The role of appropriability in sustaining competitive advantage—an electronic auction system case study

Journal of Strategic Information Systems 7 (1998) 131–152

The role of appropriability in sustaining competitive advantage—an electronic auction system case study M.H. Atkins Department of Management Studies, University of Aberdeen, Old Aberdeen AB24 3QY, UK Revised paper accepted for publication by Professor R.D. Galliers 23 April 1998

Abstract This paper reviews the process of innovation in the introduction of an electronic auction system for livestock. The growth and development of the system is tracked over a number of years and factors accounting for success and failure are analysed. Previous models of the innovation process provide useful and powerful frameworks for explaining the developments. The growth of ‘trust’ in the system was found to be an important additional factor in determining successful innovation. Appropriability, defined in terms of the ability of the system’s licensor to benefit from the innovation more fully than other stakeholders, is used to determine the Competitive Advantage each of the stakeholders has gained through the innovation. Many of the gains accrued to stakeholders other than the licensor and the long-term changes in the appropriability regime were found to determine the long-run sustainability of the Competitive Advantage. The system was the first of its type in the UK but this did not guarantee success given that a number of second-movers entered the market and were able to develop rival systems. However, early losses were weathered and strategies aimed at widening the scope of activities led to the ultimate success of the system. q 1998 Elsevier Science B.V. All rights reserved. Keywords: Electronic auction; Competitive Advantage; Sustainability; Appropriability; Stakeholders; Innovation diffusion

1. Introduction This paper examines a case study of an innovative electronic auction system for livestock. In particular, it provides a longitudinal review of the development of the system and its derivatives, from its inception in 1989 to mid-1997. Specifically, the paper addresses the issue of the sustainability of the Competitive Advantage derived from the exploitation of the innovation. An assessment is made of the role of appropriability and the extent of 0963-8687/98/$19.00 q 1998 Elsevier Science B.V. All rights reserved PII: S0963 -8 687(98)00019 -5

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the gains made by different stakeholders in the innovation in determining the sustainability of the Competitive Advantage. The paper is divided into four main sections. First, as the case is principally concerned with describing an innovative auction system, there is a review of some of the key and recent literature on innovation (Section 2). Next, given that a major objective is the examination of the relevance of appropriability to sustainability, there is a discussion of the appropriability concept (Section 3). Section 4 describes the development of the auction system and its derivatives and the final section (Section 5) discusses the implications of the findings in the case and the potential for further research.

2. Innovation ‘Innovation’ can be considered as an artefact or as a process. Rogers (1983, p. 11) defined an innovation as ‘‘an idea, practice or object that is perceived as new by an individual or other unit of adoption’’ but this does not reflect the process view. An alternative definition by Van de Ven (1986) emphasises both the time dimension and the role of people in the process: ‘‘the development and implementation of new ideas by people who over time engage in transactions with others in an institutional context’’. It is widely recognised that innovation is more properly considered a process (for example: Stoneman and Karshenas, 1993, Cawson et al., 1993) than an event. Further, it encompasses more than invention; in addition to the conception of the idea, the process view also involves adoption and use of new techniques, methods or technologies. A key framework for considering the process of the diffusion of innovations was provided by Rogers (1983, op. cit.). This considered specifically the innovation–decision process ‘‘through which an individual (or other decision-making unit) passes from first knowledge of an innovation to forming an attitude toward the innovation, to a decision to adopt or reject, to implementation of the new idea, and to confirmation of this decision.’’ Rogers identified five main steps which, he claimed, usually occur in a time-ordered sequence although the possibility that exceptions may occur1 was recognised. These steps were: Knowledge Persuasion Decision Implementation and Confirmation. Rogers developed this model of the decision-making process in depth. First, a number of prior conditions (such as previous practice, felt needs or problems, the innovativeness of the decision-maker and the norms of the social systems) are required before the decisionmaking process can start; without these innovation will not take place. The Knowledge stage (which is said to occur when a decision-maker learns about the innovation and gains an understanding of its functions) would be influenced by a number of factors such as the 1

For example, decision could precede persuasion.

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socio-economic characteristics and personality traits of the decision-makers along with their communication behaviour. Rogers also identified three basic types of knowledge he thought would be associated with any innovation (‘awareness’, ‘how-to’ and ‘principles’) which, in turn, would be influenced in different ways by the change agents. The Persuasion stage is said to occur when a decision-maker forms a favourable (or unfavourable) attitude towards the innovation. Rogers proposed a number of characteristics of the innovation which would influence matters here: Relative advantage Compatibility Complexity Trialability and Observability. In addition, it was recognised that the decision-maker’s behaviour in terms of where and what information is sought and how this information is interpreted would influence things. The third stage (Decision) would lead to adoption or rejection. If the innovation was seen to have some merits but uncertainty prevailed about precisely how much, then there may be a decision to undertake a small-scale trial. Generally, anything that can be done to reduce the risks or the costs of trials will tend to speed the adoption process. Alternatively, some may rely upon ‘trial by others’ such as a demonstration, a report in a consumer magazine or through meetings of professional groups (Newell and Clark, 1990; Swan and Newell, 1995). According to Rogers, the decision to adopt the innovation is followed by the Implementation stage (where the innovation is put to use) and then by the Confirmation stage where the initial decision (either to accept or reject) may be confirmed to reversed. Thus the final outcome is: continued or later adoption, discontinuance or continued rejection. The adoption of an innovation may itself be the start of new processes within organisations in which the ‘‘cumulative and progressive transformation of the innovation, coupled with modifications to existing knowledge bases in the organisation’’ (Clark, 1987, Swan and Clark, 1992, Newell et al., 1993), lead to new products and processes. This has been described as appropriation and represents the highest possible degree of utilisation; it describes the state where the user has transformed the shape and uses of the innovation as supplied and has been exemplified by the Japanese transformation of American usage of computers in production control into their own Just-in-Time system instead. The reader should note that the concept of ‘appropriation’ differs significantly from that of ‘appropriability’ used in the next section. 3. The concept of appropriability Appropriability refers to the ability of different stakeholders to retain for themselves the financial benefits that arise through the exploitation of an innovation2. A situation where the inventer is the main beneficiary would be referred to as a ‘strong appropriability 2

Willman (1992) has also distinguished internal and external appropriability. For present purposes external appropriability—the extent to which a firm’s innovations may be emulated by others—is discussed. Internal appropriability considers the extent to which an individual firm is able to emulate the innovations of others; this will depend upon skills, resources and organisation in the firm.

