Can creative destruction be destroyed? Military IR&D and destruction along the value-added chain

Research Policy 32 (2003) 1537–1554

Can creative destruction be destroyed? Military IR&D and destruction along the value-added chain Allen Kaufman a , Christopher L. Tucci b,∗ , Mark Brumer a a

Whittemore School of Business and Economics, University of New Hampshire, 15 College Road, Durham, NH 03824, USA b NYU Stern School of Business, 44 W 4th Street, KMC 8-71, New York, NY 10012, USA Received 14 November 2000; received in revised form 15 July 2002; accepted 30 October 2002

Abstract We elaborate a supply chain innovation matrix that can be applied to both commercial and military supply chains. By shifting the analysis from a focal firm to industry structure, we argue that the market structure of the entire supply chain functions as a major moderating variable in determining both the timing and adoption of innovations, both for commercial and military markets. We extend work on supply chain resource dependency by drawing a distinction between market-structure-induced resource dependency and supplier over-reliance on a customer in a competitive market. This has policy implications for the organization of military industrial research and development (IR&D). Joint service research and development (Jointness) will certainly bring about innovation, but it will be incremental, reinforcing established military hierarchies. Policy makers may need to add this probable consequence when comparing Jointness and inter-service rivalry. The cost savings inherent in Jointness may unwittingly sustain a military force unready for fighting the next war. © 2002 Elsevier Science B.V. All rights reserved. Keywords: Creative destruction; Industrial research and development (IR&D); Value-added chain

1. Introduction How has the military managed to promote innovation during and after the Cold War? To answer this question, we rely on management theories of innovation in the for-profit world. By adopting these concepts, we argue that competition among the services promoted rather than hindered innovation. In deductively building an argument outlining the tradeoff between efficiency and competition in military industrial research and development (IR&D)1 , we ∗ Corresponding author. Tel.: +1-212-998-0285. E-mail addresses: [email protected] (A. Kaufman), [email protected] (C.L. Tucci). 1 We use the term ‘IR&D’ in this article to refer generally to all research and development conducted by industry and sponsored by

elaborate a new supply chain innovation matrix that can be applied to both commercial and military supply chains. By shifting the analysis from a focal firm to industry structure, we argue that the market structure of the entire supply chain functions as a major moderating variable in determining both the timing and adoption of innovations, both for commercial and military markets. We extend work on supply chain resource dependency by drawing a distinction between market-structure-induced resource dependency and supplier over-reliance on a customer in a competitive market. or targeted toward the military. Our IR&D includes but is not limited to the Pentagon program (cost recovery category) of Independent Research and Development and specific military-sponsored research programs with the same acronym.

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1.1. The context: Jointness Those who study military innovation note that military bureaucracies build interest groups resistant to change, particularly during periods of relative peace (Posen, 1984; Rosen, 1994; Pierce, 2001). These theorists use political science models of bureaucracy to account for the military’s resistance to change, a model that scholars contrast to dynamic markets. The implicit comparison gives credence to those policy makers who would bring corporate cost-accounting practices to the military industrial research and development (IR&D) process. These reformers contend that business principles demand joint service IR&D (“Jointness”), which allegedly saves costs at the generic research and the system development stages (Jones, 1999).2 However, this dominant paradigm ignores important distinctions made within the managerial literature both on industrial innovation and on supply chain management. Jointness appears to run counter to the literature on industrial innovation (e.g. Vonortas, 1997; Fusfeld, 1994) that generic research works best when organizations cooperate and that product market development works best when organizations compete; likewise, the Jointness movement appears to be unaware of a growing literature (e.g. Afuah, 2002; Christensen and Bower, 1996) that views downstream relational power as a suppressant of radical upstream innovation. Instead, the Department of Defense (DOD) argument has as its basis corporate cost-accounting methods that seek economies by eliminating duplication and by gaining scale. When viewed from the managerial literature on innovation, Jointness leads to an unintended outcome. Centralized control and reduction in duplication of effort allow downstream users (the incumbent officer corps) to form a buying “cartel” that has complete control over innovation’s disruptive consequences. And, given the private defense industry’s customer focus, these firms typically become allies in efforts to halt radical innovation. 2 The services differ in their understanding of Jointness. The Army and Air Force use the term to mean unification while the Navy and Marine Corps use it to mean integration (Owens, 1997, 1998). We adopt the Army and Air Force meaning for this paper. Integration would amplify all the effects proposed in the paper.

To illustrate the Jointness doctrine, take the case of the military’s best-advertised weapons IR&D program, the Joint Strike Fighter (JSF). Although the JSF differs in details to accommodate service needs, all planes are built from the same manufacturing platform. Jointness, so the argument goes, gives the military monopsony power. Firms compete first over design, and then in producing a prototype. Savings come primarily from consolidating costs of development and from scale economies in producing and maintaining one model (Jones, 1999). However, this application of Jointness actually restricts the ability of the defense industry to generate technologies that would upset the Cold War military regime. The Defense Department explicitly states that the JSF must build from known technologies and by implication that it must perpetuate the officer corps put in place during the Cold War. In other words, the JSF offers the next generation of aircraft that were originally designed to defeat Soviet fighters. As it is currently structured, Jointness has the potential to deliver cost-effective incremental technical change that reproduces the Cold War’s military hierarchies. By using managerial concepts devised to understand industrial innovation and to oversee supply chain management, we present an alternative viewpoint on military IR&D, one that takes much from empirical work on the Cold War innovative system (e.g. Sapolsky, 1972; MacKenzie, 1993; Flamm, 1988; Koppes, 1982; Spinaldi, 1994). Defense policy wisdom portrays joint service product development as a cost-effective means to foster innovation. In contrast, we argue that this strategy creates, in effect, a “cartel”, which tends to suppress radical innovation while encouraging incremental changes supportive of the Cold War officer corps. Military IR&D works optimally when the services first cooperate on generic component part research to reduce risks and enhance knowledge and then, during the development phase, compete to bring the new weapon system to “market”. Service rivalry provides an effective check against incumbent interests opposed to change (Hayes and Smith, 1994).3 3 With the Cold War’s conclusion, Congress and the Department of Defense (DOD) took steps to eliminate the competitive phase by labeling inter-service rivalry inefficient. These reforms were hardly surprising since they can be found in a long list of blue ribbon commissions on improving DOD efficiency (Jones, 1999). On the matter of new weapon development, these reports advocated

