Profiting from Technological Prevalence: Longitudinal evidence from the Chemical Industry

Abstract

Knowledge-based competition has been a research area of considerable interest to strategic management scholars and managers, all being of the opinion that knowledge is the most important source of competitive advantage. In particular, the knowledge embedded in a firm's technological inventions, and especially within influential patented inventions (as measured by the citations they receive from subsequent patents) can be considered as a source of important competitive advantage. From an evolutionary perspective, the number of patent citations that a firm's patents receive can be viewed as a manifestation of the degree to which a firm's knowledge incorporated in its technological inventions is prevailing over other competing knowledge. The research question that is at the heart of this work is whether influential patents, viewed either as a source of competitive advantage or as a manifestation of technological prevalence, can lead 2 to superior financial performance and how long this performance will endure? We empirically test our hypotheses on longitudinal data from chemical industry. Our preliminary findings show that influential patents do indeed result in superior economic performance but this effect lasts only for one year, since it appears two years after the patents' application date and disappears in the third year and afterwards.

Full text

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Profiting from Technological Prevalence: Longitudinal evidence from
the Chemical Industry
Michalis E. Papazoglou
Athens University of Economics and Business, 76 Patission Street, GR10434 Athens-
Greece, papazoglou@aueb.gr
Yiannis E. Spanos
Athens University of Economics and Business, 76 Patission Street, GR10434 Athens-
Greece, spanos@aueb.gr
Abstract
Knowledge-based competition has been a research area of considerable interest
to strategic management scholars and managers, all being of the opinion that
knowledge is the most important source of competitive advantage. In particular,
the knowledge embedded in a firm’s technological inventions, and especially
within influential patented inventions (as measured by the citations they receive
from subsequent patents) can be considered as a source of important competitive
advantage. From an evolutionary perspective, the number of patent citations
that a firm’s patents receive can be viewed as a manifestation of the degree to
which a firm’s knowledge incorporated in its technological inventions is
prevailing over other competing knowledge. The research question that is at the
heart of this work is whether influential patents, viewed either as a source of
competitive advantage or as a manifestation of technological prevalence, can lead

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to superior financial performance and how long this performance will endure?
We empirically test our hypotheses on longitudinal data from chemical industry.
Our preliminary findings show that influential patents do indeed result in
superior economic performance but this effect lasts only for one year, since it
appears two years after the patents’ application date and disappears in the third
year and afterwards.
1. Introduction
Many scholars and practitioners today are claiming that knowledge is the most
important source of competitive advantage and sustained superior performance
(McEvily and Chakravarthy, 2002). The knowledge contained within a firm’s
technological inventions, and especially within influential (or radical) technological
inventions, can be considered as a rare and important resource that enables firms to
develop successful innovative products and, probably, to achieve higher financial
performance (Markman et al., 2004). But does this superior financial performance
indeed occur and if occurs, how long does it last? The main question that this research
addressed is whether influential technological inventions can lead to superior financial
performance and how long this performance will endure?
From an evolutionary perspective, the number of patent citations received by
any given patent can be viewed as a manifestation of the degree to which a firm’s
knowledge incorporated in its technological inventions is prevailing over other
competing knowledge by influencing subsequent technological inventions. We build
on the Generalized Darwinism framework (Hodgson, 2013a; Knudsen and Hodgson,
2006), according to which all evolving complex systems involve the dynamic
interplay of the variation, selection and retention mechanisms, and we use patents and

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patent citations to measure the evolution of patented technology, viewing patents as
manifestations of the variation mechanism and patent citations as manifestations of
the selection and retention mechanism. Firms whose technological knowledge prevail
over competitors’ knowledge have an important advantage over rivals. The question is
whether or not the technological prevalence in the “knowledge arena” can lead to a
prevalence in the “market arena”? Put more succinctly, can the particular
technological advantage that stems from influential knowledge result in increased
financial performance?
Whether firms manage to appropriate the returns from their patented
innovations or instead these profits are eliminating due to the knowledge spillover
effect, is a research question that has not been answered sufficiently so far. More
specifically, the topic that regards the impact of influential patented inventions (i.e.,
the patents that receive a significant number of patent citations from subsequent
patents) on firm’s financial performance has not been examined in sufficient detail,
while the empirical evidence on this issue is scanty (Bogner and Bansal, 2007; De
Carolis, 2003).
This study, based on the above theoretical backgrounds, aims to analyze
theoretically and empirically the relationship between a particular class of patents, the
influential patents, and the financial performance of the firms who have developed
these patents. In addition, it systematically investigates the duration of the potential
positive impact of influential patents on firm’s economic performance, a question for
which there is scant research in the literature.
Concerning the methodology, we rely on two data sources: the EU Industrial
R&D Investment Scoreboard for economic data and the Derwent Innovation Index

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database for patent data. We focus on the chemical industry and we collect data for
about 60 companies with high annual R&D expenditure over a 10-year period
(longitudinal analysis). In the regression models, we apply the Blundell-Bond
estimator (Blundell and Bond, 1998), which produces less discriminating estimators
than other similar estimators. Preliminary results suggest that influential patents do
lead to superior financial performance but this performance is short-lived. It appears
two years after the patents’ application date and vanishes in the third year and
afterwards.
The remainder of the paper is structured as follows. The next section describes
the theoretical framework within which the hypotheses are developed, while Section 3
presents our two hypotheses. Section 4 introduces our data, the variables employed,
and the statistical analysis. Finally, Section 5 includes a brief discussion of the
preliminary results of our regression models.
2. Theoretical Background
Over the last two decades, knowledge-based competition has been a research
area of considerable interest to strategic management scholars and managers, all being
of the opinion that knowledge is the most important source of competitive advantage
(McEvily and Chakravarthy, 2002) and that the roles of learning and knowledge in
developing a firm’s resource base are extremely important (Bogner and Bansal,
2007).
More generally, according to the Resource-Based View theory, the best way to
explain the differences in performance between comparable firms is an analysis based