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regime’. A ‘weak appropriability regime’ describes the situation where the inventer gains less than the other stakeholders. Teece (1989) showed that the gains from any innovation are potentially shared by four groups: the innovator (the originator, designer or inventer rather than the ultimate user); customers of the above; suppliers to the above; and imitators or followers. Essentially the analysis utilises conventional economics, which recognises that the cost of utilising new knowledge produced by someone else is frequently much less than the cost of producing that new knowledge3. The factors that govern an innovator’s ability to capture the benefits associated with innovation are: • • •

the nature of the technology used the efficacy of mechanisms designed to protect the innovation and the nature of the complementary assets4 required to support the innovation. These will be considered in turn.

3.1. The nature of the technology The principal aspect of the nature of the technology that determines the appropriability regime is the extent to which the designer has proprietorial rights over that technology or whether it is generic in nature and therefore freely available to all potential users. If the technology is advanced, leading edge and not available to others in the industry, more rewards accrue to the designer. In an IT/IS context this may apply to some types of hardware and limited types of software. In general, however, most users of IT/IS are unlikely to be developing new computer or communications hardware for their own use and therefore the main sources of Competitive Advantage are likely to lie in the development of leading-edge software or applications. Some oil companies, which rely on the successful identification of oil reservoirs from geophysical surveys would claim to be at the forefront of such technology. For the majority of firms, however, both the hardware and the software they employ are likely to be generic, although applications may be specific. Where generic technology is employed, the appropriability regime is likely to be weak. The technological environment is rarely static for long and it is therefore important to consider the dynamics of the situation. Some software developers have sought to protect their new systems by offering customers continual updating and improvements. In this way, the target for emulators is moving and not fixed. For the software developer this strategy has the added advantage that upgrades are offered to customers at prices lower than the full cost of replacement software and customers can be locked-in early on in the product life-cycle. 3

This is sometimes known as a ‘spillover’ or ‘externality’ in the sense that benefits intended for one party spill over to a third party who is external to the first relationship. 4 Clemons and Row (1991) drew heavily on Teece’s work and called these strategic resources; Teece’s original terminology is retained in the present paper.

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3.2. The efficacy of protection mechanisms Legal frameworks to protect new products are widespread and have been in existence for many years. It is widely recognised, however, that patents and copyright laws frequently fail to ensure the degree of protection they were intended to afford. In any case, for the firm seeking Competitive Advantage through IT/IS, they are unlikely to provide effective ways of avoiding emulation. For the second or ‘late-mover’ in a market, engineering a copy of the first-mover’s systems, possibly with additional features, might even be faster and require fewer resources than creating the first version. Indeed, the nature of the new system may rely not so much on novel technology but on novel applications where the collective knowledge of the organisation5 is used to create the system. If that collective knowledge is concentrated in one or two individuals, the organisation that develops the new system will face a weak appropriability regime since either those individuals will ensure through the collective bargaining process that a (potentially large) share of the benefits of innovation accrue to themselves, or they will leave, taking their knowledge and skills to a competitor. The mobility, flexibility and adaptability of the human resource in IT (and, more particularly, in IS) is therefore likely to be a factor influencing the appropriability of returns from this type of new product. It has been suggested, for example, that one factor leading to the success of one Building Society in its Information Systems development has been its policy towards staff. ‘‘Low (staff) turnover is partly a result of geographical isolation but more intentionally the result of the way BIS is organised’’ (Dyerson and Roper, 1991, op. cit. p. 69). In the case cited, an idiosyncratic programming language made staff less marketable elsewhere and there was also a strong policy of internal job promotions that encouraged staff to stay. The increasingly global nature of software and systems suggests that it is not necessarily competitors ‘just down the road’ that will seek to attract key software staff, those competitors may be half-way round the world. In the instance quoted above there is a strong appropriability regime where a priori a weak regime would have been expected. A strong appropriability regime (as far as the software developer is concerned) might be expected where collective knowledge is widely distributed throughout the firm and where the loss of a small number of individuals would not have a critical impact upon the dissemination of secrets. This may favour software developments by larger firms. Whilst it may be possible to impose legally binding restrictions on employees to prevent them working for competitors, they are unlikely to be effective, particularly in the longer run and may detract from the recruitment process in the first place. However, applying IT/IS to new processes rather than new products is likely to result in a stronger appropriability regime6. In this IT/IS innovation is similar to the many situations which favour process rather than product development because of the commercial secrecy that can be applied to processes which cannot be applied to products. 5

this is slightly different to the concept of ‘know-how’ discussed by Dyerson and Roper (1991) who emphasise the process of organisational learning rather than the extent of the accumulated body of knowledge. 6 This can be linked to the literature on adoption and diffusion of innovations. For example, Rogers (1983) discusses ‘observability’ as one of the attributes influencing the rate of diffusion of innovation. It is easier to ‘observe’ the nature of product innovations than it is to observe process innovations. However, in practice it may sometimes be difficult to distinguish product and process innovations.

