Underinvestment and Incompetence as Responses to Radical Innovation: Evidence from the Photolithographic Alignment Equipment Industry

Neoclassical theory suggests that when an industry is shaken by radical technological change, incumbent firms will be replaced by entrants because entrants have greater strategic incentives to invest in radical innovation. Organizational theory suggests that incumbent firms fail in the face of radical innovation because they fall prey to inertia and complacency. I show that if organizational effects are significant, tests of neoclassical theory in isolation will yield spurious or noisy results. Using data derived from a detailed field study of the photolithographic alignment equipment industry, I show that as neoclassical theory predicts, established firms invested more than entrants in incremental innovation, but that in agreement with organizational theory, the research efforts of incumbents seeking to exploit radical innovation were significantly less productive than those of entrants.