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on their resources and capabilities. In particular, the resources that are characterized
as rare, valuable and difficult to imitate are likely to be the sources of a sustainable
competitive advantage (He and Wang, 2009), while knowledge-based resources are
viewed as one of the most important, if not the most important, source of sustainable
competitive advantage (Coombs and Bierly, 2006). A firm’s patented technological
inventions, and more specifically the knowledge contained within its patents, can be
considered as a kind of rare and precious resource that enables firms to develop
innovative products and services that are difficult to duplicate and, consequently, to
achieve a superior financial performance (Markman et al., 2004). Especially when the
patented inventions are radical and groundbreaking, their imitations would be even
much harder (McEvily and Chakravarthy, 2002).
It is generally accepted that the knowledge that leads to innovations is a key
determinant of a firm’s competitive advantage, and hence of its financial performance
performance (Ceccagnoli, 2009). According to He and Wang (2009), innovative
knowledge (knowledge that can lead to innovative products or services) strengthens a
firm's ability to exploit potential market opportunities and increases the likelihood of
developing radical innovations, which, in turn, may lead to an increase in the firm’s
ability to generate above average returns, especially when innovations are combined
with important complementary assets (Teece,1986).
However, any competitive advantage generated by innovative knowledge
would be transitory (Artz et al., 2010), since all the new knowledge that is embedded
in technological innovation will, sooner or later, to a large or to a small extent, diffuse
to rivals. And based on this knowledge, rivals will develop competitive imitations that
will impinge on innovator’s profitability (Ceccagnoli, 2009; Koellinger, 2008). The
critical question is not whether or not the innovative knowledge will diffuse to rivals

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but when will diffuse, meaning that the important research question that needs to be
examined is whether the time until rivals manage to imitate the original technological
innovations will be enough to allow innovators to reap some of the returns that they
had projected.
More specifically, spillovers refer to the extent to which the knowledge
generated by a firm’s research effort is exploited by other firms for their gain (Bogner
and Bansal, 2007). Although, strategies that are employed to appropriate innovation
rents, such as patenting and secrecy hinder spillover effect (Von Hippel, 1982),
nevertheless, they cannot completely eliminate them, especially in cases where rivals’
absorptive capacity (i.e., ability of any firm to acquire, assimilate, adapt, and apply
new knowledge) is high (Bogner and Bansal, 2007). In every modern economy,
spillovers prevent superior economic performance from persisting, eroding inevitably
all the competitive advantages that stem from knowledge-based resources (Wiggins
and Ruefli, 2002), but, they nevertheless strengthen the innovative performance of an
industry as a whole by disseminating new knowledge to all interested parties and
acting as sources of new technological opportunities for the firms in the industry
(Cohen, 2010).
As Ceccagnoli (2009) notes, the general question of whether firms eventually
manage to appropriate the rents created by the competitive advantage that stems from
the creation of a new technological invention or instead these rents are lost due to the
fact that the knowledge contained in the new invention diffuse to competitors
(spillovers), has not been answered clearly yet. Focusing especially on breakthrough
inventions, we can consider that radical inventions are rarer, more valuable, and
potentially more inimitable sources of competitive advantage than average inventions
(in terms of radicalness) since they serve as the basis of new technological trajectories

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(Ahuja and Lampert, 2001). Thus, one would expect breakthrough inventions to lead
to more durable superior performance; but empirical evidence is inadequate to support
or to reject this expectation. The issue concerning the potential impact of influential
patented inventions (i.e., patents that have a significant impact on subsequent patents,
as evidenced by the large number of patent citations they receive) on firm’s financial
performance has not been studied systematically, and the evidence found in the extant
literature is scarce (Bogner and Bansal, 2007; De Carolis, 2003).
Moreover, to the best of our knowledge, literature does not provide us with
empirical evidence with regard to the duration of the impact of influential patents in
particular on financial performance, while the studies that empirically examine the
duration of the competitive advantage stemming from knowledge-based resources in
general are extremely rare (Ernst, 2001; McEvily and Chakravarthy, 2002; Wiggins
and Ruefli, 2002). This study is the first to offer empirical answers on how long the
superior economics performance, that stems from the development of significant
patented inventions (in terms of impact on subsequent patents), persists. Is the
competitive advantage that stems from influential inventions more difficult to imitate
and can, therefore, lead to persistent superior economic performance?
For managements scholars and for practitioners alike the knowledge
concerning the duration of the sustainability of competitive advantage is of great
importance since strategic management decisions are depending to a large extent on
whether competitive advantage can be sustained for an arguably long period of time
or only for a short. Apart from that, the analysis of the sustainability of the
appropriation of innovative knowledge is very important also for the policy makers,
because the strength (in terms of duration) of the appropriability regime is a very
critical factor for the innovation-based economic development. At one extreme, if

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firms’ ability to benefit from their technological achievements is weak, then there is a
risk that firms will reduce their R&D investments resulting in a decrease in the overall
production of new knowledge and in the development of new innovations (Teece,
2018). At the other extreme, a very strong appropriability regime will also affect
negatively the ability of an economy to develop innovative products due to the fact
that strong protection mechanisms obstruct the transfer of new knowledge from one
inventor to another, creating strong disincentives for the R&D activities in general
(Von Hippel, 1982).
In the context of this study, we will investigate whether the degree of
influence of a firm’s patented inventions on subsequent patents is causally related to
the firm’s future financial performance. In particular, we will examine if the impact of
the patents that a firm developed in a year t (measured as the number of patent
citations received by future patents) is positively related to the firm’s financial
performance in years t+1, t+2, t+3, t+4 και t+5. Schematically, this relation is
depicted in our conceptual framework in Figure 1, in which it is shown that except
from influential patents, economic performance is potentially affected by a number of
other variables for which we attempt to account (Bogner and Bansal, 2007; Surroca et
al., 2010).

