and may favour the entry of new firms rather than the success of established ones (Christensen-Rosenbloom,1996).

This brief discussion highlights the need to take into account major sectoral differences in the change of sectoral systems and to try to asses the factors causing these changes. In particular, some key questions that need to be explored in depth could be the following. First, how do new agents come into being and what are the main sectoral differences in the rate, type and determinants of entry? Second, do new competences, organizational forms and strategies radically differ from the old or do they emerge from the old? Do we have adaptation or drastic change? How is the balance between the two affected by sectoral features? Third, do the relationships among agents and the networks show a great stability or do they change over time? and in which direction? Fourth, how new sectoral systems related to new sectors emerge? What is the link with previous systems and sectors?

From the previous claim that the elements of a sectoral system are closely connected, it follows that their change over time results in a coevolutionary process. This process involves technology, demand, knowledge base, learning processes, firms, non-firm organisations and institutions. Nelson(1994) and Metcalfe (1998) have discussed these processes at the general level by focussing on the interaction between technology, industrial structure, institutions and demand.

In this paper the claim is that these processes are sector-specific. For example, just looking at three elements such as technology, demand and firms, in sectors characterized by a system product and consumers with a rather homogeneous demand, coevolution leads to the emergence of a dominant design and industrial concentration (Klepper,1996). However in sectors with a highly heterogeneous demand, or competing technologies with lock ins, or network externalities and standards, specialized products and a more fragmented market structure may emerge.

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In addition, often coevolution is related to path-dependent processes (Arthur,1988; David,1985). Here local learning, interactions among agents and networks may generate increasing returns and irreversibilities that may lock sectors into inferior technologies. The cases of sectors with competing technologies such as nuclear energy (Cowan,1990) cars (and their power source -Foreman-Peck,1996) metallurgy (ferrous casting - ForayGrubler,1990) and multimedia (VCR - Cusumano,1992) are interesting examples of pathdependent process.

In sum, a lot of empirical and theoretical work has to be done in order to understand the dynamics of sectoral systems and their basic coevolutionary processes. Recent work such as Mowery and Nelson (1999) on the long term evolution of sectors such as semiconductors, computers, software, pharmaceuticals and biotechnology, chemicals, medical devices and machine tools has started to shed new light on these coevolutionary processes over time and across countries. In this book it has been shown that these coevolutionary processes clearly differ among sectors, and require careful explanations. An example is given by the computer industry, whose long term growth cannot just be described in terms of sales growth and the introduction over time of radically new products (such as the mini, the macro and the computer networks) with different features and demand. Rather, in this sector the complementarities between changes in components and changes in computer systems have affected the strategies of firms (see IBMs vertical integration and now specialization). A coevolutionary process involving technology, demand, firms structure and, institutions has charaterized the whole history of the industry (Bresnahan-Malerba,1999).

At the modelling level, one way to proceed in order to represent coevolution in different sectors is through history friendly models (Malerba-Nelson-Orsenigo-Winter,1999a). These models allow to capture in stylized way some of the aspects of the coevolutionary processes in a specific industry. Two of this type of models refer to the computer industry. One refers to the dynamics of technology, firms competences, market structure and demand. During the long-term evolution of an industry major technological and demand discontinuities may take place, thus greatly affecting market structure and the

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survival of established firms. In general, technological discontinuities have been absorbed successfully by industry leaders much more than demand discontinuities. When a technological discontinuity takes place within an existing demand, incumbents are able to shelter the major change in the technology through the lock-in of existing customers. On the other hand, a major change in demand is usually associated also to changes in the related technologies, so that firms have to pass through several shifts in terms of knowledge, with major consequences for the entry and growth of new entrants. These results emphasize the need to examine the possible tradeoffs and complementarities between knowledge about technologies and knowledge about demand (Malerba-NelsonOrsenigo-Winter,1999a). A second model examines the organization of innovative and production activities in the computer sector when knowledge complementarities among components and systems are present as a the result of the dynamic interplay of knowledge, competencies and market structure, and more broadly of the coevolution of the upstream and downstream industries. (Malerba-Nelson-Orsenigo-Winter 1999b). Once developed for several sectors, history friendly models will allow comparative analyses of the patterns of structural evolution and industrial dynamics common to several sectors, and an understanding of some factors causing them. In addition to firms, these models focus on several elements of sectoral systems: non-firms organizations, suppliers and users and public policy. In this way they could prove quite useful in the analysis of the interaction among several elements of the sectoral systems.

4. THREE

KEY

ISSUES: BETWEEN

TAXONOMIES SECTORAL

OF

SECTORAL AND

SYSTEMS, NATIONAL

INTERPLAY

SYSTEMS

INSTITUTIONS AND LINK BETWEEN SECTORAL SYSTEMS AND COUNTRIES INTERNATIONAL PERFORMANCE.