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To make this argument, we propose that market structure along the supply chain is a critical determinant of the timing and effects of innovation. We develop an IR&D supply chain matrix, absent in the managerial literature, and apply it both to commercial and military ventures. On the military side, we offer a theory of inter-service rivalry and innovation derived from microeconomic concepts. Others have made claims about inter-service rivalry’s benefits, but these have relied on institutional arguments outside microeconomics (Sapolsky et al., 2000). 1.2. Method and organization The literature on innovation and on regulatory policy provides the basic theoretical tools for our investigation into IR&D supply chain management. Note that both share a microeconomic foundation in which markets are assumed to be less than perfect (Williamson, 1985; Stiglitz, 1997; Knight, 1921). Transaction cost economics and property rights theory best elaborate a theory of the firm under the assumptions of imperfect information and bounded rationality (Hart, 1996; Williamson, 1985). Further, public choice theory has extended microeconomics into the public policy domain (Riker, 1982; Buchanan and Tullock, 1962). Our method for answering the question of how the military promoted innovation during and after the Cold War proceeds deductively and synthetically. We employ a deductive method by following the logic of microeconomic theory in assessing innovation, both in the commercial and military sectors. We build in each section of the paper below a series of assumptions that, when combined, clarify the dynamics of technological change and creative destruction. Further, our method is synthetic in that it links together transaction cost and public choice theories of the private and public sectors. Logical consistency is paramount. We divide the theoretical exposition into six parts. Section 2 contains the first three parts and focuses on building the argument that cartels in a supply chain change the kinds of innovations the supply chain procentralized administration, i.e. joint service projects. By placing IR&D weapon system research under a single authority, reformers promised that the costly redundancies found in separate service IR&D pursuits would be eliminated. At the same time, centralized control would bring economies of scale during the project’s IR&D, manufacturing and maintenance phases.

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duces. In Section 2.1, we define terms and review the literature in the management of innovation relating to “radical” and “incremental” technology. Then (Section 2.2), we recount economic rationale for and obstacles to forming an industrial consortium. During the generic phase of a radical IR&D project, a research consortium offers substantial benefits. However, collective action problems associated with the formation of a consortium regularly thwart the undertaking. The private sector’s inability to capitalize on IR&D consortia displays the military’s potential for organizing such consortia. Finally, we elaborate our own theory relating to the market structure of the supply chain. In Section 3, which includes the last three parts of the argument, we apply the theory from Section 2 to the context of military IR&D. First (Section 3.1), we review the military’s advantage in managing a research consortium. The military’s command and control structures simply eliminate the collective action problems that market actors encounter. However, command and control brings with it substantial problems, which, if not solved, render military IR&D expenditures ineffectual. Once established, the “inefficiencies” inherent in the military’s command structure (impacted information) and in the congressional budgetary process (rotating majorities) provide an entanglement of interests that can sustain and expand IR&D investments. Section 3.2 reviews how coalitions form from the IR&D project officers’ oversight requirements. The US political system provides incentives that bias the military to outsource many key services. Through outsourcing, technical officers can hone an effective political lobby. Should these technologies prove effective and threaten the incumbent officer corps, a political battle will ensue between these officers and reformers both inside and outside the military. Finally, by constructing two hypothetical cases, we consider (Section 3.3) the dynamics by which a new technology may advance and devalue an old one, as when missile technology lessened the importance of long-range bombers. The first hypothetical assumes a “Joint” command structure while the latter presumes a structure divided among services. This exercise leads to interesting conclusions: (1) radical, new military technologies fall into two distinct stages, one in which the technology is developed and prototyped,

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and one in which the technology is deployed and brought to market; and (2) intra- and inter-service rivalry provides the diversified portfolios required in undertaking IR&D and the political dynamic for advancing these technologies, once they move into the prototyping phase. The final section (Section 4), offers implications for theory. We discuss how market power alone is insufficient for understanding competence-destruction along the supply chain. Instead, we propose that market structure of both customers’ and suppliers’ industries affect the adoption and timing of innovation. We conclude Section 4 with policy recommendations. 2. Theory development 2.1. Incremental versus radical innovation 2.1.1. Incremental and radical innovation defined Since at least the time of Schumpeter (1934), researchers have been interested in how innovation reshapes industries. Scholars speak of two kinds of innovation: incremental and radical (Utterback, 1994; Anderson and Tushman, 1990, 1991; Afuah and Bahram, 1995). Incremental innovation improves on a known product or the process for producing it, reinforcing existing engineering and manufacturing know-how (thus, “competence-enhancing”). These innovations may be simply minor process improvements—such as introducing statistical process control—or incremental product quality improvements, as when software firms introduce a new edition of an existing software package. Such innovations allow firms temporarily to build upon their former competitive advantage. Incremental improvements may also be discontinuous. Take the striking case of turbo-jet engines. Although the turbo-jet dramatically changed engine performance, the innovation built from existing engineering and manufacturing know-how. In this sense, the turbo-jet engine enhanced existing engine firm capabilities. Discontinuous change may be subtle as when a firm reconfigures known components to make a new product. The transformation of electric room air fan into a ceiling fan offers a simple illustration. Here, the components (blade, motor, control system)