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Figure 1. Conceptual framework
An evolutionary perspective of influential inventions
From an evolutionary perspective, the number of patent citations received by
any given patent can be viewed as a manifestation of the degree to which a firm’s
knowledge incorporated in its technological inventions is prevailing over other
competing knowledge by influencing subsequent technological inventions. We build
on the Generalized Darwinism framework (Knudsen and Hodgson, 2006; Hodgson,
2013a), according to which all evolving complex systems involve the dynamic
interplay of the variation, selection and retention mechanisms, and we use patents and
patent citations to measure the evolution of patented technology, viewing patents as
manifestations of the variation mechanism and patent citations as manifestations of
Profitability
at t+1
Profitability
at t+2
Profitability
at t+3
Profitability
at t+4
Profitability
at t+5
Control
Variables
Citations Received by
Patented Inventions
Applied for in Year t

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the selection and retention mechanism. Firms whose technological knowledge prevail
over competitors’ knowledge have an important advantage over rivals. The question is
whether or not the technological prevalence in the “knowledge arena” can lead to a
prevalence in the “market arena”? Put more succinctly, can the particular
technological advantage that stems from influential knowledge result in increased
financial performance?
More specifically, according to Generalized Darwinism, all evolving complex
systems must involve the dynamic interplay of the three Darwinian principles —
namely the variation, the selection and the retention (or inheritance) mechanism. First,
the variation mechanism explains how variation occurs within a population, whether
in the biological sphere (e.g., mutations or recombinations of parental genes) or in the
social sphere (e.g., novel artifacts or ideas). Second, selection mechanism refers to
the mechanism that causes the survival of some variations rather than others, often
reducing variety. For example, the prevalence of a new species over others or the
acceptance and the dominance of a new technology over competing alternatives are
manifestations of the selection mechanism in the biological and in the social world,
respectively. Finally, the retention mechanism ensures that some useful information to
particular problems is retained and passed on. In the biological realm, retention
mechanism is realized through DNA while, in the social realm, it is realized through
habits, routines, rules, knowledge components and more (Aldrich et al., 2008;
Hodgson and Knudsen, 2006).
Apart from the three Darwinian principles, the Generalized Darwinism
framework considers that each complex evolving system can be analyzed on the basis
of the replicator-interactor distinction. The replicator-interactor categorization
provides a mechanism that can explain how the information concerning adaptations to

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the environment can be copied with some degree of fidelity through time (Aldrich et
al. 2008). More specifically, replicator involves a causal relationship between two or
more entities, where there is substantial similarity between the original and replicated
entities (Aldrich et al., 2008), while interactor denotes any entity that carries
instructions which can be passed on to the next generation of entities by some form of
more or less faithful copying or reproduction (Schubert, 2014). Common examples of
interactor are the organisms from biology and the organizations from social world. As
examples of biological replicator are considered the DNA and the genes while
customs, habits, and routines are the most obvious examples of social replicators.
Shifting focus to organizational world, it should be emphasized that
organizations are capable of creating new routines, rules, practices, ideas or
technological inventions, among others. With regard to the new knowledge
components, the set of all technological knowledge components that are incorporated
in patented technological inventions that have been developed by organizations
actually constitute the whole “path” of patented technological evolution. More
specifically, in this article, Generalized Darwinism is used to explain how patented
technology evolves as a result of the organizations’ technological activity.
Consequently, in the context of this study, technological prevalence actually
refers to the prevalence of patented inventions and not to the prevalence of
innovations in general (i.e., new products or new services). Nevertheless, it is logical
to assume that the firms whose patent inventions prevails over other patent inventions
will have increased likelihood of developing innovations that will prevail over other
competing innovations as well. Besides, it is not uncommon in the relative literature
to employ patent data to capture technological competition (Cattani, 2005).

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Despite its important drawbacks (e.g., not all inventions are patented, only a
subset of patents actually affects the evolution of innovations), patent data seem to be
the most suitable system of information for analyzing technological evolution because
of its validity and its technological, geographical and temporal coverage. More
specifically, patents can serve as a proxy of new technological inventions whose
novelty is by definition guaranteed by the examiners of the patent offices. Moreover,
patent citations (i.e. a list of references to all “prior art” upon which the patented
invention has been based) can be used as a proxy of the influence that prior patents
have on the new patented invention. The integrity of the citation procedure is
maintained by the patent examiners, who guarantee that relevant patents will be cited
and irrelevant patents will be omitted (Stuart, 1998; Hoetker and Agarwal, 2007).
It is important to note that the Generalized Darwinism is applied on the novel
knowledge components that are created by organizations and are included within a
patent and not on the organizations. In this study, we are not examining the
competitive selection of the organizations but the competitive selection of the
knowledge that is developed by organizations. However, it is reasonable to believe
that the organizations that prevail in the arena of knowledge have an advantage over
the competitors in the final arena where firms compete for market shares, growth and
profits.
This particular relation between the prevalence of knowledge and the
prevalence of firms can be viewed as multi-level evolutionary relation, where the
competition at the level of knowledge components affects the competition at the level
of organizations. What we mean is that the firms which own the knowledge
components that prevail over competing knowledge components are in a better
position to prevail over the competitors, mainly by developing innovations that are

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based on the prevailing knowledge components, which, in turn, can lead to powerful
competitive advantages in the markets’ arena.
We start the application of the Generalized Darwinism to patented
technological evolution with the mechanism of variation. In particular, the event of a
patent grant can be viewed as a manifestation of the variation mechanism. Every time
a patent is applied, claiming for a new technological invention, one or more new
variations are introduced into the population of technological knowledge components.
More specifically, each patent contains a set of claims which are the list of the
specific technological developments for which the patent assignee is claiming
exclusive rights (Harhoff and Wagner, 2006). Patent claims actually declare the
specific novelties that are claimed to have been achieved by a particular patent
(Markman et al., 2004). Consequently, in the granted patents, each claim can be
considered as a new piece of knowledge for which the patent assignee asks for
protection, or as a new variation in the population of technological knowledge
components. Its novelty is by definition guaranteed by the examiners of the patent
offices and its contribution is explicitly and precisely defined within the patent
document. The set of all claims that are included within the patented technological
inventions constitute the set of all variations of patented technological evolution and
the technological “raw material” on which selection mechanism operates. Although
some scholars have already stressed that, in general, novel ideas or artifacts can be
viewed as manifestations of the variation mechanism in the social sphere (Cordes,
2006; Murmann, 2013), those social creations cannot provide the guarantees of
novelty and the precision of contribution, in the way that the granted patents can.
Proceeding with the selection, we argue that the event of a patent citation can
be viewed as a manifestation of the selection mechanism. When a patent cites a focal