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3.3. The nature of the complementary assets Referring to innovation in general, Teece (1989, op. cit.) observed that the successful commercialisation of new products would require the linking of know-how with services such as marketing, manufacturing and after-sales support7. The availability and quality of these functions, known as complementary assets, will influence the success of the new product and the nature of the appropriability regime. If all requisite complementary assets are available within the organisation then the appropriability regime will be strengthened. Alternatively, if it is necessary to obtain some of these complementary assets (or ones of a sufficiently high quality) from outside the organisation, the appropriability regime will be weakened. Just how far it is weakened will depend upon the number, size and bargaining power of outside suppliers. In addition to the skills of marketing, manufacturing and after sales support mentioned above, many organisations may find that financial resources form a key complementary asset. To be successful will require working capital adequately to fund the new product as well as an effective marketing strategy8. It is possible to categorise the complementary assets that may be needed. Again following Teece, the assets may be generic, specialized or cospecialised. Generic assets are general-purpose and do not need to be adapted to suit the needs of the new product. An item of software designed to run on an existing computer would be an IT/IS example; from the point of view of the buyer or user, the new software is attractive because the usefulness of existing hardware can be enhanced at little additional cost. From the point of view of its designer, however, the fact that the complementary assets are generic weakens the appropriability regime because the assets are widely available and not specific to the organisation-possession of the assets does not provide a distinctive capability for the software designer. Teece (1989) op. cit. p. 52) defined specialized assets as those ‘‘on which the innovation depends, tailored to that innovation’’. In the case of some new IT products or information systems, it may be important to consider not only whether the developer possesses the necessary complementary assets but also whether customers need complementary assets9. This point is all the stronger on recognising that the assets need not be physical but may also take the form of human capital (skills). For example, new software that requires users (customers) to invest significant time and effort in retraining would weaken the appropriability regime. On the other hand, installing specialized hardware and systems on customers’ premises and ensuring that it could not be used for competitive purposes would strengthen the appropriability regime. An airline booking system such as SABRE (Anon., 1993) or a computerised ordering system such as the renowned American Hospital Supply (Lucas, 1986) may succeed over time because of the specialised skills that are built up by the innovator’s customers and which would need replacing if customers were to adopt a rival system. The extent to which any system requires customers to acquire 7

Complementary assets are also discussed in Kay (1993) and Grindley (1991). Clearly this point is linked to the role of communications in the innovation diffusion process discussed in Section 2 above. 9 Essentially this arises because part of the production process may take place at a location physically remote from the supplier’s activity. This is particularly important in applications such as remote banking, electronic auctions, reservation systems and credit card sales. 8

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tangible or intangible complementary assets will partially determine the success of a ‘locking-in’ strategy. Previous literature on this has emphasised the role played by ‘sunk costs’ and by ‘switching costs’ in determining behaviour; it is the specific nature and ownership of the complementary assets in any innovation which underlie these costs. Where there is a bilateral dependence between one new product and a second, the assets are said to be cospecialised and the impact upon the appropriability regime will depend upon the extent of buyers’ dependence on the new product and the nature and distribution of the complementary assets. An IT/IS example might be the FAX card which can be installed in a PC and which utilises scanner technology developed for FAX transmission. The framework for analysis of the role of complementary assets is closely related to the concept of ‘asset specificity’ inspired by Williamson (1975, 1979, 1985). Referring to ‘‘the economics of idiosyncrasy’’, Williamson identified the degree to which durable transaction-specific investments are incurred as the third critical dimension (alongside uncertainty and frequency of recurrence) of the characterization of transactions. This key distinction arises in the extent of transaction-specific or nonmarketable expenses incurred in the transaction. Unspecialized (what we might call ‘commodity’) items pose few risks because of the buyer’s ability to find other suppliers. However, instead of reliance being placed on the nature of the product, it is alternatively possible that the specific identity of the parties to the transaction will be important because of specific aspects of the transaction. Williamson distinguished four different types of asset specificity: site specificity (related to aspects of transport costs); physical asset specificity; human asset specificity and dedicated assets. In the context of innovation in electronic markets, it is likely that the second and third of these are most important. Information systems will be written to perform on specific hardware or in conjunction with specific operating systems; ownership of such hardware and systems software will be essential to the successful use of an Information System. Over time the hardware (and the operating system) may become obsolete and need replacement which might prompt search for an alternative IS. It is at this stage that human asset specificity is likely to become important. Given that there are likely to be learning costs associated with the adoption of any new software, buyers will be reluctant to abandon their pre-existing skills in the use of existing software and engage in costly acquisition of new skills unless the applications potential of the new software offers the potential for significant new benefits. The outcome of such a situation, as summarised by Williamson, is that the relationship between buyer and supplier is transformed into one of bi-lateral monopoly with, most likely, the buyer ‘locked-in’ to the products of the supplier. 3.4. The sustainability of benefits It is the hypothesis of this paper that the determinants of the sustainability of Competitive Advantage from innovation are the long-term adjustments that take place in the three factors influencing appropriability: • • •

the nature of the technology used the efficacy of mechanisms designed to protect the new product and the nature and ownership of the complementary assets required to support the new product or system.

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If the new product provider can remain at the leading edge of technology; if the protection mechanisms are effective and if the cost and availability of complementary assets remain in favour of the designer/originator, then the Competitive Advantage from IT or IS is likely to be sustainable in the longer term. However a weakness in any one of these will lead to a weaker appropriability regime and hence less sustainable Competitive Advantage. In reality, market conditions do not remain static for very long, and almost certainly this is the explanation for the general perception that, despite the earlier hype, the long-term benefits and Competitive Advantage derived from IT and IS are much smaller than had been expected.