are modified to produce a new product that opens new markets (Henderson and Clark, 1990). In contrast, radical (or “competence-destroying”) innovations economically devalue existing technologies (Anderson and Tushman, 1990, 1991; Utterback, 1994). These innovations typically depend on scientific understanding and technical know-how that does not build on a firm’s current capabilities. The transistor illustrates this sort of discontinuous change. The transistor did not rest on the scientific knowledge or make use of production skills accumulated by firms manufacturing vacuum tubes. Those who were unable to transit into the new technological/manufacturing system went out of business. To represent this, Henderson and Clark (1990) proposed knowledge destruction along two dimensions: core system and component part knowledge. Note that only the destruction of both fully undoes a product market’s technological determinates. 2.1.2. Market resistance to radical innovation The possibility that a new, radical technology may displace established firms accounts for their frequent efforts to seek out and suppress new, threatening technologies. This behavior regularly occurs when industrial markets have matured. Two literatures, one from economics and the other from management, have documented alternative ways that entrenched firms have resisted radical innovation. Economists and political scientists argue that established firms regularly organize to help establish or to capture state regulatory agencies. These provide an effective—some say the only effective—defense against price competition and radical innovation (Stigler, 1971; Peltzman, 1976). These regulatory agencies have the power to set entry barriers, establish price, and regulate technological change. Still, regulatory agencies have the capabilities to promote change by using regulatory incentives and by promoting competition. The Cold War innovative system provides the most cogent example (Mowery and Rosenberg, 1998; Nelson and Wright, 1992). Economists consider the defense industry a de facto regulatory system, even though no independent regulatory agency controls entry and exit. The military effectively acts as this agency because of its monopsony procurement powers (Ferguson, 1994; Sandler and Harley, 1995; Scherer, 1964). Unlike their regulatory counterparts,

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like the now defunct Civilian Aeronautics Board, Cold War military technical and procurement officers use their resources to promote radical innovation. Even critics of Cold War budgets concur on the military’s excellence in conducting weapon system IR&D (Alic et al., 1992). Researchers who employ this concept of a Cold War innovative system usually refer to (1) the ways that DOD budgets spurred IR&D; and (2) how firms used this new technical know-how to spin-off commercial products beyond the military’s regulatory reach (Mowery and Rosenberg, 1998). The Cold War, however, was a military campaign, not a commercial venture. The military evolved a regulatory framework that provoked radical innovation, remaking industries and undoing military hierarchies. Here, economists have done little work in accounting for how this innovative military system overcame vested bureaucratic interests to generate radical new technologies. The managerial literature relating to supply chain management identifies the second way by which firms suppress economically threatening innovation. Transaction cost economics provides the logic of this process. Firms (customers/suppliers) co-specialize their assets to gain efficiencies and establish collaborative, long-term relationships to optimize on transaction costs (Williamson, 1985; Kay, 1997). These relationships allow for firms within the supply chain to engage in joint product design and concurrent engineering, to share personnel and equipment, and to leverage financial and marketing resources (Kaufman et al., 2000; Dyer and Singh, 1998). Thus, supply chains that invest in complementary assets and collaborate to improve their competitive positions have: (1) a joint interest in uncovering innovations that enhance their capabilities; and (2) a joint interest in suppressing innovations that devalue these investments and relationships (Afuah, 2002). Should a downstream firm—say the end supply chain customer (an original equipment manufacturer)—gain monopoly power, it could use its monopsony position to enforce the supply chain propensity to promote incremental innovations. Alternatively, if a few downstream firms account for a large portion of the market, technological threats to their investments may provide sufficient incentive for them to overcome their collective action problems and act as an oligopoly to suppress value-destroying innovations.

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Afuah (2000) offers an example of how this resistance to innovation works in a commercial supply chain. When a supply chain member attempts to introduce a technology that would disrupt the chain, others band together to resist its introduction. These circumstances make it difficult for the innovative firm to quickly deploy the new technology. Christensen and Bower (1996) offer a second example found in the disk drive industry. They describe how disk drive suppliers that are heavily dependent upon customers failed to develop new technology that, while potentially competence-enhancing to the supplier, were competence-destroying for existing customers (which they labeled “disruptive”). In both cases, the firms that resisted the new technologies successfully prevented their suppliers from adopting it. However, innovations eventually entered the market through alternative suppliers that sought out savvy customers. 2.2. Private sector Industrial research and development 2.2.1. The promise of industrial research consortia The literature on innovation makes it plain that radical industrial research and development (IR&D) is an uncertain business (Freeman and Soete, 1997; Stiglitz and Wallsten, 1999; Utterback, 1994; von Hippel, 1988; von Hippel, 1998). Results may be long in coming, intangible, and inapplicable to developing proprietary products. In fact, radical industrial research is so risky that typically only the most daring and well-financed firms engage in these activities. Nevertheless, uncertainty itself induces investments because of the high returns that the few successes bring. When product development managers pursue innovation, they invariably define the product as a system composed of subsystems or component parts. Some components set the design parameters of others and some are so fraught with practical problems that they constrain the system’s movement from design to development to production (Vincenti, 1990). Product development managers identify these troublesome spots and put extra resources at the disposal of those responsible for developing the component. Solutions to a problem hindering a component may rearrange the order of addressing design problems and the relationships among components; hence the idea that critical

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components pose reverse salient problems (Hughes, 1989). The distinction between generic and proprietary research opens the possibility for a research consortium where competing managerial teams collaborate to solve generic, component part problems. Because generic knowledge precedes proprietary applications, firms can share this information without divulging “trade” secrets. Obviously, if a firm uncovers answers to these basic engineering problems and develops the data for a “critical” component part solution before others, it will have a competitive advantage in being first to market. However, the costs of going it alone are extremely high given the various solution paths and the multiple kinds of research and disciplinary training required. Thus, firms have incentives to form consortia to share risks and costs and exclude others from their joint knowledge (Ouchi and Bolton, 1988). An IR&D consortium reduces the associated costs of basic research by enhancing information flows and by distributing the risk among multiple participants. In a research consortium, member firms: (1) divide alternative routes for developing non-proprietary component parts; and (2) share information on the results of these vying solutions. This arrangement reduces overall costs by allowing firms to share complementary technologies and know-how. Research regularly puts firms on paths that take them outside their expert domains. A consortium brings together firms whose combined technical inventory can handle many problems as they arise. Consequently, cost sharing reduces high IR&D overhead investments. An IR&D consortium also reduces market risk. Since technical problems have competing solutions, redundancy must be built into research and development projects. By dividing the multiple paths among members, the consortium reduces its members’ risks: each firm holds a diversified research portfolio (Corey, 1997; Stiglitz and Wallsten, 1999; Grindley et al., 1994). A consortium reduces another sort or risk: information asymmetry (cf. Williamson, 1985; Casson, 1998). An IR&D consortium fashions a dense and an extensive information network, in which firms co-mingle (Fransman, 1990). The formation of this intensive and extensive selective learning network provides members with anticipated and unanticipated information to which non-members are denied access (Noteboom,