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patent, it increases the longevity, the fecundity and the degree of adaptation of the
certain knowledge components of the focal patent that are claimed to be novel (i.e.,
patent claims) and are selected by the citing patent as a basis to draw upon. Whenever
a patent citation takes place, a new patented technological invention explicitly
declares the knowledge upon which it was built, or, using the evolutionary
terminology, it declares its technological ancestor. The event of a patent citation
increases the presence of a particular piece of knowledge of a certain cited patent in
the population of the knowledge components that are included within the patented
technological inventions. The selected knowledge component of the cited patent
exists in more technological inventions after the citation; its frequency of presence
increases. Or, in other words, the selected knowledge component heightens its fitness
in the population of the knowledge components that are included within the patents,
as its technological offspring increases (i.e., new patents that incorporate the selected
knowledge).
In the same vein, Murmann (2013) argued that the selection process in the
academic realm comes about because researchers adopt in their work only a subset of
the ideas available at a given moment in time, meaning that each idea always
competes with other ideas for the attention of researchers who are willing to
incorporate particular ideas into their work. By analogy, each piece of knowledge of
each patented technological invention competes with other pieces of knowledge from
different patented technological inventions for the attention of the inventors who are
willing to incorporate the appropriate for them knowledge components into their
work.
It is necessary to clarify that, in the context of this work, the technological
environment is limited only to those organizations that develop new patents and

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through their patents citations select the most appropriate for them prior knowledge
components; it cannot comprise the more complex nature of technological evolution
where the institutional factor as well as the innovative products or services (and not
just the patents) play a powerful role. Nevertheless, each organization that create new
patented technical knowledge operates in a certain institutional environment and in
given market conditions that certainty affect the organization’s decisions concerning
on which prior knowledge to rely upon, meaning that the institutional or the market
effect is to some extent embedded in the organization’s decision with regard to which
knowledge to draw upon.
Relatedly, and in agreement with Knudsen and Hodgson’s (2006) view that
the outcomes of a selection process are not necessarily optimal, technological
evolution does not always move on the basis of the optimal technical solutions, but
various non-technological, sociopolitical factors play a critical role in the dominance
or in the rejection of a technology (Munir and Jones, 2004; Rosenkopf and Tushman,
1994; Tushman and Murmann, 1998). As Astley (1985:231) put it, “the triumph of a
technological breakthrough over competing adaptations depends on its timing and the
resources available to its champions rather than on its intrinsic superiority”. This
phenomenon can be captured in the patent system in the cases where a technologically
superior patent receives less patent citations compared to a competing,
technologically inferior patent.
Moreover, the event of a patent citation can be viewed also as a manifestation
of the retention mechanism. Each citation denotes the transfer of knowledge from the
cited to the citing patent. The citing patent replicates and reproduces one or more
knowledge components from the novel knowledge components of the cited patent (i.e.
patent claims). A patent citation reveals that a certain knowledge component of the

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cited patent is copied and passed on, through learning, to the organization of the citing
patent, even though it cannot reveal the degree of exactness of the replication.
Buenstorf (2006) stressed that the imitation of technologies among organizations can
be framed as a form of the retention mechanism, giving the example of the patent
license, in which a substantial amount of transfer of technological knowledge between
firms takes place.
So, the event of a patent citation incorporates simultaneously both the
selection and the retention mechanism. It is an event that manifests that the
organization that owns the citing patent has already chosen and already reproduced
some certain knowledge components from the cited patent. There cannot be a patent
citation without a selected knowledge component or without a reproduced knowledge
component. On the one side, a patent citation declares that the organization of the
citing patent selected some knowledge components included in the cited patent as the
most suitable piece of knowledge to draw upon, among the whole population of
knowledge components that are included within the patented technological inventions.
On the other side, patent citation discloses that the organization of the citing patent
assimilated knowledge components from the knowledge that is incorporated within
the cited patent and achieved to reproduce them in such a way that, in combination
with other knowledge components, resulted in the creation of a new patented
technological invention.
Concerning the application of the replicator-interactor concept in the evolution
of patented technology, organizations can be regarded as interactors while
technological knowledge components can be regarded as replicators. More
specifically, focusing again on the event of a patent citation, the organization of the
citing patent copies successfully knowledge components from the cited patent, and by

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combining it with different knowledge components from other cited patents, it
achieves to create a new technological invention. A copy of a replicator (i.e.,
knowledge component) that exists in an interactor (the organization of the cited
patent) is established in a second interactor (the organization of the citing patent)
(Hodgson, 2013b). A patent citation declares that the copied knowledge component
has become rooted in the knowledge base of the follower organization and has been
used in the development of a new technological variation.
Summarizing the application of generalized Darwinism to technological
evolution, every time a new technological invention is patented, a series of events set
patented technological evolution into motion. First, one or more new variations (i.e.,
patent claims), whose novelty has been guaranteed by the patent examiner of the
patent office, has been added to the population of knowledge components that are
included in patented technological inventions. Second, the list of references to prior
art (i.e., patent citations), that compulsory accompanies each new patent, changes the
longevity and the degree of adaptation of the existing technological variations and
redistribute the frequency of their presence. The cited technological variations
increase their fecundity since they have been used as seeds for the creation of new
variations. Third, each patent citation within the list of references is a declaration of
the reproduction of certain knowledge components that took place during the
development of the new invention. Knowledge components (i.e., the replicator) that
were incorporated in the cited patent were replicated by the patent assignee (i.e., the
interactor) and they were used as a basis for new technological variations.
This is not the first time that patents and patent citations are used for the study
of social phenomena based on concepts derived from biology. Martinelli and Nomaler
(2014) studied the “genetic” structure of the contemporary technical knowledge and

