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Disruptive Innovation – Why Lawyers Matter

Instructor Prof. Wulf A. Kaal, with Prof. Erik P.M. Vermeulen

January 2017 Intensive

Syllabus

Course Objectives

• Students are able to identify trends in exponential disruptive innovation affecting large and small firms.

• Students understand the changes disruptive innovation brings to law and governance of firms.

• Students develop an appreciation of regulatory challenges associated with exponential disruptive innovation.

• Students appreciate what innovation induced governance changes and new governance structures mean for the practice of law

Course Description Disruptive Innovation – Why Lawyers Matter, 2 Sem. Hrs. The purpose of this course is for students to gain an understanding of the exponential rate of disruptive innovation in a broad array of industries, the effect on corporations, the possible approaches for regulating such innovation, and the role of lawyers in this context. The course examines the exponential rate of disruptive innovation affecting multiple industries. Students will learn about concrete real-life and data-driven examples of disruptive innovation and the short- and long-term effects of this innovation, including the emergence of flat corporate hierarchies to foster innovation and ensure the best ideas prevail in corporations struggling to stay relevant, open communication, and inclusivity. The course will examine innovation driven business cycles and highlight examples pertaining to corporations that failed to institute relevant changes to remain relevant in the face of disruptive innovation (Kodak, Nokia, among others). We will also examine how and why certain corporations (Amazon, Google, Tesla, Under Armour, among others) continue to thrive and what changes they instituted, allowing them to capitalize on disruptive innovation. More specifically, we will examine the emergence of “Dinosaurs” (companies that find themselves in a process of slow and terminal decline); “Unicorns” (large companies that remain private in order to avoid the stifling effects of post-IPO regulation); and “Governance Renegades” (public companies that adopt unconventional corporate structures in order to retain the pre-IPO-start-up-feel). Given these governance changes and new structures imposed by disruptive innovation, the course examines the role of attorneys in this rapidly evolving environment. Students will learn about the legal relevance of the evolution of business strategy, technology, and the application and evolution of artificial intelligence in businesses. Based on the understanding of challenges and opportunities presented by disruptive innovation, students will develop the ability to discern their own possible value proposition in the disruption of businesses in various industries. The course will evaluate the different skills that allow students to remain relevant including soft skills, psychology, and the ability to understand business cycles

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and technology. The course emphasizes the importance of student skills at the intersection between law, business, psychology, and technology. In the first class we will discuss an assignment with problems that students will be required to work through in groups during the duration of the course in teams of four. Each team will present its proposed resolution for the class assignment during the final class session. No prior coursework required.

Class Location and Times 2 weeks in January 2017 intersession 2:20 hours per session – with 10 min break: Regularly 2:00 pm to 4:30 pm. Room MSL 244

Required Texts Supplemental reading materials as per assignments below. Financial Times New York Times Business Section

Office Hours Daily after class

Honor Code Students are expected to comply with the Honor Code of the University of St. Thomas School of Law.

Evaluation Students will be evaluated based on the quality of classroom participation, their group presentations, and performance on the final examination.

Examination The final examination will be a take home exam. Group presentations will be graded separately.

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Session Overview Subject # Date Assignments Topics

Defining Innovation

1 1.3.

http://www.mesopartner.com/fileadmin/user_files/books_monographs/MM05_Ed_3_edited_The_fundamentals_of_innovation_system_diagnosis_and_promotion_Comic_with_front___back_page.pdf

Introduction

Disruptive Innovation

2 1.4.

https://hbr.org/2015/12/what-is-disruptive-innovation Fenwick and Vermeulen Paper (Forthcoming)

Data, examples, anecdotes etc.

Effects of Innovation

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1.5. 9:30 am – 12 pm

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2659763

Effects of disruptive innovation

Impact of Innovation Governance

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1.5. 2:00 pm – 4:30 pm

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2659763 http://papers.ssrn.com/sol3/papers.cfm?abstract_id=894785

Flat hierarchies, open communication, inclusivity – Silicon Valley examples

Group Presentations

5 1.6.

Compare and contrast annual reports of “Dinosaurs”, “Unicorns”, and “Governance Renegades”

Core Differences between “Dinosaurs”, “Unicorns”, and “Governance Renegades”

Innovation as a regulatory challenge

6 1.9.

https://wulfkaal.com/2016/09/19/dynamic-regulation-via-investment-data-as-a-remedy-for-laws-diminishing-capacity-to-react-to-innovation/

Innovation as a Regulatory Challenge – Shortcomings of existing regulatory processes

Role of Law in Innovation

7 1.10.