1999; Kaufman et al., 2000; Simonin, 1999; Dyer and Singh, 1998; Powell and Koput, 1996). Once a consortium solves the generic technical problems, member firms proceed to integrate the components into proprietary products until one design holds sway over the market, either through consumer choice or through regulatory fiat. At this point, the managerial literature tells us product innovation moves into a third period. Firms begin to compete to improve incrementally the product and the processes required for its production and distribution (Utterback, 1994; Anderson and Tushman, 1990; Mowery, 1998). 2.2.2. The hindrances in forming an IR&D consortium The incentives for IR&D collaboration seem compelling. However, IR&D managers know that market hindrances typically offset collaboration’s benefits. Free riding is the most pervasive problem (Olson, 1965). A consortium attempts to resolve this problem by functioning as a “selective” organization, in which only its members share in the collaborative payoffs (Hardin, 1982). But the problem persists. Each member firm hopes that others will delegate their best staff and best resources to the project. When one firm conducts research in its facilities or its team takes on a project in a joint facility, the firm has an incentive to less than fully disclose information. Personnel sharing may mitigate this tendency, but effective research teams take time to form, so that inter-firm collaboration brings substantial costs. Consortium coordination poses another set of costly problems relating to setting the agenda and defining a generic research program. Given the multiplicity of interests and the complexity of the consortium’s connections to outside parties, consortia tend to leak information. These difficulties typically lead firms to favor competition over collaboration, creating a less than socially “optimal” outcome. 2.2.3. An IR&D supply chain taxonomy A consortium, then, functions as a supplier to the industrial firms that design and develop the product. In fact, innovation, whether of a competence-destroying (radical) or a competence-enhancing (incremental) sort, can work through a supply chain (Afuah and Bahram, 1995). The firm that designs and develops the product or system functions as the customer while the firm or research laboratory that performs com-

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Fig. 1. Market structure of supply chain and innovation.

ponent part research and development functions as the supplier. Customers may compete or cooperate in managing their supply chain; and they may either arrange their supply base either in a cooperative or competitive manner. Fig. 1 illustrates the industrial forms that this innovation supply chain can assume. In those cells in which customers (or suppliers) cooperate, competence-enhancing innovation dominates. In these situations, customers have market power and can use it to sustain capabilities rather than to “destroy” them. In the cells to the right, customers have neither monopoly nor monopsony power. Market competition functions, making for uncertain outcomes. The possibility that a rival might undo the reigning paradigm compels each to pursue both incremental and radical research. In the upper right, which we label “supplier-led innovation”, customers compete with other firms in their own markets, while suppliers either cooperate or enjoy monopoly positions. The

lower right, “traditional”, is the cell in which competition reigns along the supply chain. Those cells to the left, where customers cooperate and exert market power, typically requires cartel legislation or exemptions from anti-trust laws. The US government has not allowed for the cartel arrangement in the lower left hand cell—except during the two world wars and a brief experiment during the Great Depression. However, during 1970s and 1980s, when Japanese firms captured market share in numerous markets, Congress relaxed antitrust laws when it passed the Cooperative Research and Development Act of 1984. This allowed firms to cooperate on industrial research and development. Perhaps the best-known IR&D example, Sematech (see lower left cell: “cartel-induced innovation”), arose from 1987 Congressional legislation (Corey, 1997). The DOD, fearing Japanese encroachments into the US semiconductor industry, lobbied for this bill on national security grounds. The Act authorized

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DOD subsidies and exempted the companies from anti-trust constraints, claiming that they would be engaged in non-competitive basic research and development. However, the industry failed to cooperate in establishing a basic research agenda. Instead, Sematech became an association by which the industry’s primary players, Intel, IBM, Motorola, etc. organized its supplier base. By setting standards and improvement milestones, Sematech has effectively promoted incremental innovation (Corey, 1997; Mowery, 1998). 3. Application of the theory to military IR&D 3.1. The officer corps, budgets and radical IR&D projects The pitfalls for firms in forming IR&D consortia points to a general problem: that profit-maximizing firms tend to under-invest in R&D. To correct this market imperfection, government frequently invests in R&D and subsidizes private initiatives (Mowery et al., 1999; Stiglitz and Wallsten, 1999; Cohen and Noll, 1991; Narin et al., 1997). However, national security provides its own rationale for government-sponsored IR&D. As government representatives, the military does not encounter the collective action problems found in the marketplace. This potentially allows the military to be a more effective agent for IR&D than the market. However, advocates for a radical IR&D weapon system consortium must overcome the incumbent officers’ misgivings about investing in competence-destroying technologies and create the administrative means to coordinate the project. 3.1.1. The incumbent warrior officer corps’ resistance to radical change Modern militaries have developed two kinds of officers: the traditional warrior who plans and carries out military campaigns and the technical officer who reviews industrial and scientific advances that affect a military’s war-making capabilities (Van Creveld, 1991). Within the US military, warriors have dominated the officer corps. These officers’ careers are generally tied to a particular weapon platform: bombers, aircraft carriers, etc. (Hundley, 1999). This officer corps welcomes opportunities for incrementally improving its weapon platform’s performance,