4. An illustrative case-study: the electronic livestock auction 4.1. Markets, hierarchies and auctions In the UK, livestock are often transported by sellers over long distances, herded into pens and then paraded briefly in a ring before being sold. Frequently buyers need to transport animals over long distances from the auction markets to slaughterhouses. The distress caused can lead to a reduction in the economic value of the meat. An electronic auction avoids this need to transport the livestock and therefore avoids distressing the animals and potentially improves the quality of the meat10. There is therefore an economic case to be made for eliminating as much travelling for livestock as possible, and not just in terms of the transport savings thereby achieved11. In many parts of the world, the market for slaughter cattle is monopsonistic; while there are many sellers (farmers) there are relatively few buyers (meat processors) and the balance of market power lies with the buyers. One way that sellers can avoid the cost of transporting their livestock to market is by coming to a negotiated deal with a buyer; buyers’ agents tour farming areas making themselves known to farmers and identifying the good ones from which quality animals can be bought. A negotiated deal brings benefits to the farmer who has a secure outlet and possibly continuity of demand12. However, prices may be less than might be achieved in an open market13. The electronic auction14 therefore has a potentially manifold impact upon the market for livestock. Farmers can save on transport costs, animals suffer less in transport, meat buyers 10 The electronic auction may, alternatively, increase journey distances for cattle if it attracts more remote buyers than would otherwise have been the case at a live auction. (Hobbs, 1995). 11 Other electronic auctions have also been used to decouple product flow from the sales process; for example in Japan, the AUCNET system avoids the need to move used cars to auction sites before sale. (Warbelow and Kokuryo, 1989) Similar developments are now occurring elsewhere (in the Dutch flower market, for example) and it is the current author’s belief that increasingly such electronic auction systems will be part of a significant ‘re-engineering’ of entire industry supply chains. 12 Some aspects of buyers’ costs might also be reduced; this form of behaviour represents a move away from market exchange to internalised exchange and Williamson’s analysis of transaction cost economics applies here. 13 A full economic analysis of the market impact of this electronic auction was undertaken by Wilson (1995). 14 This term is used in order to emphasise the fact that bidding is conducted over a computer network; it represents a higher level of sophistication than an electronic sales channel or an electronic market such as the TELCOT market for cotton in Oklahoma and Texas. (Malone et al., 1989).

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get better quality, farmers get higher prices and meat processors pay more for their raw materials although their transaction costs may be reduced. These are not the only potential outcomes; however. Malone and others (1987) distinguished the effects of changing technology on electronic markets and electronic hierarchies15. Their paper shows how the structure of a market may change with technology; whilst some technological developments might encourage the development of electronic sales channels, technology might equally enable more radical restructuring of the supply chain thus enabling an electronically mediated hierarchical structure. 4.2. The EASE system: origins and scope This case study examines the system set up by EASE16 (Electronic Auction Systems (Europe)) which is a subsidiary of a large farmers’ cooperative steeped in the traditions of providing outlets for farmers’ cattle through auction markets17. The traditional weekly market is for many both a business and a social occasion and introducing a new system designed to eliminate the physical market and replacing it by a virtual market was bound to face initial opposition from some shareholders who saw the system as ‘‘shooting themselves in the foot’’18. The system installed had initially been developed by Texas State University and operated in Canada as the OLEX system. The cooperative was able to negotiate the Europeanwide franchise for the system although by the end of 1993 this option had not been fully taken up and the system was operating only in the UK19. Technically, therefore, EASE were licensees of the new system, not the originators. The main attraction of the system in the eyes of the licensees was that it was easy to understand and use, users would require ‘minimal’ equipment and the system was capable of being adapted to the UK operating environment at relatively low cost. A detraction was that any rewriting of software would have to be done by the licensors in Canada which might be both an inconvenience in terms of the inevitable communications delays and financially costly. 15 The terms market or hierarchy are used to distinguish the different governance forms that may apply in an industry. In some industries, deals between firms at different stages of the value chain will be based largely on price and this can be called a market governance. In other industries, these deals will tend to be negotiated with a small number of suppliers and/or customers with whom there is a long-term relationship; this can be considered hierarchical governance. Major factors influencing whether markets or hierarchies are favoured will be asset specificity and the complexity of product description. A recent paper by Geun Lee and Clark (1996), distinguished Electronic Brokerage and Electronic Auction in terms of the major role played by the latter’s role in price discovery. 16 EASE is therefore both the name of the auction system and the name of the company with the rights to its exploitation; to clarify matters, the later text will refer to the EASE system in the context of the auction system and EASE in the context of the owning organisation. 17 An interesting and possibly unique aspect of this case is that the EASE system is actually owned by its customers—the farmers. This may have been partially influential in building up users’ trust in the system. 18 This was almost certainly a knee-jerk reaction. The creation of electronic markets may well influence prices and Bakos (1991) provides a detailed economic analysis of the potential consequences of establishing electronic markets. The influence of this form of selling is principally through the reduction in transaction costs although some of the seller’s transaction costs (possibly through the uncertainty of using a more remote slaughterhouse) may increase. (Wilson (1995, op. cit) and Hobbs (1995, op. cit.)). 19 A description of the evolution of other electronic auctions together with that described here may be found in Christie (1991).

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The initial markets chosen for the electronic auction system were carefully selected. Basically livestock auctions can be divided into two groups depending on the nature of the buyer. Some auction sales are for young animals bought by farmers who finish the rearing process on their farm. When buying such animals at auction, farmers find it very important to be able to observe the condition, comportment and physical character of the animal in the auction ring even if only for a very short time. Accordingly, any form of electronic auction which did not allow the buyer an opportunity to view the animals would be unlikely to be acceptable to buyers and vendors alike. On the other hand, the arrangements for buying animals for slaughter are quite different. For many categories (sheep, beef cattle and pigs) there are, in the UK and Europe, accepted carcase classification systems operated within the abattoirs which are based upon conformation (shape) and level of fat cover. After the animal has been slaughtered, the carcase is classified by qualified staff independent of the abattoir and employed by the Meat and Livestock Commission in the UK. The price paid at auction reflects a "standard" classification and may be adjusted upwards for carcases of a very high quality or downwards for carcases of a very low quality. These classification systems have been in existence in the UK since 1982 which has led to a generally good understanding within the farming community of the trading terms based upon them. Farmers may, of course, form their own view of the quality of their animals which might be at variance from that of the classifier. However, over time farmers are likely to learn to trust the judgment of the classifier, particularly if they consistently send their animals to the same slaughterhouse. The fact that the classification systems are well established and generally well trusted by farmers means that risks for buyers and sellers are minimised even if animals are sold unseen. The classification system is best viewed as

Fig. 1. The EASE system schema.