Finally, three key research issues can be identified regarding taxonomies of sectoral systems, the interplay between sectoral systems and national institutional frameworks and the role of differences in sectoral systems in countries international competitiveness.

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First, while each sectoral system has its own specificity and dynamics, it is important to group similar sectoral systems together in order to arrive to some general understanding about the structure, determinants and change of sectors. Pavitts taxonomy (Pavitt,1994) is a useful starting point as far as the sources of innovation, the appropriability means and the industrial structure are concerned. But also knowledge, networks, non-firms organizations and institutions have to be considered.

Second, the interplay between sectoral systems and national systems is another key issue to examine. As seen previously sectoral systems have their own specificities in terms of technology, demand, knowledge, complementarities, firms, networks, institutions and dynamics. So differences across sectoral systems may be high. However in a country sectoral systems may be greatly affected by the national organizations and institutions, such as the national financial system, education, labor markets, intellectual property rights, and so on. As a consequence, some similarities among sectoral systems within a country may exist and those similarities may be different from the ones of another country. Empirical research has confirmed that major differences exist across sectors, but these patterns are rather similar across countries for the same sectors. This has been associated to features of the knowledge base and of learning processes that are rather invariant across countries. National innovation systems affect not differences among sectors within countries, but the absolute values of innovative variables (such as entry, concentration, turbulence and so on). For example, on average in Germany and Japan technological entry is lower than in the United States and the UK (Malerba-Orsenigo,1994 and 1996).

Much more research is needed at a finer level of analysis. One useful starting point is to see whether the features and dynamics of the same sectoral system are similar or whether they are different across countries. And to study the role of national institutions in affecting some basic cross-country invariant features of the structure and dynamics of a sectoral system. National institutions could play this role in two ways: either stimulating or constraining sectoral systems, or adapting to the specificities of the sectoral systems. Of course, the interaction between sectoral instititutions and national institutions could go either way (i.e. could go from sectoral institutions to national ones), depending on the strength of the sector

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within the economy and the international specialization of the country. More broadly, one may ask what is the degree of endogeneity of the national institutions with respect to sectoral systems. Are differences across countries in institutions exogenous and as such some countries are at an advantage because their national institutions fit sectoral specificities better than the institutions of other countries? Or is the presence and strength of some sectors in a country moulding the emergence of national institutions?

The third issue regards the relationship between sectoral systems and countries international performance. Again, this issue may be tackled from different angles.

As a starting point we may claim that in continuously changing environment (as in most sectors) there is no way to identify an optimal and coherent sectoral system. So countries may differ in the role played by some sectoral elements as a result of past history and coevolutionary processes. The identification of the link between specific elements of sectoral systems and successful international performance is still ground to be covered by emprical research. Also, the link between cross countries differences in the structure and dynamics of a sectoral system and differences in the international

performance of these countries has still to be fully explored.

The most interesting attempt in this regard is the book by Mowery and Nelson (1999). By examining six sectors in the United States, Europe and Japan, they claim that countries international competitiveness is closely related the presence of competent firms, interactions among firms (such as with users and suppliers) and advanced non-firm organizations and institutions. These factors however differ from sector to sector.

Some general remarks may be advance as a way of conclusion on this issue. As previously mentioned the relationship between countries international performance and sectoral systems may be mediated by national institutions and non-firms organizations that form a national systems of innovation and production. In fact it might well be that those sectors that fit better the presence and strength of national institutions are the ones that grow and in which a country becomes internationally specialized. However in some

27

sectoral systems, regions and not countries are the appropriate unit of analysis for international competitiveness. This is related to the discussion mentioned before about the regional boundaries of sectoral systems. Finally, multinational corporations may span over different countries in order to profit from countries specific advantages. Therefore, these firms international competitiveness may be based on the use of a composition of different elements of a sectoral system, each one located in a different country. For example, a multinational firm operating in a specific sector may locate its research laboratories in a country, have cooperation with a top university in another country, produce, have links with key suppliers in another and so on.

5. CONCLUSIONS

5.1 Differences between the sectoral system approach and other approaches

This paper has discussed concepts and methodology regarding the analysis of sectoral systems. It has started from a definition of sectoral system as composed by a set of heterogeneous agents carrying out market and non-market interactions for the generation, adoption and use of technologies and for the creation, production and use of products that pertain to a sector (sectoral products). Sectoral systems have a knowledge and a technological base, and key links and dynamics complementarities among products, knowledge and technologies. The agents composing the sectoral system are individuals and organizations (either firms and non-firm), as well as organizations at lower or higher levels of aggregation. Agents are characterized by specific learning processes, competences, structures and behaviors. They interact in a market and non market way through various processes, and their interactions are shaped by institutions. A sectoral system changes over time through coevolutionary processes.

