Knowledge and Competitive Advantage: The Coevolution of Firms, Technology, and National Institutions

Published by EH.NET (September 2004)

Johann Peter Murmann, Knowledge and Competitive Advantage: The Coevolution of Firms, Technology, and National Institutions. New York: Cambridge University Press, 2003. xxi + 294 pp. $60 (cloth), ISBN: 0-521-81329-8.

Reviewed for EH.NET by Brent Goldfarb, Department of Management and Organization, Robert H. Smith School of Business, University of Maryland.

William Henry Perkin invented the first synthetic dye in London in 1856. While Perkin quickly established a firm to commercialize his technology, sixteen years later the German synthetic dye industry, dominated primarily by Bayer, BASF and Hoechst had a fifty percent market share and by the turn of the century controlled 85 percent of the world market. In this book based on his doctoral dissertation, Johann Peter Murmann attempts to solve two puzzles. Why did the Germans come to dominate the market? Second, why is it that particular firms became dominant and others failed? Murmann uses evolutionary theory to solve the puzzle. What is particularly impressive in this book is how Murmann utilizes ideas from economics, political economy and sociology to better understand the different selection criteria needed to employ the evolutionary theory.

For those unfamiliar with the nuances of evolutionary theory, Murmann’s theoretical development will serve as an excellent primer. Murmann illustrates the theory with institutional detail at the country level and with in-depth case studies of a successful firm and a failed firm in each of three countries, the U.S., the U.K. and Germany. He uses the theory of co-evolution to describe how different and complementary institutions associated with the industry evolved. The primary intellectual contribution in economic history, i.e. the demonstration of the explanatory power of evolutionary theory in explaining the differing performance of national innovation systems, could be understood, though not appreciated, by reading the final chapter.

The central argument to explain the rise of Germany in the synthetic dye industry is as follows: While the British had the first mover advantage in 1856, small chance differences in initial conditions in Britain, Germany and the U.S. ultimately determined which country would dominate the industry. To Murmann, the German prominence in organic chemistry (the central body of knowledge needed for development and production of synthetic dyes), the lack of patent laws in Germany before 1877, and perhaps the relative insignificance of the textile industries in Germany compared to the U.S. and the U.K were central factors in the competitive outcome. The endogenous choices of firms, governments, and the academic community as well as the economies of scale associated with the production of dyes and new dye development magnified the effects of the initial conditions. Murmann demonstrates, for example, that access to the German knowledge hub was critical in his description of U.S. firm American Aniline, which failed because its personnel, trained in chemical engineering, could not produce aniline cheaply enough to compete with the Germans. The absence of patent monopolies in Germany before 1877 led to easier entry, a phenomenon which was reinforced by a relatively large number of newly minted Ph.D.s looking for employment opportunities and often founding firms. Importantly, this created a harsher selection environment in Germany and produced fitter firms than the British system where firms were protected by patents. This led to German global market dominance. Evolutionary theory is invoked to focus our attention on how small differences in initial conditions led to large differences in outcomes by thoughtful identification of selection criteria:

“This [German] capturing of the market share through cost reduction had a self reinforcing property because the average cost share of production would decline more for firms that were ahead in scaling up their plants, product offerings, and market organizations. Until a limit was reached in which the cost of dye production could not be reduced any further by increasing scale and scope, firms with a larger output had the advantage that their per unit R&D and operating costs were lower than those of firms with smaller output. … This allowed German firms to reduce prices and still make profits on many dyes” (p. 214).

Finally and perhaps underemphasized by Murmann, because the textile industry in Germany was insubstantial compared to its prominent role in the U.K. and the United States, the German synthetic dye industry was successful in lobbying for policies that favored their bottom line while firms in the U. K. and the U.S. were not. (The textile industry was unlikely to favor policies that increased rent-sharing with the dye industry through protectionism or other means.)

In his case studies of six firms in the synthetic dye market, Murmann is less successful in explaining why individual firms succeeded while others failed and as we shall see, this leads to a more important critique of the book’s central argument. Murmann finds that “what amounted to successful firm strategies differed across countries” (p. 119). For example, Perkin was unwilling to professionalize the management of his firm, a step taken by successful German firms such as Bayer. However, Murmann does not report any example of a British or American firm that tried to professionalize their management, and hence one cannot identify if this indeed was a cause of failure or whether it was other differences in the institutional environments that Murmann emphasizes in other parts of the book. If, say, a British firm had aggressively sought to professionalize its management structure, would the British have successfully fended off the German competitive onslaught? Thus, there is an inherent under-identification in Murmann’s analysis. Indeed, this shortcoming is inherent in any historical analysis that attempts to identify institutional factors that led to different economic outcomes.

Murmann is well aware of this weakness: On page 256 he states “If my analysis of the observed history of the synthetic dye industry is correct, the fact that Germany had a much large number of organic chemists in 1856 than Britain and the United States and the fact that Germany, in contrast to Britain and the United States, did not have any meaningful patent protection at the time were decisive in giving German firms a dominant position for more than four decades. We would have much greater confidence that the logic of the co-evolutionary argument is correct, if 80 of 100 runs in a simulation would show Germany with a dominant market share.” Faced with this problem, Murmann does what any good scientist would do. He substitutes theory for data. As he weaves his story he provides strong historical support for the key assumptions that drive his conclusions.

While this book provides an excellent description of the development of the synthetic dye industry, its primary contribution is in demonstrating how evolutionary theory might help us understand the success and failure of national innovation systems. Johann Peter Murmann’s demonstrates to us that economic analysis that is devoid of institutional knowledge is woefully inadequate in understanding the emergence of dominant industrial positions. Moreover, Murmann makes us question whether a narrow focus on economic incentives might inhibit our ability to understand broad economic phenomena. This book is a must-read for management scholars, those interested in why the West grew rich, evolutionary economics and technological change. The only suggestion this reviewer has is that the publisher consider a larger typeface in the next printing. (Until then, bring a magnifying glass.)

Brent Goldfarb’s publications include “Bottom-Up vs. Top-Down Policies towards the Commercialization of University Intellectual Property,” (with Magnus Henrekson) Research Policy 32, no. 4, (2003): 639-58. He has also studied the diffusion of electric motors during the second industrial revolution.