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an enabling environmental factor that was a necessary but not sufficient condition for successful innovation. Fig. 1 is a schematic representation of the system. It will immediately be noticed that farmers do not figure in the system: they supply information about the cattle they have for sale at any point in time to EASE through a network of fieldsmen. The preparation of a catalogue and the advertising of the sale is undertaken by EASE. The sale catalogue is available to buyers electronically if they wish. In addition, farmers may choose to participate in the auction either as observers or as buyers and in either case they will need the same hardware and software as other participants. Farmers may act as buyers and also have the opportunity to withdraw, during the course of the auction, any lots they consider may be sold too cheaply. The system comprised individual computer work-stations connected by telephone line to a central computer system at Inverurie, Scotland. Individual buyers (and sellers, for that matter) needed a computer and a modem. The software (which was DOS-based, intended for a monochrome screen and, until 1995, not significantly updated) required no computing skills to use. The starting or current bid price was displayed on the computer screen and anyone wishing to bid for the next incremental price (which was known in advance) could do so simply by pressing the "RETURN" key. A five or perhaps ten-second bidding period at each price was allowed so if no bids were received at the next higher price, the lot would be sold to the previous highest bidder20. A sense of the level of activity in the market could be obtained by observing how quickly higher bids were obtained, in a very similar way to the atmosphere in a live auction. The system displayed the number allocated to the buyer and, again in a similar way to a live auction, a sense of who was buying and at what price could be obtained. The system automatically processed all sales and purchase deals with sellers being paid (less their commission) within the normal trading period of 12–14 days. It was recognised at the outset that electronic auctions could not totally and immediately (if ever) replace the live auction. The development of the electronic auction was accordingly seen by auctioneers as an additional service that might be offered to their customers, not as an immediate replacement for existing services. The logical way forward was to franchise the system to existing auction marts throughout the regions of the UK and by 1995 there were nine franchised operators of the EASE system. This figure includes ANM, the parent company which owns EASE. In a sense, therefore, the innovators were the auction houses which had to decide whether or not to use the new system but this is slightly too narrow a view. Farmers had to be persuaded that the new system was appropriate (and might lead to higher prices for them) and buyers had to be persuaded that the "cost" of higher prices was outweighed by other benefits such as not having physically to travel to the auction. It was essential from the beginning to build the trust of those using the service and most important in this process was the trust of the farmers themselves. Indeed, this trust can be seen as an important aspect of the adoption/rejection decision and/or the continued adoption/later adoption and discontinuance/continued rejection decisions in the latter stages of the innovation decision process referred to in the discussion of Rogers’ 20 Note that the normal English (rising bid) system was in operation; this reduces some of the technical problems (such as the need for synchronisation of clocks and the addition of a time-signature to the bid) that are encountered in Dutch (falling price) systems.

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model discussed in Section 2 above. If the user mistrusts the system, it will be rejected at the outset or discontinued after a trial period21. A key aspect of the system was the catalogue "description" of the livestock provided in advance of the sale to all interested buyers22. Any auction has to have a list of the items included in the sale and the electronic auction is no exception except, possibly, it may differ in the means of the delivery mechanism for that list. Given that the buyers were unable visually to inspect the cattle, the catalogue overcame this deficiency by providing a brief description and other qualitative material. The catalogue was prepared by fieldsmen who were representatives of each of the franchised marts who would visit farmers, encourage them to enter livestock for sale in the electronic auction, and prepare the entry. Fieldsmen were paid on a commission basis for the number of cattle they were able to bring through the system. Because payment to farmers was based on the well-established classification system in use at abattoirs, there was no incentive to over-describe the lots as it would quickly become known that a particular fieldsman could not be trusted to provide a fair view23. However, the role played by the fieldsmen was to become, to a certain extent, pivotal in the system as without them, few, if any, livestock would have been offered for sale over the electronic auction. They therefore became a key complementary asset in the innovation process. They knew the farmers and advised on when best to go to market and, looking at the situation from the viewpoint of appropriability, it is clear that some of the early benefits accrued, through high commissions, to these fieldsmen as marketers of the new system. Indeed, one commentator said: "the electronic auction system has made people more important as it emphasised the relationship between the farmer and the auctioneer". 4.3. The EASE system: strategy and competitive advantage The licence originally negotiated by EASE covered the whole of Europe and accordingly, it might have been thought that the venture would encounter little, if any, competition. This was not to be the case. The chances of obtaining legal protection over software innovations are slim (Atkins, 1993) and the protection afforded by the licence was to the software and not to the idea. This left the door open for competitors prepared to take the risk and develop their own software. Competitors were second-movers who had the potential to spot weaknesses in the EASE system and capitalise on them. It will be recalled that the licence for the software stipulated that any amendments or developments had to be undertaken by the originators in 21 Meat buyers were generally less enthusiastic; as will be understood from analysis above, the introduction of the electronic auction increases the competition between monopsonistic buyers and leads to the disadvantage [in the mind of the buyer] of an increase in price obtained. 22 Malone et al. (1987, op. cit.) showed that product complexity may be reduced if the product description was represented in a standardised form and this was handled electronically and they give the example of the commodities futures market. In the EASE case, the innovation had no impact on the way in which descriptions were handled. The nationwide livestock classification system referred to earlier had come about in 1982 in response to general market requirements of the meat trade. 23 classification systems ensure exactly the same pricing mechanism as for animals sold direct to the abattoir as was explained above; the MLC classification system is not used for any sales which take place ‘live’ in the auction ring.