for developing the next generation of the existing technology, and for amassing budgets to carry out these IR&D projects. However, incumbent officers have little inherent interest in introducing weapon systems that sabotage their commanding position, and they have the power to delay or halt deployment. This contrasts with private markets, in which radical technologies improve consumer wealth and enrich first-mover suppliers. So why does an incumbent officer corps invest in potentially radical IR&D? For two reasons: to increase military budgets (Niskanen, 1971) and to develop technologies that enhance capabilities (Pierce, 2001). The incumbent officer corps can garner additional funds beyond those required to sustain and improve the given force structure by embracing radical IR&D projects. Investments in IR&D programs have long time horizons and uncertain prospects. In fact, officers know that most radical technologies fail. Because the incumbent officer corps closely monitors program managers, they must seek out senior officer alliances and disguise implications if radical technologies are to move forward (Davis, 1967; Pierce, 2001). The second IR&D investment reason, to enhance current capabilities, affords radical change through unanticipated outcomes. To understand this point, recall Henderson and Clark (1990), which Pierce (2001) adapts to military organizations. Unlike Henderson and Clark, Pierce considers a third variable: doctrine (cf. Rosen, 1994). By this, he refers to unified concepts by which the military organizes its war-making capabilities. In a logical—structure follows strategy— sense, doctrine precedes weapon systems and its various components. However, history rarely conforms to logic. Doctrinal changes typically occur when an officer group discovers how incremental technological changes allow for a radically new way of making war (Hayes and Smith, 1994). The blitzkrieg provides the salient example, for it radically changed land warfare by combining known technologies—radio communication and armored vehicles (Posen, 1984; Pierce, 2001). Here, radically different refers both to the military’s novel integration of proven technologies into a new weapon systems and to the new career possibilities that open to young officers when a doctrinal shift occurs. Fig. 2 presents Pierce’s (2001) modification of Henderson and Clark. Notice that in Pierce’s matrix

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Fig. 2. Architectural innovation and military doctrine (Pierce, 2001).

two types of innovation—radical and architectural innovation—challenge established interests. Where radical innovation does this by replacing one weapon system (and so, one officer corps) with another (competence-destroying), architectural threatens the existing order by working directly with the old technologies to undermine the military’s career patterns. Thus, military officers may invest in IR&D to enhance a given weapon system and only later find out that these investments—contrary to expectations—caused a military upheaval. 3.1.2. The technical officer corps’ complex interest in radical IR&D Technical officers’ career paths depend less on the prevailing weapon system than combat officers. Although military officers, they are also scientifically trained professionals. These experts—whether as operational technical officers or as staff officers—pursue technical objectives and provide advice on possibilities. Here, scientific and engineering knowledge gauges actions, making for internal conflict between

those who pursue technological advances and those who make use of technology to reinforce set authority patterns (Davis, 1967). Governmental “inefficiencies” sustain military investments in radical IR&D. By “inefficiencies”, we are not referring to mismanagement or programs that lack effective cost controls and oversight. Rather, we are speaking about the information asymmetries inherent in large-scale government bureaucracies and the “log rolling” tendencies of democratic governments. Though reformers generally rally against these allegedly wasteful consequences of democratic government, these practices play an important role in sustaining military innovation. They ensure the overlapping experimentation in which innovation thrives. 3.2. Project IR&D coordination and outsourcing All of this may give technical/procurement officers space for developing radical technologies. However, such research requires effective organization. For the military to be successful in this endeavor, it must co-

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ordinate the IR&D project. To proceed, procurement officers must decide on whether to invest in additional research capacity or to purchase these services from university laboratories and private firms. In making the decision on the “optimal” proportion of in- and out-of-house research, military officers must consider such variables as the costs of building and administering in-house capacity against the costs of writing, monitoring and enforcing contracts. This accounting problem, however, becomes complicated when military officers consider the consequences of their decision on the military’s internal power relations and on its abilities to build budgetary coalitions (Kaufman et al., 1993). 3.2.1. The military’s propensity to outsource In general, the officer corps’ composition and the US political system provide incentives for outsourcing. Since World War II (WWII), warriors have dominated the officer corps. They assure that the military’s core competency revolves around winning wars rather than managing weapon programs. Typically, warrior officers prefer outsourcing to building in-house research capacity; an expansion of the latter may rework the relative positions of warrior and technical officers. Tradition, however, limits outsourcing. More importantly, if the military outsourced all its technical capabilities, it would become information-dependent on outsiders, e.g. firms, research labs, consultants, etc. Technical officers who oversee IR&D projects have a second compelling reason to build links with civilians. IR&D works best when it occurs among various organizations and disciplines and when information flows among these “partner” and affiliate organizations. Conceptually, the link between the applied sciences’ desire to dominate nature and the military’s desire to dominate adversaries strikes an intuitive chord. Both have an interest in demonstrating their prowess over nature. This fact—and not the lobbying benefits associated with it—persuaded the post-WWII military to enter into a cooperative relationship with the scientific and engineering communities (Kelves, 1975). The military must consider another non-accounting issue when considering its make/buy decision: the budgetary process. As Buchanan and Tullock (1962) noted, democratic politics do not allocate resources to correct market failures. Instead, representatives form

rotating majorities that redistribute tax dollars to local constituencies through public programs, including military IR&D (Riker, 1982; Schattschneider, 1960). Since budgets are fundamentally political, military officers must consider how expenditures on in-house capacity and on subcontracting will affect the military’s political influence. This structure ensures that the budgetary process will be anything but straightforward. The process’s multiple entry points allow interests ample opportunities to revise and counter-revise budgets. To participate effectively, interests must enter into coalitions. Though these coalitions are hardly stable, the constitutional structure does provide two general rules: align oneself with (1) broad congressional-constituent interests; and (2) powerful private sector interests. In short, the political process biases the military toward outsourcing. Once procurement officers secure a budget and once they have built a constituency, they may perpetuate their programs by exercising political influence (Cohen and Noll, 1991). These lobbying forces may overcome incumbent officers’ self interest to weaken threatening programs, or they may overcome well founded technological or balance of power objections. 3.2.2. Managing the IR&D complex Given its predisposition to outsource, the military must develop procurement skills to minimize transaction costs. First, long-term contracts offer one method by which to reduce these costs. Procurement officers require discretionary authority to grant these contracts on a non-competitive basis. Research teams and research problems exist in well-defined communities in which peer review serves as a substitute for market competition. Still, contractors may shirk, falsify data, and act in other opportunistic ways. The military has two effective means for overcoming this problem: (1) the military can establish a monitoring system by assigning procurement officers (or their civilian equivalents) to research facilities and by assembling expert review committees; and (2) the military can punish non-performers by refusing to award them future contracts. The military may turn either to private firms, university research centers, or to non-profit research organizations to conduct IR&D on a component part or in a field that may contribute in finding technical solutions. In general, the closer the project is toward prototyp-