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=942993 http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2795042

The new company law, outstanding company law reform

Role of the Lawyer in Innovation I

8 1.11.

https://www.linkedin.com/pulse/only-lawyer-matters-erik-p-m-vermeulen?trk=mp-reader-card Fenwick and Vermeulen Paper (forthcoming)

Role of the Lawyer

9 1.12. Kaal and Vermeulen Paper (forthcoming)

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in Innovation II Student Presentations

10 1.13 Student present their movies

Abstracts Session 1: Defining Innovation Contents

Chapter 1 Introduction.......... 9

Chapter 2 The interplay between innovation, technology and knowledge within innovation systems........... 12

2.1. De-mystifying innovation........ 12

2.1.1 Invention vs. innovation............ 13 2.1.2 Innovation is not a linear process 2.1.3 Incremental vs. radical innovation 2.1.4 Architectural vs. component-level innovation

2.2 Understanding innovative behaviour in practice

2.3 Defining technology from a broader system perspective ....... 20

2.4 Defining knowledge from a broader system perspective ....... 23

2.4.1 Internal sources and generations of knowledge within industries and firms

2.4.2 How knowledge intensity can be increased 26

2.5 Distinguishing between technology and innovation management and improving innovation systems......... 27

Chapter 3 Innovation systems: transforming knowledge and learning into innovation.. 32

3.1 What is an innovation system? . 32

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3.2 Different perspectives on innovation systems.

3.2.1 National innovation systems....... 34

3.2.2 Sectoral innovation systems...... 36

3.2.3 Regional or local innovation systems 38

3.3 The practical relevance of the distinctions between the different kinds of innovation systems .. 40

3.4 Chapter summary................ 43

Chapter 4 Identifying the factors affecting innovation systems in value chains and clusters........... 44

4.1 A framework for the diagnosis of an innovation system 44

4.1.1 First line of inquiry: factors affecting the performance of firms............................... 46

4.1.2 Second line of inquiry: macroeconomic, regulatory, political and other framework conditions ......... 47

4.1.3 Third line of inquiry: technological institutions that disseminate knowledge........... 48

4.1.4 Fourth line of inquiry: the role of education and training institutions ..... 50

Chapter 5 approaches and frameworks ................. 54

5.1 Using a Value Chain logic to understand an innovation system........................ 54

5.1.1 Distinguishing between linear and more networked value chains................. 58

5.1.2 Combining a value chain perspective with an innovation system perspective................ 59

5.2 Using Porter’s Diamond to diagnose industry structure and demand on the sector........ 63

5.3 Systemic competitiveness as a framework of

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understanding the broader system................. 66

5.3.1 What is Systemic Competitiveness?

5.3.2 Why Systemic Competitiveness?.

5.3.3 Theoretical background to the concept of Systemic Competitiveness....

5.3.4 What is meant by ‘meso’?..........

5.3.5 Mesopolicy at the local and regional level ...................... 76

5.3.6 Using Systemic Competitiveness to develop industrial and innovation development interventions ..... 77

Session 2: Disruptive Innovation “Disruption” describes a process whereby a smaller company with fewer resources is able to successfully challenge established incumbent businesses. Specifically, as incumbents focus on improving their products and services for their most demanding (and usually most profitable) customers, they exceed the needs of some segments and ignore the needs of others. Entrants that prove disruptive begin by successfully targeting those overlooked segments, gaining a foothold by delivering more-suitable functionality—frequently at a lower price. Incumbents, chasing higher profitability in more-demanding segments, tend not to respond vigorously. Entrants then move upmarket, delivering the performance that incumbents’ mainstream customers require, while preserving the advantages that drove their early success. When mainstream customers start adopting the entrants’ offerings in volume, disruption has occurred.

