Why the Number of Firms Doesn’t Matter for Innovation

By: Per Bylund

Consumers do not gain because there are many producers of the same good, the number is irrelevant. They also do not gain from firms competing with each other, their strategies matter little. Consumers gain from production directed toward value creation.

We have been taught that competition “is” many actors trying to do exactly the same thing, which “forces” them to outdo each other. But it is a simplification that gets very close to being a lie.

The reason is that  the competitive pressure that makes a business continue to innovate and even reinvent itself is not that there “are others.” What matters is that others may beat them in the future. This is more than hairsplitting. 

Consider a runner who is so fast that nobody in that sport can beat her/him. Does that mean s/he stops training or just works to maintain that skill? No. Because there is no guarantee that others, who have trained differently and developed a new set of skills, won’t enter. So to stay on top, the runner needs to continue to get better. For business, it is more difficult, since those who judge the outcome — consumers — might change their minds and develop new wants. 

The same thing holds true though, it is not enough to “simply” beat the existing competition, because there may be new entrants with innovations that undermine the value of your offering. And competitors may reinvent themselves to do the same. 

True competition, which any business needs to deal with, is the possibility of better offerings in the future.

More importantly: this pressure exists regardless of how many are currently producing a certain good. Competitors in the flip phone market were not disrupted by a better/cheaper flip phone, but a different type of device: the smart phone. 

In other words, what really matters is the value proposition, how well one satisfies consumers — not the number of competitors in the present market.

While firms in the existing market try to keep prices lower and quality higher than the existing competition, and try to position their offering with respect to competitors’ similar offering, this “dance” is not what creates value. Innovative, imaginative, entrepreneurship is what facilitates value for consumers and creates, reshapes, and destroys industries. 

In other words, all that is needed for a competitive product offering is *one* producer — as long as others are not hindered from entering. There is this mistaken belief that what matters to consumers is the number of firms already busy producing a good, preferably almost the same good, which has made us think of competition not in terms of entrepreneurship but “how many.” It often is true that more firms competing for limited demand will therefore engage in innovation, but it is not the fact that there are other firms that benefits consumers–it is the innovation. 

And what drives innovation is the pursuit of future profitability. You can have a market with hundreds of similar firms producing, which is disrupted by one innovative entrepreneur, and that one entrepreneur is much more important than any of the hundreds of competitors. 

The entrepreneur creates the valued new offering that satisfies consumers; s/he destroys the old by creating the new. That’s what matters, not the number of firms. 

Formatted from Twitter @PerBylund

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