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endeavored to trace its origin, in the same way as population geneticists compare the
genotype of contemporary populations with the genοtype of prior populations. In
particular, they employed a genetic approach on patent citations network in order to
identify technological lineages of cumulative chains of technological advances that
lead to today’s technical knowledge.
3. Hypotheses
Hypothesis 1 - The effect of influential inventions on financial performance
Focusing on the effect of influential inventions on financial performance, we
posit that, theoretically, firms which develop impactful technological achievements
are likely to enjoy better financial performance. The creation of influential
technological knowledge within a firm can substantially strengthen the firm’s
competitive position resulting in the generation of rents by developing successful
innovations (Díaz-Díaz et al., 2008). This effect can be realized through higher profit
margins that causally relate influential inventions and financial performance. Even if
the significance of complementary assets and capabilities as determinants of private
returns is well-established, setting prices for innovative products is still considered of
great importance for value capture (Teece, 2018).
In particular, firms that develop impactful inventions have the chance to
introduce to the market a technological breakthrough; a product that incorporates a
substantially different technology from the existing ones. First movers have the
advantage of enjoying greater profit margins since the higher selling price of a
particular innovative product or service will not lead to a large decrease in its sales

19
(Ceccagnoli, 2009). This may happen probably because of the low competition on this
specific new market segment or because of the innovative product’s greater
technological advantage compared to others products that address the same customer
needs using older technologies.
It is important to clarify that the significant number of citations received by a
firm's patents can be interpreted as an indication that the firm owns a number of
patented technologies that can be characterized as important and radical and, thus, the
firm is likely to develop new products based on these technologies that will have a
similar effect. But this effect will not involve inventors of future patents but
customers who are willing to spend their money on such innovative products. In this
vein, we must emphasize that our argument regarding the relation between influential
patents and financial performance is based on the assumption that there is a close
analogy between patent success, in term of patent citations, and the success of the
products based on these patents, in terms of sales and profit margins.
A substantial number of studies have empirically supported the positive effect
of influential inventions on financial performance. For example, Lahiri and
Narayanan (2013) showed that innovation performance, measured as the number of
granted patents weighted by five-year forward citations, exerts a positive influence on
net income. In addition, Bogner and Bansal (2007) showed that new knowledge with
higher knowledge impact (i.e., more patent citations received) is positively associated
with sales growth and return on equity. Moreover, Gu (2005) showed that a 1%
increase in the number of patent citations is associated with an increase in next year's
revenue by 0.111%, while Hall et al. (2005) found that, on average, for each new
citation received by a firm's patents, its market value increases by 3%. The positive

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relation between influential inventions and firm performance has also been
empirically demonstrated by He and Wang (2009) and Markman et al. (2004).
Nevertheless, several other researchers take the opposite view and argue that
the development of influential inventions has no effect or even a negative effect on
financial performance. By definition, R&D is a risky activity since it is concerned
with a-priori unknown outcomes (Czarnitzki and Kraft, 2010) with regard to whether
the R&D process will materialize into ready-for-market innovations, and to whether
these innovations will be adopted by consumers (Sorescu et al., 2003). The risk of
failure presumably increases with high-impact inventions because of the significantly
higher amount of resources that are typically needed for creating breakthroughs
inventions.
However, the greater danger for the profitability of R&D intensive firms does
not stem from their capabilities to successfully develop cutting-edge innovative
products or from the products’ acceptance in the marketplace. It stems from the extent
of the spillover effect to other firms. Especially for influential patents, the fact that
receive a large amount of citations from subsequent patented inventions is an
evidence of technological influence and, at the same time, an evidence of knowledge
spillovers. Impactful inventions are exposed to the hazard of imitating their embedded
new knowledge and the consequences of this exposure may be significantly negative
to a firm’s economic performance (De Carolis, 2003). Rivals can develop, in a short
period of time and at a lower cost
1
, products that can substitute original innovations
(Bogner and Bansal, 2007), leading first-movers to revise their expectations of cash
flows generated from their high-impact innovations. Under these conditions,
1
According to Mansfield et al. (1981), the ratio of the cost of developing products based on imitation
to the cost of developing original innovative products is about 0.65.

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influential patents do not lead to significant financial gains; on the contrary, their
contribution to economic performance may be neutral or even negative due to the
sizable resources dedicated to the development, production and commercialization of
these new technologies. A well-known example of such cases is Xerox, whose Palo
Alto Research Center (PARC) had developed many groundbreaking inventions with a
significant impact on subsequent inventions but failed to capitalize them (Sørensen
and Stuart, 2000). Moreover, one could refer to Apple’s iPod which dominated this
particular segment for a lot of years, even if it wasn’t a first-mover and to Merck,
whose groundbreaking cholesterol-lowering drugs didn’t prevent Pfizer, a late entrant,
from capturing important market positions (Teece, 2018).
There is also some empirical evidence supporting the above contention. In
particular, Chen and Chang (2010) found that in the pharmaceutical industry the
number of patent citations received by a firm’s patents is related to its market value in
a curvilinear (inverted-U shaped) manner. More specifically, they showed that above
a certain threshold, patent citations adversely affect market value, considering the
spillover effect as the main reason for this negative impact. Similarly, Branch and
Chichirau (2010) reported a negative relation between patent citations and
profitability, concluding, inter alia, that R&D activity is generally a process whose
positive outcomes may require a lot of years to appear while its financial gains are
generally unstable and difficult to predict. Finally, Narin et al. (1987) showed that
influential inventions are not statistically related to financial performance.
Nonetheless, although the negative relation may occur is some cases, we
expect that, at the aggregate level, influential inventions will exert a positive influence
on financial performance. Either way, all firms that invest in R&D are aware of the
spillover effect and they always account for this effect when they predict their future