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Session 3: Effects of Innovation The New Firm: Staying Relevant, Unique & Competitive The key to success for any business enterprise is to build and maintain relevancy in the market place, whilst also remaining relevant to all the various stakeholders within the firm (e.g., employees and investors). Relevancy in the market means delivering products or services that matter for consumers. Relevancy to stakeholders means offering a meaningful experience that allows individuals to develop a unique identity and related capacities; communicate an image; and participate in a fulfilling collaborative project. These two objectives are interconnected in the sense that a firm that remains relevant to stakeholders gives itself the best opportunity to remain relevant in the market place. One recent trend amongst large public companies - often encouraged by activist investors - is to go down the “break up” route in an attempt to remain relevant or recapture relevancy. There is something to this strategy of splitting up or selling off certain parts of the business. The idea is that these newly formed - and smaller - companies will be able to better focus on their respective core competencies. We, however, suggest that firm size does not matter. What is important is to realise that the most innovative firms currently seek to achieve relevancy via the implementation of various “new” corporate governance practices. This paper offers an interpretation of the principles underlying these practices - namely, flat hierarchy, open communication and inclusivity. Equally, these principles provide a starting point for a critical review of the existing legal framework. The current regulatory framework has a tendency to over-emphasise investor interests and this has created a number of unintended side-effects, namely “Dinosaurs” (companies that find themselves in a process of slow and terminal decline); “Unicorns” (large companies that remain private in order to avoid the stifling effects of post-IPO regulation); and “Governance Renegades” (public companies that adopt unconventional corporate structures in order to retain the pre-IPO - start-up - feel). In the light of these unintended side-effects, we propose a recalibration of existing regulation based around the three principles, i.e., a relevancy based approach to regulation.

Session 4: Impact of Innovation on Governance

The New Firm: Staying Relevant, Unique & Competitive One recent trend amongst large public companies - often encouraged by activist investors - is to go down the “break up” route in an attempt to remain relevant or recapture relevancy. There is something to this strategy of splitting up or selling off certain parts of the business. The idea is that

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these newly formed - and smaller - companies will be able to better focus on their respective core competencies. We, however, suggest that firm size does not matter. What is important is to realise that the most innovative firms currently seek to achieve relevancy via the implementation of various “new” corporate governance practices. This paper offers an interpretation of the principles underlying these practices - namely, flat hierarchy, open communication and inclusivity. Corporate Governance and Innovation - Venture Capital,

Joint Ventures, and Family Businesses Most of the literature on corporate governance focuses on listed companies. However, the majority of firms worldwide are non-listed. Given the importance of these firms for innovation and job creation, the absence of a robust debate on the best governance practices for these firms is perplexing. Corporate governance for non-listed companies, such as joint-ventures or venture-capital-backed start-ups and spin-offs, is concerned with ensuring that firms are run efficiently and protect the interests of business parties and investors. The article recounts the history of corporate governance from the development of the joint venture business form to the recent initiatives that help to foster the legal infrastructure to keep a modern economy in gear. We argue that the corporate governance debate for non-listed companies will proceed along three dimensions: (1) legal and institutional structures, (2) contractual arrangements, and (3) optional, best practice guidelines.

Session 5: Group Presentations Session 6: Innovation as a Regulatory Challenge

In a series of recent papers – ‘Dynamic Regulation for Innovation’, ‘Regulation Tomorrow: What Happens When Technology Is Faster Than the Law?’, and ‘How to Regulate Disruptive Innovation – From Facts to Data’ – I evaluate the diminishing relationship between regulation and innovation. The so-called ‘pacing problem’ between innovation and regulation suggests that innovation driven by science and technology is accelerating, yet, simultaneously, federal and state agencies’ regulatory processes have slowed down. Several factors contribute to this pacing problem. Some consensus exists that the legal and evidentiary burdens placed on regulatory authorities have increased substantially over time, precipitating the remarkable slowdown in rulemaking by regulatory agencies. The growing divergence between the time cycles of technological innovation and the time cycles of governments around the world contributes significantly to the pacing problem. Systemic factors such as the political and ideological structures in the rulemaking process, the political gridlock in a two-party system that impedes the passing of

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legislation, legislators’ disagreement on how outdated statutes should be updated, and the need for crises to precipitate legislative action also help to explain the pacing problem. The existing regulatory infrastructure contributes significantly to this problem. In the existing regulatory framework, the regulatory challenges presented by disruptive innovation are largely associated with facts-based, ex-post, trial-and-error rule-making, with stable and presumptively optimal rules. In essence, some evidence exists that governments mostly regulate to react ex-post, after problems arose in the existing regulatory framework but rules are always assumed to be optimal even though optimality is unattainable in a rapidly innovating and increasingly complex world. Other regulatory challenges are presented by the slow speed of regulation, and ever-increasing unknown future contingencies in rulemaking. Because facts-based, ex-post, trial-and-error rule-making cannot anticipate regulatory issues created by innovation, rule-makers may not – or may much too late – realize what new regulatory demands apply to a given innovation. Rulemakers’ near exclusive reliance on stable and presumptively optimal rules created to attain permanent solutions for perceived regulatory issues ignores the ever-changing environment for rules driven by the exponential growth of technology, and the associated exponential growth of innovation. The timing of regulation in an environment of exponential innovation is a primary problem for regulators. Formal rulemaking in the existing regulatory infrastructure is almost always too time-consuming because the speed of product innovation often makes regulations pertaining to an innovative product obsolete before such regulations are finalized. Finally, the existing regulatory infrastructure, with stable and presumptively optimal rules, is largely incapable of addressing the ever-increasing unknown future contingencies associated with disruptive innovation. Given the pace of innovation, future contingencies in rulemaking are likely to increase substantially, making the dynamic anticipation of future contingencies more important for rulemaking.