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ing, the more likely the military will subcontract with a production firm. For firms, IR&D contracts must be sufficiently promising for production contracts or closely enough related to ongoing weapon system expertise to divert resources from profit generating activities. When research tends toward generic knowledge, universities or private research institutes become likely contractors. For universities, the research must be consistent with the faculties’ perceptions of their knowledge generating activities and must be conducive to peer reviewed journal writing (Van der Meulen, 1998). For those who publish first, research grant opportunities become plentiful, whether from public or private research institutions. Successful researchers capitalize on their reputation by converting research grants into laboratories and by garnering prestigious outside advisory positions, including military advisee roles. In-house military officers find their rewards through the normal promotion process, while civilian employees are civil servants who are subject to its established procedures. Neither of these reward systems is attractive to research engineers. The first takes researchers outside civilian networks in which researchers distinguish themselves. And, the second (civil service) puts researchers in an organization that works like a union, securing benefits by years of service rather than by merit (Johnson and Libecap, 1994). If the military is to enlist academics into this effort, it must devise contracts that university officials will find beneficial and compatible with the institution’s knowledge creation and dissemination purpose. If such a contract cannot be written, procurement officers must create novel organizations that can accommodate both the military’s and the researcher’s needs. Typically, these organizations (such as Rand, MITRE, the Applied Physics Laboratory, and the Jet Propulsion Laboratory) become a military–civilian hybrid: military sponsored and civilian controlled (Koppes, 1982; MacKenzie, 1993). As component IR&D evolves into an ongoing weapons program, the military must assemble a coordinating committee to rationalize efforts. To “command” a consortium, the military must have in-house know-how: (1) to divide up the various component problems and their possible solutions; (2) to assign them to the most capable research team; (3) to monitor progress and redress problems; and (4) to ensure that (re)integration proceeds smoothly.

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Because the military tends to outsource and because the coordination requires such a diverse set of skills, the military will favor a civilian coordinating team. The military cannot easily delegate the task to a private firm or to a university research center. When a firm takes on this role, other companies will look suspiciously at their rival’s decisions. University research centers are unwilling to manage a project that produces a weapon system prototype. The military cannot use a component part center for this undertaking because it does not have expertise in assessing the weapon as an integrated system. The coordination agencies may be ad hoc committees for the project’s duration or sponsored organizations with system integration skills. 3.3. The dynamics of military: creative destruction All of these factors prepare a fertile environment for developing prototype radical technologies. However, incumbent officers usually resist competence-destroying technologies when they enter into the prototyping phase. Because the officers work within well-defined bureaucratic regimes, they are more likely to suppress threatening technologies than private firms that operate in open markets. How, then, do radical new weapon platforms make it into the field when no clearly defined external threat exists? Rivalry, within—but especially among—the services is the most salient force for change. 3.3.1. Military IR&D under a joint command To illustrate how these two factors operate, consider a hypothetical situation in which no clear danger exists (as was the case before 11th September 2001) and the military operates through a “Joint” command. Though this structure eliminates inter-service rivalry, it cannot fully repress intra-military rivalry. Also assume that the military has competent technical staff and line units and that the incumbent officer corps has secured budgets large enough to initiate IR&D on several competence-destroying weapon systems. However, the problems associated with the weapon system’s development: (1) are so complex that they require diverse, specialized disciplines; and (2) in some instances, demand fundamental research. These problems exceed the intra-military units’ in-house capabilities.

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Although this hypothetical case assumes a joint command structure and a pre-operational radical technology, competition still plays a role. Because IR&D requires diverse disciplines and because it serves different functional parts of the military, multiple technical units will evolve inside the joint command. Each has constrained budgetary discretion. To pursue new technologies, the units attempt to loosen budgetary rules and to build budgetary accounts. In the battles over budgets, each unit pursues a self-interested strategy that makes for rotating coalitions, both in and outside the military. To strengthen its political standing, each unit hones civilian networks, allowing for alternative funding sources. Markets can augment this process. Research scientists and engineers can uncover market opportunities to manufacture either component parts or subsystems for a new weapon system. Usually, the opportunity appears when incumbent firms find little market prospect for the device’s growth potential, or they lack the skills for designing and manufacturing it (Nelson and Wright, 1992). Once researchers become entrepreneurs, they have a paramount interest in promoting the new component and the weapon system to which it belongs (Howells, 1997), which may foster intra-military rivalry both during the developmental and deployment stages. Established firms also have an interest in pursuing novel technologies. These firms compete for IR&D dollars both as a revenue source and as a way to stay technologically current. These firms need to hold a diverse technological portfolio, both to reduce risk against radical change and to enhance in-house learning. Serendipitous discovery is the “raw material” out of which profits, or to be precise, new wealth, is made. Since defense firms serve an incumbent officer corps with monopsony power, competence-destroying innovation seems an unlikely option. However, profits can be a subversive force. If an incumbent firm believes that it can be the first-mover in manufacturing a radical technology, it has a monetary, though risky, incentive to promote the technology and build discord between officers divided by generation or function. 3.3.2. Military IR&D under service commands Here, let us assume that: (1) the military is divided among services, though the line of command subordinates these rival services to a single authority; (2) they

compete for missions and budgets; and (3) no clear enemy exists. This situation offers more opportunities for radical change than a joint military command. However, these opportunities come with increased costs. Each service has an incentive to pursue new technologies that diminish the others’ strategic importance and its budgetary share. The services pursue these new technologies through programs aimed at creating specific weapon systems. In effect, each looks at the other as a “market” competitor. However, the services are more likely than market players to have accurate information about the others’ strategic plans and its organizational capabilities. The budgetary process alone forces information “disclosure” that can incite a lax service to invest in radical R&D. Unless the services collude, which is a possibility given the small numbers and the stakes involved, each service must engage in this inter-service competition or simply succumb. Service rivalry has another effect. It promotes redundancy (functional divisions and IR&D units) greater than that found in a joint command. Thus, service rivalry multiplies the avenues for IR&D funding, for start-up initiatives, and for firm technological diversification. These redundancies make for a fertile IR&D field. As know-how about a technology grows and disseminates, service coordination offers opportunities for lowering costs and improving development cycle time. An organizational network may also arise by “design”. Take the case in which several services contract with a research center to work on a set of related topics. This research center acts as a hub where technical personnel from the services and private firms gather to learn about recent developments. Rival services may bring their contractor to learn about generic advances on a component part. These contractors can take this information and rework it into proprietary designs for a component to be included in a specific weapon system. Alternatively, the research center may be a hub around which agencies that have existing information connections rotate. Here, the hub functions more like a coordinator of efforts than as a new knowledge creator and transfer mechanism among discrete research entities. Finally, if the new technology can benefit each service, they may join together to form a research consortium. This effort typically requires DOD intervention, for inter-service rivalry produces collective