22
cash flows from their innovations. Apart from this, we should add that although R&D
intensive firms may unintentionally disclose innovative knowledge, they also receive
innovative knowledge from the rivals. Concerning the beneficial aspects of social
returns, Nelson (2018: 1389) eloquently noted that “the benefits of technological
advance are widely shared, and in particular that members of the technological
community involved in advancing the field are able to learn about and build from the
advances that are made by others”. Therefore, on the basis of the above, we formulate
the following hypothesis:
Hypothesis 1: The greater the impact of a firm’s patented inventions on
subsequent patents (i.e., the greater its technological prevalence), the higher its
financial performance.
Hypothesis 2 – The duration of the effect
It is commonly accepted that, in intensely competitive markets, abnormal
profits stemming from any innovative product will be temporary (Artz et al., 2010).
According to Roberts (1999), an innovative product tends to face low competition at
the time it enters the market, and due to this, this product can generate substantial
profits. However, these excess returns are exactly what attract rivals and lead them to
develop competitive products, aiming to gain some of the market share in this market
segment. The intensification of competition will inevitably result in the normalization
of the profit margins. It is reasonable to expect that this movement of the profit
margin (initially high and then normal) would be even more intense for breakthrough
innovations, which, in most cases, are based on influential patented inventions. The
next question to which we seek answers in this study is how long does the superior

23
financial performance that results from the competitive advantage stemming from
important innovations persist over time?
In general, although there are numerous of theoretical and empirical studies
that examine the effect of competitive advantage on firm performance, almost none of
them have addressed the research question regarding the duration and the persistence
of the impact of competitive advantage on financial performance (Wiggins and Ruefli,
2002). In our effort to develop well-grounded hypothesis concerning the duration of
the profitability that the groundbreaking innovations generate, we refer to Von Hippel
(1982), who emphasized the importance for profitability of the “response time”,
namely the time that an imitator requires to bring an imitative product to market.
Actually, the “response time” is the time period during which groundbreaking
innovations can confer monopoly rents and secure high profit margins (Von Hippel,
1982). It might be reasonably expected that the more commercially successful the
product is or the higher the profit margin is, the quicker the rival’s response time
would be. In the same vein, Koellinger (2008: 1318) stressed that “the quicker an
innovation is copied by other firms, the less time each innovating firm has to reap
additional payoffs from the investment in the innovation”, emphasizing that the
duration of this particular economic advantage is the substance of the appropriability
problem. Concerning the “response time” in the cases where the innovations are
patented, Cohen et al. (2002) showed that the average time required to develop a
product that imitates a patented innovation is about 2.6 years in Japan and 3.76 years
in USA.
To replicate successful innovations and to bring to market imitative products,
rivals need access to the knowledge components upon which these innovations are
based (McEvily and Chakravarthy, 2002). They must be engaged in their own R&D

24
and possess a certain amount of relevant absorptive capacity in order to be able to
recognize, assimilate and use the technological knowledge that is embedded in the
breakthrough innovations (McEvily and Chakravarthy, 2002) Apart from the
information that rivals can draw from the analysis of an innovative product (i.e.,
reverse engineering), important information can also be derived from the study of the
patent upon which this product is based. The most important patent offices worldwide
(i.e., European Patent Office, United States Patent and Trademark Office, Japan
Patent Office) publish the content of the patents 18 months after their application,
regardless of whether the patent-granting decision is still pending (Ernst, 2001). In
this way, knowledge embedded in the patented invention becomes public and
diffuses, and so, rivals are able to analyze in depth the new technology (McGahan and
Silverman, 2006).
Cohen et al. (2000) and Harabi (1995) argued that many firms are quite
reluctant to protect their R&D achievements through patents for fear of the
uncontrolled knowledge diffusion to rivals. More specifically, according to the results
of the study of Cohen et al. (2000), the two most important disincentives for patenting
are the disclosure of the knowledge embedded within the patents and the unintended
convenience provided to rivals to legally develop new inventions around the protected
technological areas of the original patents.
As far as the prior empirical research is concerned, one can argue that there
has been a noticeable lack of empirical evidence on the examination of the duration of
the competitive advantage that stems from important innovations. One of the most
important studies on this particular topic is the work of McEvily and Chakravarthy
(2002) who focused on whether the complexity, specificity, and tacitness of a firm’s
technological knowledge can affect the time (measured in months) it takes

25
competitors to replicate the firm’s innovations, based on survey data. In addition,
another study that examined multiple time lags concerning the lagged effect of patent
applications on corporate performance is the paper of Ernst (2001) who found that the
patent applications of the German machine tool firms lead to sales increases with a
time-lag of 2 to 3 years. Finally, we have to mention the work of Wiggins and Ruefli
(2002) who, based on a sample 6,772 firms in 40 industries over 25 years, found that
the competitive advantages manifested by superior economic performance very rarely
persist for long time frames. However, to our knowledge, there is no prior research on
the examination of the persistence of the effect that a firm’s influential patented
inventions can have on the firm’s financial performance.
Consequently, based on the above considerations, we can hypothesize that any
competitive advantage that results from the development of innovations which rely on
influential patented inventions will be short-term. We anticipate that rivals, by
examining the innovative products and by studying the patents upon which these
products are based (published 18 months after their application), will be able to
develop competitive products that will overcome the limitations set by the intellectual
property rights of the patents. This situation will increase the competition and will
force the firms of the original inventions to reduce their profit margins. Thus, for the
abovementioned reasons, we can form the following hypothesis:
Hypothesis 2: The positive effect of influential inventions on firm’s
profitability will occur only in the short term.
4. Methodology