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Canada and this left EASE in a situation where technological improvements were either slow or expensive or both. Five competitors entered the fray. With one exception, they offered broadly similar technical facilities to the EASE system and none had a distinct Competitive Advantage. One was developed by an early franchisee of the EASE system who dropped the EASE franchise to offer their own system. The other competitors included LEAN (a system virtually extinct by mid 1995), BEACON (which ‘discovered’ a niche market in sheep which needed no visual information for buyers) and, DIRECT (a system set up by a former franchisee). There were two other competitors of note: APEX was formed by two founder members of the EASE system. They left EASE and marketed a microcomputer version of the software (which, they argued, was not covered by the terms of the original licence); obviously the industry contacts and insider knowledge assisted greatly in establishing this new venture. EASE sought to protect themselves from the breakaway APEX operation through legal action but the case was never satisfactorily resolved and the APEX operation continues but, by the middle of 1995 that operation was of limited geographical spread. With the subsequent liquidation of its main franchiseee in England, throughput has declined further in 1996. The second-mover advantages for APEX here were considerable; the hardware costs of the APEX system were approximately one-sixth of those for the EASE system. The final competitor in the electronic livestock industry was CLASS—a system that was part-funded by EU finance. CLASS offered its customers a distinct Competitive Advantage: it linked buyers to the auction by satellite television and bidding was conducted via the telephone. It was therefore appropriate for the (as yet) untapped areas of store stock and breeding cattle. The nature and extent of the complementary assets required by customers was similar to the EASE system: the technology was simpler but instead of a computer, a television and satellite decoder was needed. Although similar in cost, customers were reluctant to opt into both CLASS and EASE systems—few wanted or had a need for both systems. (Those who might have done so were almost certainly restricted to buyers in large meat processors.) Working capital (the classic complementary asset) was exhausted by early 1995 despite EU financial assistance and CLASS went into liquidation. Early analysis might suggest that EASE had managed to gain Competitive Advantage through a classic locking the customers in action by introducing its own idiosyncratic operating system that users had invested heavily in learning and of which they were therefore reluctant to divest themselves. This judgment will, in the light of subsequent developments, be seen to be premature. It will be recalled that CLASS operated a satellite system that enabled buyers to see video pictures of the animals they were preparing to buy. The liquidation of CLASS offered EASE the opportunity to move into this vital area of electronic auctions and, by forming a joint-venture activity with another auction mart that had previously been a competitor, a new system known as AgVision has been established. Two types of electronic auctions are operated; the ‘conventional’ electronic auction as first developed as the EASE system which requires an IBM compatible PC and a modem telephone link. This is used for the marketing of prime stock, agricultural commodities and quotas. The second electronic auction is "AgVision Satellite" which enables live or video-recorded pictures of animals to be viewed by buyers and is therefore appropriate for both liveweight and deadweight selling. Fig. 2 is a schematic representation of the

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Fig. 2. The AgVision satellite system schema.

AgVision system. The complementary assets needed to use this system are a satellite receiver and dish connected to a television and a telephone-bidding is conducted over the telephone to the studio from which the auction is conducted24. The ‘feel’ of the auction is provided by the intensity of the bidding by those acting on behalf of buyers in the studio. This development provides a useful perspective on the strategies pursued by EASE over time in the sense that the serendipity of the collapse of CLASS provided an opportunity for a new emergent strategy to take shape. Competitive Advantage was gained both through the removal of a previous competitor and also through the widening of the scope of EASE’s operations. 4.4. The EASE system: new horizons Ansoff (1987) developed a matrix model of corporate strategy which incorporated concepts of "old" or "new" in products and markets. New product development is the introduction of new products into a company’s existing markets whereas market extension is the development of existing products into new markets. Both types of strategy can be observed in the this case and provide further evidence of the factors determining success or failure of the innovation process. 4.4.1. New product development Given that its owners were firmly established in the agricultural sector, it was natural that EASE should first seek to widen its scope in its existing market. Considerable effort was put into developing the electronic auction for previously unexplored agricultural 24 At least, this was how the system was first set up; later developments have shown satellite time to be very expensive and AgVision have resorted to distributing video-recordings of cattle; however, new developments (especially Digital Terrestrial television broadcasting) are being explored.

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markets where selling by description was adequate and where visual inspection of the product was not essential for the buyer. EASE developed electronic auction sales of fodder, hay, silage and straw. An ideal candidate for sale at an electronic auction is a financial instrument or licence25. All UK dairy farmers are now required to possess a quota licence before they can produce. EASE pioneered the introduction of the sale of milk quotas by electronic auction. Although not established by EASE, sales by electronic auction of standardised products including liquid milk26 and timber have been introduced since 1995. The move into sales of fodder, hay, silage and straw was not, however, without its complications. Of course, selling by description was acceptable and there was an established team of fieldsmen with knowledge of farmers and their produce. The complementary assets on the part of the auctioneer were complete and the working capital required to enter this market was minimal. The difficulties arose because of the nature of the system’s users who were no longer buyers in meat processing firms but individual farmers much more reluctant to acquire the technology and the skills needed to use the system. Thus, whilst most of the ingredients for successful innovation were present, the complementary assets on the part of users did not exist and this led to an initial failure to innovate. The solution was to introduce the concept of the bidding station—an electronic auction held inside auction marts where farmers who normally came to buy, sell and meet with others, could place their bids by signalling to an operator working the computer system. Not necessarily high-tech, this system works. 4.4.2. Market extension Market extension comprises the extension of existing products or services into new markets. After its extension in additional agricultural markets, EASE sought to widen further its scope of operations and introduced EASIGOE-Electronic Auction Systems International for Gas and Oil Equipment27. This was established in 1992 to enable the sale of surplus equipment by North Sea oil companies. By 1995 more than 300 buyers were linked into this system in various parts of the world (Smith, 1995) and this level has been maintained since then. In the early 1990s many North Sea oil operators found they had considerable surplus equipment and the usual method of disposal was to permit buyers to make private offers much in the same way that buyers of cattle still try to make doorstep deals with farmers. Whilst this suited both parties in some respects, there was no guarantee that the best prices were being paid and, in addition, oil companies also needed information on what was available for sale as from time to time they were buyers as well as sellers. The development of the EASIGOE system was relatively straightforward from the technological standpoint; essentially the same hardware and bidding systems were used 25

There have been a number of recent developments in this respect. Electronic auctions have been established to sell the servicing of mortgages (McCarthy, 1994), pollution credits (Lux, 1995) and even complete businesses as in the Russian privatization programme (Knox, 1993). 26 The restructuring of the market has opened up milk sales to competition instead of a uniform price being paid by the numerous Milk Marketing Boards throughout the UK. 27 EASE is located approximately 10 miles from Aberdeen which is dubbed the ‘oil capital of Europe’. All major oil companies either have their Headquarters in Aberdeen or base their North Sea operations there and a high proportion of local business activity is gained in oil exploration and production.