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action problems like those found in private markets. To take advantage of the promising technology, the DOD must command the services to cooperate. The coordination agency needs to identify the salient problems and parcel out solution paths to each service. Recall that the problems themselves pertain to individual component parts or the assembly of these parts into a system. Thus, the services may search for answers by developing experimental weapon systems. In these situations, the services will duplicate weapon systems, e.g. air-to-air missiles, surface-to surface missiles, surface-to-air missiles. However, for efficiencies to be had, each service must pursue unique solutions to component part development and to systems integration; further, each service must have access to the other’s progress. Again, the DOD plays the role of coordinator and judge. Once a radical technology approaches operational status, the services will race to be first in bringing the “product to market” with the inherent advantages. Of course, if the incumbent officer corps colludes, they may halt the deployment of this radical technology. This is much more likely to happen if the military promotes Jointness than if it promotes rivalry. 3.3.3. A military IR&D supply chain matrix The concepts that structure these two hypothetical cases allow for a military IR&D supply chain matrix comparable to the one developed for the commercial sector, as shown in the lower portion of each cell in Fig. 1. Again, the industrial systems on the left tend to foster competence-enhancing innovation and those to the right both competence-enhancing and competence-destroying. Notice that the lower right hand corner utilizes cooperation to form an industrial research consortium and product development competition to bring weapon systems into the field. In the case of the Service Arsenal/Shipyard System, it did not have a central apparatus (DOD) to facilitate a military consortium. In the US, this system operated until WWII, when the Office of Scientific Development was established to oversee research efforts. After the war, Congress established the DOD that, by subordinating the services and their arsenals/shipyards to a central authority, set the foundations for the Cold War innovative system (Vander Meulen, 1991; Cooling, 1979; Smith, 1985).

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Jointness constrains both product design and development competition. The Jointness cell captures current DOD military IR&D doctrine. Here, the services cooperate to enhance their buying power over private defense contractors. Service arsenals/shipyards and non-profit research and development organizations mediate the relationship between the joint service program officers and the private contractors. The officer corps’ concentrated buying power gives it incentives to, like a monopsonist, invest only in those innovations that augment its current capabilities.

4. Implications and conclusions Our theory on supply chain IR&D management has implications for both commercial and military managers. As discussed above, firms may not want to develop or even adopt innovations if they are competence-destroying to customers. If a supplier pursues such a technology, the customer may switch to another supplier. If the innovative supplier depends heavily on this customer, then, the technology may be slow in coming to market. Because the supplier–customer relationship runs along a supply chain, the threatened customer need not be the final user. Supply chain inflexibility is particularly unyielding in the defense industry. In the military IR&D scenario developed above, we found a paradox in which the customers (incumbent officers) encouraged innovation but prevented it from entering the marketplace. When public policy restrains inter-service rivalry, the officer corps may gain absolute market power along the value-added chain and wholly prevent competence-destroying innovations from diffusing. Unlike the Christensen and Bower (1996) example discussed earlier, there is no competitor to enter and offer new technology. If the officer corps succeeds in stopping innovation, the innovating firm may not be hurt, as in the commercial situation (cf. Afuah and Bahram, 1995). The supplier need not worry about a new entrant convincing risk neutral firms from adopting the new technology. The military monopsony simply has no interest in change. Ironically, the military IR&D process has the potential to disable entrants and destroy “creative destruction” itself.

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4.1. Implications for theory There are several theoretical implications of the scenarios developed above. In particular, if we examine the market structure of both suppliers and customers, it may help us understand both military and commercial patterns of entry timing and technological evolution. In this section, we first examine how market structure might affect resource dependency; then how technological changes that are radical to customers might affect suppliers’ performance; and finally, how technological changes that are competence-destroying to customers might affect suppliers’ entry timing. We include testable propositions that result from these assertions. 4.1.1. Resource dependency Our study suggests that market structure may cause resource-dependent relationships. Thus, as market structure varies, firm dependence varies. Resource dependence theory has not explicitly examined the relationship between market structure and firm dependence. Christensen and Bower (1996), for example, do not distinguish between resource dependence due to market structure and resource dependence due to over-reliance on a single customer in a competitive market. Specifically, if one examines the lower left corner of Fig. 1, market structure of suppliers (competitive) versus customers (cooperative) ensures that suppliers are dependent on customers. Likewise, the upper left dictates that there is a mutual dependence between suppliers and customers. In the upper right, market structure dictates that customers will be resource-dependent upon suppliers. But in the lower right, suppliers may or may not be dependent upon customers. If suppliers are dependent on customers in this quadrant, it is because they have over-invested in one customer when they had the option of maintaining relations with more than one. To use Afuah’s (2002) terminology, the customer may be “dominant” because of market structure reasons (monopsonist or cartel), or the customer may be dominant for other reasons (e.g. the customer happens to be important despite its position in a competitive market). In a sense, we have overlain on top of our matrix another dimension: resource dependence; however, as resource dependence is partially determined by market structure along the supply chain we