26
Data
We used the chemical industry as our research context, since it seems to be
suitable for the study of this phenomenon for a number of reasons. First, in this
industry new technological inventions are being developed at high rates and large
amounts of capital are spent on R&D (Powell et al., 1996; Rothaermel and Hess
2007). Second, chemical industry is characterized by strong intellectual property
protection, leading to a tight link between technological inventions and patents,
meaning that the majority of the technological inventions result in patents (Ahuja
2000; Ahuja and Lampert, 2001; Sørensen and Stuart, 2000). Third, patented
inventions transform into innovations ready to be introduced to the market within a
reasonable time frame, especially compared to pharmaceuticals, where the time frame
from the technological discovery to the introduction of the innovation into market
may be more than seven years due to the drug approval processes (Bogner and
Bansal, 2007)
We drew upon two sources of data: the EU Industrial R&D Investment
Scoreboard (Scoreboard) for economic data and the Derwent Innovation Index
Database (DII) for patent data (Papazoglou and Spanos, 2018). The Scoreboard
provides economic and financial data of the top corporate R&D investors from all
over the world (Filippetti and Archibugi, 2011; Moncada-Paterno-Castello et al.,
2010; Wiesenthal et al., 2012). From the Scoreboard, we collected data regarding the
R&D Investment, the Number of Employees, the Profitability, the Country of Origin,
and the Industry. Our data include observations from 61 chemical companies for the
ten-year period from 2003 to 2012.

27
Our second source of data was the DII, which is a database of international
patent information (Alencar et al., 2007; Gittelman and Kogut, 2003; Lettl et al.,
2009). Patent is a temporary monopoly awarded to a patent assignee for the
commercial use and protection of a new invention (Trajtenberg et al., 1997). Patent
data are regarded as the most popular indicator in innovation studies (Schoenmakers
and Duysters, 2010) because they represent an externally validated measure of
technological novelty (Ahuja, 2000) and because they offer important time and spatial
coverage. Moreover, a patent document can provide valuable information to
researchers such as the organization that generated the patent, the date of application,
and the technological classes in which a patent is classified (Phene et al., 2006).
Each patent application is confidential until a certain stage in the proceedings
(e.g., upon patent grant), or until a certain date (e.g., 18 months after filing). After that
date (or that stage), the patent application is made public, and anyone interested can
have access to the information that is contained within the application. This procedure
is followed by the most important patent offices worldwide, such as the European
Patent Office (Harhoff and Wagner, 2006), the World Intellectual Property
Organization (The Thomson Corporation, 2007), the Japan Patent Office, (Kondo,
1999) and the United States Patent and Trademark Office. Therefore, patents can be
viewed as codified knowledge that can be used by firms other than the originators
(Hoetker and Agarwal, 2007).
All patent applications must include a list of references to all “prior art” of
which the applicants are aware (Miller et al., 2007). Patent citations serve the
important legal functions of delimiting the scope of the property right granted to the
patent (Hoetker and Agarwal, 2007) and emphasizing the novel aspects of the
invention (Sørensen and Stuart, 2000). The integrity of the citation procedure is

28
maintained by patent examiners, who guarantee that relevant patents will be cited, and
irrelevant patents will be omitted (Hoetker and Agarwal, 2007; Stuart, 1998). Patent
citations reveal the prior knowledge upon which a new patent is built. Rothaermel and
Boeker (2008: 58) noted that “patent citations can be viewed as ‘technological fossils’
representing the intellectual lineage of new patents” while Stuart (2000: 798)
emphasized that “just as citations between journal articles reveal the transmission of
ideas between papers, patent citations trace technological ancestries”.
The DII gives information on the full patent family, comprising all the
different patents issued in different jurisdictions around the world with regard to a
given invention and all the different patents that are considered as extensions (or
improvements) of this invention (Gittelman and Kogut, 2003). In other words, the
patent family is a set of patents that are related to the same invention. By employing
patent families, the bias introduced by the counting of the same invention multiple
times is eliminated (Lettl et al., 2009). The use of patent families determines the way
the DII constructs its data, meaning that all the measures are based on patent families
and not on single patents. For example, the number of citations is computed as the
number of citations the firm’s patent families receive from subsequent patent families.
Therefore, if a patent cites two patent documents that belong to the same patent
family, the DII counts them as one citation. Similarly, if two patents that belong to the
same patent family cite another patent, the DII count them again as one citation.
Another useful characteristic of the DII is the use of the assignee code, which
is a standardized form of patent assignee (Alencar et al., 2007). By using this code, all
the subsidiaries and the related holdings of a company share the same code with the
parent company. This feature significantly simplifies our search for the patent families

29
of each firm included in the sample. From DII, we collected patent data for the 61
chemical firms for the seven-year period from 2003 to 2009.
Variables
Dependent variables
We employ the operating profit margin to measure financial performance
computed as operating profit divided by net sales (Bierly and Chakrabarti, 1999;
Goerzen, 2007; Robinson and McDougall, 1998,). According to Kostopoulos et al.
(2011), the profit to sales indicator is one of the two most popular financial indicators
of profitability.
Independent variables
Influential Inventions: We measure Influential Inventions as the aggregate
number of citations that the patents filed by a given firm in a given year have received
until a given point in time (in our case this point was the December 2011, the month
that we collected the patent data). More precisely, using patent families instead of
patents (since DII is a based on patent families), the variable of Influential Inventions
of a firm is computed as the aggregate number of citations that the firm’s patent
families filed in year t (2003 ≤ t ≤ 2009) received until December 2011. We must note
that we do not include the citations made by the same firm that generated the patent
family (self-citations).
Time lags of Influential Inventions: We use five different time lags for
Influential Inventions, starting from one-year lagged value and ending with a five-year
lagged value. By examining the effect of influential inventions on financial