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and only minor modifications to the software were need to accommodate new terminology. For buyers, new complementary assets of a workstation were required but these were cheap and easy to use. As far as EASE was concerned, the major complementary asset was working capital to pay the salaries of the General Manager of the operation and the support staff, together with other marketing expenses. In part this was covered by assistance from the local Enterprise Company and did not have to be raised wholly from within. In its first full year of operation (1993), the EASIGOE system generated commission on sales exceeding £150 000 and the following year commission on sales doubled and in 1996 they reached £400 000. One aspect of recent sales has been a decline in the number of lots but an increase in their value. Again with the assistance of the local Enterprise Company, other markets have been explored such as international sales of oil and gas equipment, or alternative industries such as the civil engineering or medical equipment markets. A key complementary asset in the development of these new markets is the skills and knowledge of the auctioneer’s staff who can deal with both buyers and sellers in an informed way. Of these, only the international oil and gas plant sales has proceeded with the opening of an office in Perth, Western Australia and, overall, approximately 50 per cent of sales are accounted for by international sales. Entry into this market has afforded substantial Competitive Advantage and EASE has been able to appropriate much of the gains. Conditions for successful innovation were favourable. In addition, EASIGOE has been a first and only mover (there are currently no competitors) in the development of electronic auctions of such equipment. The complementary assets needed by users and the system’s developer were small and, with electronic price formation, sellers are assured that the true market price is achieved which is considered a major bonus. Not all lots are sold immediately but the detailed descriptions of unsold lots are retained in a database. This can be scanned quickly when enquiries from potential purchasers are received and such enquiries are handled by automated FAX and wordprocessing facilities. Thus at comparatively small cost, the system has been extended into an electronic knowledge base of buyers, sellers and items for sale: an electronic market. Indeed, EASIGOE have become a significant information source for the industry enabling them to play a major role in brokering deals in addition to selling through the electronic auction. EASIGOE are now (early 1998) exploring ways of further developing their service, possibly using the internet to display pictures of the equipment for sale and ultimately conducting auctions through the internet.

5. Discussion It is appropriate to review the findings from this case alongside the literature on the innovation diffusion decision-making process and the role of appropriability in sustaining the gains from innovation. 5.1. Knowledge in the innovation–decision process Rogers claims that the knowledge stage is influenced by socio-economic characteristics, personality variables and communication behaviour. We can see that in this instance

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EASE had to influence three distinct types of customer: auction marts that were accustomed to the traditional auction of cattle in the ring or in the field; meat processors whose principal objective was to minimise the cost of their raw material and farmers who had to be persuaded of the benefits of selling their animals in this way. The introduction of the EASE system was a slow process which contrasts with the speed with which the EASIGOE system was introduced and in this comparison can be seen evidence for the factors that Rogers advanced. Farmers are deeply rooted in tradition and it is possible to surmise that their personality makes them cautious and reluctant to adopt new ways of working until the benefits of new systems have been firmly demonstrated. The paradox is, of course, that the key benefits farmers expected were in terms of higher prices and if prices had risen significantly, meat processors might well have boycotted the new system. The danger of a meat processor’s boycott would, however, have been fairly small given their need to maintain a high level of output through their plants (BSE crises excepted!) and this requires geographically widespread sourcing of animals. The more rapid introduction of EASIGOE might be put down to more technologically aware users and the fact that the marketing campaign for the auction system was financed and supported by the local Enterprise Company; thus greater financial resources led to better ‘‘communication behaviour’’ in Rogers’ terms. 5.2. Persuasion in the innovation–decision process The relative advantage of the EASE system—for any of the users—was difficult to establish. Traditional auction marts could see it having little impact upon their overall trading levels with electronic sales substituting for live sales unless the practice of meat processors buying ‘off the farm’ could be slowed or halted. The meat processors tended to view things only in terms of the ‘bottom line’ of the price paid to the farmer and tended to ignore the transaction costs of buying off the farm or attending auctions in person. Growing managerial sophistication in the meat processors might well mean that increasing emphasis is put on the buyers’ cost of time, thereby enhancing the relative advantage of buying electronically. For the farmer, there may have been only slight advantages perceived in the first instance but at least there were no disadvantages so the system was relatively risk-free. In terms of compatibility, the EASE system fitted well since the established grading/ pricing systems remained in place but auction marts needed to employ fieldsmen to prepare a catalogue. Meat processors required some computer equipment and skills but these were generally compatible with pre-existing equipment and skills—no special telephone lines were needed, for example. The other three persuasion factors were also generally favourable to the EASE system—it was not complex, it was observable in the North East of Scotland and gradually spread to other regions and, for farmers at least, it was trialable at very low cost. Meat processors were involved in higher costs (in terms of equipment and learning to use the system) to try out the system but they were undoubtedly very small in comparison to the annual costs of running any buying function. The system was least trialable for auction marts themselves and the way this was handled possibly accounts for the slow take-up. Had the franchising arrangements encouraged early experimentation with the system and, perhaps, the defraying of marketing costs it is possible that more rapid diffusion would have occurred.