Sectoral systems may prove a useful tool in various respects: for a descriptive analysis of sectors, for a full understanding of their working, dynamics and patterns of change,

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for the identification of the factors affecting the performance and competitiveness of firms and countries and finally for the development of new public policy indications.

The novelty of this approach has to be confronted, on the one hand, with the industrial economics literature dealing with industries and, on the other, with the systems of innovation literature dealing with innovation and change.

With respect to the first one, the sectoral system approach differs significantly from econometric industry studies, the structure-conduct-performance tradition, the transaction costs approach, sunk cost models and game theoretic models of strategic interaction and cooperation, which have emphasized differences across industries in the contexts in which economic agents act. First of all it pays a lot of attention to the knowledge base and the learning processes of agents. Second, it focusses on within-sector agents heterogeneity in terms of learning, competences, organization and behavior. Third, it pays a lot of attention to non-firms organizations and sectoral institutions. Fourth, it stresses the role of dynamic complementarities. Finally, it focusses on change and dyamics of the whole system through coevolutionary processes. The recent contribution by

Geroski(1998) about strategic markets is an attempt to capture some of the elements of a sectoral system.

With respect to the system of innovation literature, the differences regard mainly the focus on sectors rather than on technologies of countries, and the inclusion of production in addition to innovation. The concept of innovation systems in the literature is very broad and encompasses a wide variety of topics and issues (see for example the book by Edquist (1997)). Other more focussed concepts have either a technological dimension or a geographical one. The first include technological systems, in which the focus is mainly on networks of agents for the generation, diffusion and utilization of a technology (Carlsson-Stankiewitz,1995), complementarities and interdependencies among

technologies (Hughes,1984) and networks of cooperating agents (Callon,1992). The second include the studies in the national systems of innovation literature tradition. Here the focus is on national boundaries and on non-firms organizations and institutions, with

29

the inclusions of a wide variety of sectors (Freeman, 1987 Nelson 1993 and Lundvall 1993). A tradition closer to sectoral systems are the studies on regional or local systems: very often in fact a local system overlaps with a sector (see for example the studies of industrial districts and the machinery industry).

5.2 Methodology, future research directions and policy implications

Two methodological remarks have to be advanced as a way of conclusions. In this paper the term firm and non-firm organization has been used for the sake of simplicity. Actually there are different levels of analysis: the individual, the department, the business unit, the consortia, the industry associations and so on. Flexibility has to be used in terms of what kind of unit of analysis, which variables have to be examined and how much fine grained analysis has to be conducted. Second, the level of aggregation of a sectoral system has to be left open. Sometimes it is necessary to analyse very broad sectoral systems, such as computer hardware and software. Other times not, as in the case of software. The goal and the objectives of the analysis should dictate the appropriate level of disaggregation.

Future directions in the research on sectoral system should move along four lines. The first and the most urgent one regards analyses of sectoral systems along similar

dimensions. While relevant progress has been done in identifyng sectoral differences in the types of innovation and production, the kinds of actors, the sources of knowledge, the key dimensions of demand and the presence of non-firms organizations, much less advancement has concerned the extent and features of within-sector agents heterogeneity and the structure and change in the relationships and networks among agents. Even less progress has been done in understanding sectoral differences in the role of sectoral institutions, the processes of heterogeneity generation and selection, and coevolution. Albeit these issues present quite different levels of analytical and empirical difficulty, all of them have to be studied in depth and understood in order to have a full comprehension of the differences in the features, working and dynamics of sectoral systems.

30

Second, on the basis of the results obtained from the analyses mentioned above, taxonomies of sectoral systems have to be constructed. They should group sectoral systems along several dimensions. These taxonomies should complement the ones already available, which have provide enormous progress in understanding differences across sectors such as Pavitt taxonomy or the Schumpeter Mark I and Mark II distinction for the sectoral patterns of innovative activities.

Third, alongside the empirical work and interacting closely with it, conceptual and theoretical work has to be carried out on the relationships among the variables of a sectoral system, the role of within-sector heterogeneity, the basic processes of heterogeneity generation and selection, and coevolution, and on their effects on firms and countries performance. Here both theoretical models of industry dynamics and history friendly models can be useful.

Finally, from the above mentioned analyses of the role of non-firm organizations and of national and sectoral institutions, public policy indications may be developed regarding how to affect the growth and transformation of sectoral systems, the innovation and diffusion processes, and the competitiveness of firms and countries.

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