30
performance in five different time frames, we anticipate to capture as much as
possible of the cases that regard the timing of the appearance and the duration of their
causal relationship. Even though, the related literature has proposed a maximum time-
lag of four years in order patented inventions to be able to impact economic
performance (Ernst, 2001), we nevertheless extend this time frame to five, in order to
confirm (or to contradict) previous knowledge.
Control variables
In our regression models, apart from our main independent variable (number
of patents citations received by a firm's patents developed in a given year), we also
include a series of variables that could influence operating profit margin. In particular,
we control for the Number of Employees (Lahiri and Narayanan, 2013), Sales (Sher
and Yang, 2005), Capital Expenditure (Sher and Yang, 2005), R&D Expenditure
(Coombs and Bierly, 2006), and, Knowledge Stock (i.e., the number of patents the
firm had applied for in the previous five years) (Czarnitzki and Kraft, 2010). We also
include country and year dummies to control for time and industry effects (Lahiri and
Narayanan, 2013).
Statistical analysis
Firm’s profitability is a variable that can be affected by numerous factors such
as marketing skills (De Carolis 2003, Lin et al., 2006), organizational structure and
human recources (Koellinger 2008), productivity (Rothaermel and Hill, 2005),
reputation and culture (Surroca et al., 2010), and so on. But since it is extremely
difficult to include all the potential predictors of financial performance in one
empirical study (Surroca et al., 2010), we employ a statistical method that mitigates
this shortcoming. To reduce the potential omitted variable bias (i.e., bias caused by

31
the absence of variables that affect the dependent variable), we include in the
independent variables’ list of our statistical model the dependent variable with a time
lag. However, the introduction of the dependent variable as a time-lagged independent
variable may lead to the inconsistency of the standard estimators (Benner and
Ranganathan, 2012). To address this problem, we employ the Blundell-Bond
estimator (Blundell and Bond, 1998), and, in particular, we use the xtdpdsys command
from the Stata statistical software.
To our knowledge, there has been hardly any study that provides empirical
evidence concerning the determinants of financial performance based on the Blundell-
Bond estimator or on a similar indicator that deals with the model’s misspecification
(Koellinger, 2008). The main advantage of this statistical method is that it produces
less biased estimators, since the estimators’ bias caused by the unobserved variables is
largely absorbed by the presence of the dependent variable as a lagged independent
variable.
5. Discussion on preliminary results
Preliminary results suggest that influential patents lead to increased financial
performance two years after their application. However, this effect attenuates on the
third year and afterwards probably because of the competitive products developed by
rivals relying on two sources of imitation, that is, the product itself and the
information contained in the disclosed patent application (each patent is publicized 18
months after application).

32
If our empirical models eventually support our hypotheses, then, from a
strategic management or from an evolutionary perspective, one can reasonably
assume that important patents (in terms of impact on subsequent patents), do lead to
superior financial performance because of the dominance of the positive effects of
influential patents on profit margin (e.g., first movers advantage that allows higher
profit margins) over the negative ones (e.g., significant but unintended diffusion of
innovative knowledge to rivals). Moreover, by viewing influential inventions as
important technological breakthroughs, we can argue that although radical
innovations may introduce uncertainty and increases time-to-market, they “also
generally raises returns and allows firms to build on those innovations and maintain
leadership” (Bogner and Bansal, 2007: 186).
However, this dominance will not last long. A firm must continually be at the
forefront of technological change and constantly produce important inventions in
order to systematically reap the fruits of its technological achievements. Or, in other
words, as our empirical preliminary findings suggest, a firm must continuously
develop groundbreaking innovations since any competitive advantage and its
concomitant higher profitability that stems from a few technological achievements
will be short-lived. A similar conclusion can be inferred from the study of Coad and
Rao (2008) who examined the economic performance of innovating firms as
compared to non-innovating firm, based on a sample of 539 large UK firms over the
period 1972–1983, and found that the “effects of innovation on corporate growth are
realized very soon after an innovation is introduced, generating a short, sharp one-off
increase in sales turnover” (p.81).
Even if the superior economics performance that stems from influential
inventions is short-term, firms that accomplish once to develop influential inventions

33
have better chances to produce groundbreaking technological achievements
systematically. According to Ahuja and Lampert (2001), the capacity to create radical
inventions can itself be regarded as a form of dynamic core competence that reflects
the firm’s problem-solving capabilities that in turn can lead to the development of
new breakthrough inventions. And if a firm manages to continuously develop
important innovations then the competence gap between the firm and its competitors
will widen (McEvily and Chakravarthy, 2002) and its superior performance will be
maintained. Some examples of effect of innovations’ persistence on firm profitability
include the cases of Hewlett-Packard and 3M, which achieved a superior economic
performance for over 20 years based on their successive development of successful
product innovations (Wiggins and Ruefli, 2002). Therefore, although the competitive
advantage that stems from influential patents lasts only for a limited period of time,
nevertheless those firms that have succeeded once in developing important
innovations are in a better position to continue doing it in the future.
Moreover, it would be interesting to refer to the opinion of Bogner and Bansal
(2007) who stated that “ironically, it may well be the very threat of such undesired
spillover that motivates the original inventor to more aggressively exploit the
potential for subsequent inventions”. Firms, by being aware of the inevitability of
spillovers (especially when new knowledge is patented), are in perpetual vigilance to
continue developing important inventions in their quest for the sustainability of their
competitive advantage and for the continuation of their technological prevalence.
Concluding with an evolutionary perspective on the basis of the preliminary
findings, we can argue that firms that produce new technological variations in the
population of technological knowledge (i.e., new knowledge components embedded
in patents) which are to a large extent selected and replicated by subsequent variations

34
(i.e., numerous citations received from subsequent patent) achieve superior economic
performance. It becomes obvious that the degree of survival, longevity and prevalence
of the new knowledge components is positively related to the degree of survival,
longevity and prevalence of the organization which created these components,
assuming that economic performance is the major determinant of the survival,
longevity and prevalence of a firm within a population of competing firms. Our
preliminary findings corroborate our proposal that there exist multi-level evolutionary
relation between the prevalence of knowledge and the prevalence of firms, since the
competition at the level of knowledge components affects the competition at the level
of organizations.
However, as already mentioned, the duration of this particular relation will be
short in duration. A possible prevalence in the population of knowledge components
will positively affect the prevalence of a firm in the market arena only for one year.
This drive us to the overarching conclusion of this study that a firm must continually
prevail in the sphere of technological knowledge in order to survive and to prevail in
the sphere of modern economy’s markets.
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