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Finally, it is possible to add to Rogers’ categories of factors influencing persuasion, the element of trust. It has been suggested elsewhere that, in addition to low asset specificity and simple product description, essential elements for the successful development of electronic markets were a certain degree of standards for product ratings and the presence of a trusted third party for product evaluations. Clearly the EASE system possessed all of these characteristics, particularly in terms of the meat grading schemes operated through the slaughterhouses and with which farmers were fully acquainted. 5.3. Competitive advantage and appropriability The other perspective of this paper—implied by its title—is that of the appropriability of the gains from innovation. The hypothesis advanced in Section 3.4 is that where the appropriability regime is weak, then the gains from innovation are unlikely to be sustainable in the long run. The case study provides important evidence in respect of this hypothesis and all three aspects of the appropriability regime. 5.3.1. Appropriability and the role of technology Consider first the role of technology itself. Section 3.1 argued that the appropriability regime would be strong if the system designer had proprietorial rights over it. Clearly in this case EASE did not; not only did PC-based competitors emerge, but a number of competing systems all offering roughly similar functionality also emerged. This shifted the balance of market power away from EASE towards the important group of customers—the auction marts. They had the opportunity not only to choose whether to go electronic—they also had the opportunity to choose between alternative electronic systems. At best for EASE, it gave the auction marts an excuse for prevarication. This situation was compounded by the fact that EASE did not retain full rights to the use of the system—all amendments needed to be carried out by the licensors in Canada and this proved both costly and slow. This prevented EASE from being able to introduce a series of product innovations to ensure that the product was continually at the leading edge of technology. 5.3.2. Appropriability and protection mechanisms Section 3.2 above developed Teece’s analysis and showed how the appropriability regime would be stronger where it was possible to protect the innovation in a legally enforceable way. The case provides compelling evidence for this—not only were numerous competitors able to develop the idea of the electronic auction, EASE was ultimately unable to prevent two of its former employees from leaving and starting up their own rival business. Had EASE succeeded in their legal case against their former employees, there can be little doubt that the total gains to the innovation would have been higher. The fact that the establishment of this rival did not lead to the ultimate collapse of EASE was probably fortuitous. 5.3.3. Appropriability and complementary assets The third determinant of the appropriability regime was shown to be the nature and ownership of the complementary assets required for the innovation. Again, the case study

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provides useful evidence here. Within EASE, the required complementary assets were marketing skills together with working capital to set up the system and tolerate early losses. The meat processors were an easily identified target market, as were the auction marts in other parts of the UK outwith North-Eastern Scotland. Both were well known to the EASE parent company and the nature of the marketing campaign was appropriate. It was financial resources that EASE missed most; farmer–shareholders were reluctant to commit themselves deeply to what they saw as ‘shooting themselves in the foot’ and external financial sources were naturally wary of the viability of the technology. In fact, when this had been demonstrated effectively and EASE sought to branch out into EASIGOE, external financial support became much easier to secure and was instrumental in the success of EASIGOE. The case study also shows how complementary assets outwith or only indirectly under the control of the innovator are important for success. The fieldsmen were essential for building up trust, and encouraging farmers to use the system. Their success was matched by their earnings and it is clear that they were able to appropriate some of the benefits away from the EASE shareholders thereby diminishing the long term profitability of the venture. Furthermore, the case shows how complementary assets—in the form of capital for the purchase of equipment or in the form of the skills needed to use the equipment—can also be needed by customers. The fact that meat processors were not prepared to adopt multiple purchasing systems illustrates the fact that the process of ‘locking-in’ depends, in part at least, on the extent and nature of the complementary assets required by the users of this sort of computer system. 5.4. Innovation and strategic development Finally, the case illustrates how some basic business strategies may be employed to enhance the benefits accruing from new products or services. Initially the EASE system was confined to the sale of animals for slaughter but through ‘new product development’ the system was extended into sales of other agricultural products. In addition, a strategy of ‘market extension’ enabled the organisation to develop into a completely new market of the sale of oil and gas equipment. The company was able to enter this market at low cost and, with fewer technological resistances to change it was able to obtain significant ‘firstmover’ advantages. 5.5. Overview There has been a very substantial literature on how new Information Systems may provide Competitive Advantage. This paper shows that the innovation process is not an easy one; potential users have to be informed and persuaded of the benefits which might arise from any new system. Further, to be successful, merely writing a new system (or, as in this case, licensing the rights to exploit it) is not sufficient to achieve success. A complex pattern of factors revolving around the technology, the potential protection mechanisms and the nature, ownership and distribution of the complementary assets will ultimately determine the success or failure, the profitability or otherwise of the venture. The benefits will be long-term sustainable if the appropriability conditions are right and management are able to pursue business strategies that are capable of building on

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early developments. However, as in other areas of innovation, the introduction of new systems is not immune from the threat of second-movers who may possess greater complementary assets and/or a product which focuses more precisely on the needs of the customer. Being first is not a necessary or sufficient condition for success. 5.6. Directions for further study Clearly this cannot be the last word on electronic auctions—indeed, this area is likely to provide interesting case material for some time. It will be appropriate to take an overview of the EASE system in, say, another five years’ time. Meanwhile other electronic auctions in Australia, USA, Canada, Netherlands and the former USSR all form the legitimate focus of study. The electronic pig auction in Singapore has already been the subject of an earlier article in this journal. Issues that arise out of the more extensive study of electronic auctions include questions such as: • • • •

are there cultural or legislative factors that impinge upon the nature and distribution of the benefits from innovation? what are the key drivers of innovation in this area of software development? can different types of electronic auction be distinguished and do these impact upon effectiveness and success? what are the impacts of the establishment of electronic auctions on the structure of markets and the relationships between organisations at different points in the value chain?

The answers to these and related questions should provide useful insights for observers and guidance for policy and decision-makers alike.

6. Postscript The electronic auction element remains for its most appropriate market–agricultural commodities and quotas—but the prospects for electronic auctions of livestock seem to depend upon a second generation of software which will in turn depend upon the prior development of appropriate communications links that can handle both data and television pictures. This technology exists in the form of ISDN telephone networks but whether any of the existing players in the UK agricultural electronics markets have any stomach left for such an affray, remains to be seen.

Acknowledgements The author would like to thank the staff of ANM Ltd who gave their time for a series of protracted interviews and provided the information on which this case is based. The author also wishes to thank three anonymous reviewers for their full comments upon earlier drafts of this paper which have been instrumental in significant changes. The views expressed are those solely of the author who alone is responsible for any errors or omissions.

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