will focus exclusively on the most interesting cells: the lower left versus lower right of Fig. 1 and the lower right of Fig. 1 with high versus low resource dependence. 4.1.2. Customer performance Market structure interacts with customer firm performance in an interesting way. If we assume an innovation is competence-destroying to a customer firm, the firm will most likely reject the technology. But the ramifications of this rejection depend in a substantial way on the competitiveness of the market in which the customer competes. If there is absolutely no competition and no way that the technology could lead to an entirely new value network, then the firm (customer) will not be hurt by rejecting the technology. However, as soon as we move away from this iron-clad protectionist world, it is clear that the firm may be substantially damaged or in need of major restructuring. This is due to the fact that if the customer’s market is competitive, the technology will spread in any case to competing incumbent firms that have different capabilities, or to new entrants. If the firm does not adopt the technology, it may be severely impaired. If the firm does adopt the new technology, it may find itself in need of substantial restructuring. In this case, its own suppliers will likely be harmed (Afuah and Bahram, 1995). 4.1.3. Supplier performance This leads to the next question. How do these sorts of contingent resource dependencies influence supplier performance when the innovation destroys customer capabilities? We claim that resource dependency that is not due to market structure (lower right corner of Fig. 1) would hurt suppliers. The logic is as follows: if the innovation is competence-destroying, we can assume customers will tend to resist the change. However, as the customer is in a competitive market, either another incumbent with different capabilities or an entrant will accept the technology and the customer itself will be negatively affected, either severely weakened, destroyed, or restructured, thus directly hurting the resource-dependent supplier. Afuah and Bahram (1995) make this argument by implicitly assuming a competitive customer market. However, if we look at the lower left quadrant, we see the potential for the supplier, even though

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resource-dependent upon the customer, to be unaffected by the change. In this situation, the customer rejects the technology as above. However, as the customer itself is not in a competitive market, there is little chance of the technology diffusing and the customer being substantially hurt.4 This leads to our first proposition. Proposition 1a. Suppliers in a competitive market that are resource-dependent upon customers that operate in a competitive market will be negatively affected by innovations that destroy customer capabilities. Proposition 1b. Suppliers in a competitive market that are resource-dependent upon tightly controlled cartelized or monopsonistic customers will not be affected by innovations that destroy customer capabilities. 4.1.4. Supplier entry timing In the previous section, we examined the incentives for a supplier to adopt a competence-destroying innovation. Here, we examine how market structure affects the speed of these innovations. Suppliers to market-dominant customers (cartel or monopsony, see lower left corner of Fig. 1) know that the customer will not be harmed due to market competition. Consequently, these suppliers, whether in competitive or non-competitive markets, will develop new technology as quickly as or quicker than suppliers providing goods to dominant customers in competitive markets. If the dominant customer accepts the technology, the supplier can adopt the technology in a wholesale manner, thus making a major commitment to it. In other words, the downside risk is limited. Contrast this situation to one in which the supplier is dominated by a customer in a competitive market (Fig. 1, lower right). In this case, development of radical technology has a negative downside risk that the innovation may undo the supplier. Thus, the supplier will be slower in both development and adoption of the new technology than a supplier that serves a customer 4 Regarding the top row of the matrix in Fig. 1, in the upper right corner suppliers are not dependent on customers. In the upper left corner, where there is mutual dependence, it seems plausible that the innovation may not hurt the supplier based on the same logic as above.

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operating in a non-competitive market. These arguments are consistent with Afuah’s (2002) findings on the development of supercomputer technology, even though Afuah does not frame the argument explicitly in terms of development versus adoption and again implicitly assumes a competitive customer base. These arguments are also consistent with King and Tucci’s (2002) findings that incumbent suppliers of disk drives were quick to adopt new technology. Our matrix suggests that most disk drive suppliers in the King and Tucci study had little resource dependency on customers (who were themselves in an intensely competitive market). Thus, resource dependency in and of itself does not necessarily predict a firm’s innovative speed. However, once market structure is known, then resource dependence does act as powerful predictor. In combination with market structure of both markets, it might be a better predictor. Proposition 2a. Suppliers that: (i) operate in a competitive market; and (ii) are resource-dependent upon customers operating in competitive markets will be slower to develop customer competence-destroying innovations than suppliers that: (i) operate in competitive markets; and (ii) are not resource-dependent on a customer operating in competitive markets. Proposition 2b. Suppliers that: (i) operate in a competitive market; and (ii) are resource-dependent upon tightly-controlled cartelized or monopsonistic customers will be faster to develop customer competence-destroying innovations than suppliers that: (i) operate in a competitive market; and (ii) are resource-dependent on customers operating in competitive markets. 4.2. Implications for military policy When considering whether to promote inter-service rivalry or Jointness, policy makers typically have examined the tradeoff between duplication costs and flexibility. In making these calculations, policy makers have relied on economies of scale, noting that these follow business practices. However, policy makers have rarely asked whether Jointness promotes or squelches competence-destroying innovation. In

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attempting to answer this question, we too have made use of a market analogy, namely, creative destruction. Our theory of supply chain market structure has categorized Jointness as a collusive activity damaging to radical innovation. Jointness will certainly bring about innovation, but it will be of an incremental sort, reinforcing established military hierarchies. In our estimation, policy makers need to add this probable consequence when comparing Jointness and inter-service rivalry. The cost savings inherent in Jointness may unwittingly sustain a military force unready for fighting the next war. This persistent status quo does not surprise military organization theorists who contend that radical military innovation comes infrequently and with great difficulty (Hundley, 1999). As in other bureaucratic regimes, these theorists identify elite decision-makers—in the military case, the incumbent officer corps—as the principal obstruction. They propose four factors that may undo this resistance: (1) a clear foreign threat that places the existing military regime’s capabilities into question; (2) intra-service rivalry in which a dormant officer corps aligns its future with a new weapon system that challenges the established order; (3) civilian intervention that overcomes incumbent officer corps interests; and (4) inter-service rivalry over budgets during which the services use new weapon systems to encroach on rival services’ missions and budgetary appropriations (Posen, 1984; Rosen, 1994). The first threat (a clear and present danger) has become apparent since 11th September 2001, and it has added to civilian calls for radical military innovation (Rumsfeld, 2002; Cohen, 2002). As civilians act to overcome incumbent military interests, policy makers must reevaluate whether the costs savings that Jointness promises is worth the costs that it imposes on those who wish to foster radical change.

Acknowledgements The authors thank Harvey Sapolsky and Engene Gholz for many insights into military IR&D and thank the anonymous Research Policy referees for their helpful suggestions. The authors acknowledge the support of the MIT Security Studies Program and the Berkley Center for Entrepreneurial Studies at the NYU Stern School of Business.

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