Session 7: Role of Law in Innovation

New Business Challenges; New Legal Risk All firms - but particularly large, well-established firms - are currently facing a series of new business challenges without precedent in the history of modern capitalism. Most obviously, the emergence of global markets and digital technologies has resulted in more competition and disrupted established business models. Firms need to constantly re-examine their products or services. But it is also important that they do not neglect their organizational and governance

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structures. Commercial realities mean that firms must exist in a permanent state of innovation; a task that is not easily accomplished by over-extended and - often - cumbersome organizations that have lost the capacity for agile re-invention associated with younger or smaller firms. These business challenges have to be met against a background of increased regulatory scrutiny from government and other policy makers. Contemporary debates surrounding firms have involved calls for ever-stricter rules in the areas of corporate governance, tax, finance, sustainability and privacy. The inevitable result has been the emergence of a regulatory landscape that requires firms to make a much more significant investment in compliance and the management of legal risk. Firms can easily become bogged down in the regulatory thicket that now surrounds all aspects of a modern business. Companies are obliged to spend more time and money on managing the rising costs associated with navigating the mosaic of overlapping legal rules. This is an issue for all firms, but particularly those firms that conduct any part of their activities in multiple jurisdictions or across different sectors of the economy. Firms need a mechanism to reduces such costs, whilst at the same time making them more agile. This is what we refer to as strategic legal solutions. The New Company Law - What Matters in an Innovative

Economy? Lower barriers of entry for new firms and more flexibility in structuring a business organization are the two important factors motivating the introduction of the new company law. In general, policymakers use new company law initiatives to encourage entrepreneurship, innovation, and cooperative arrangements. This paper distinguishes the different strands of company law reforms arising in the United States, Europe and Asia and points to the underlying conditions that shape the markedly different reform outputs. Our empirical analysis points to three important factors - (1) private ordering, (2) fiscal transparency, and (3) limited liability - that effect the incentives for new firm creation. However, we find that many of the new company law reforms are incomplete. Nevertheless, these new company law reforms retain the ability to generate rents due to their adaptability and responsiveness to social and economic change.

The Future of Capitalism: 'Un-Corporating' Corporate Governance

A corporate governance model built around hierarchical structures, in which authority and empowerment flows

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through the board of directors to management and eventually staff, and the board is responsible to shareholders (the owners) of a company, worked well in an era of industrial capitalism, but in a connected age it proves far less durable. Large firms that have adopted this hierarchical corporate governance model seem to be less responsive to competitive global markets, disruptive new technologies, cultural shifts in attitudes towards consumption and work, new demands for environmental sustainability, and looming automation. The reason for this is simple. An unintended side effect of the hierarchical model has been to feed the growth of a “corporate attitude”, i.e. a corporate culture in which conservative decision-making, short-term profit and formalistic compliance are prioritized. Firms dominated by such a corporate attitude are at risk of becoming “Dinosaurs”, i.e., lumbering giants facing extinction. In order to overcome this disconnect, it is necessary to re-visit the key elements of the firm - namely the product, people, process - and to examine the meaning of these elements in a contemporary context, i.e., in the context of global markets, disruptive new technologies, etc. This involves asking: What kind of products do firms need to deliver in order to disrupt markets and satisfy the dynamic needs of today’s consumers? What kind of corporate culture do firms need to put in place in order to attract the most talented “Millennials” who will shape the future of the firm? And what organizational processes are best placed to deliver such products and culture? The answer to these questions involves “un-corporating” corporate governance. By embracing this strategy, large firms give themselves the best opportunity to maintain relevancy in the context of rapid and profound transformations in the way we should think about capitalism.

Session 8: Role of the Lawyer in Innovation I

All too often, lawyers operating in the corporate sector bring a traditional legal “tool kit” to solve contemporary business problems. This approach might have worked well when business models were relatively static, but in a world where corporate, innovation and product-service life cycles are much shorter, the traditional tool kit is often out of touch with the needs of dynamic and disruptive business. Lawyers are being asked to deal with issues that they don't fully understand and within a legal framework that doesn't always offer clear or helpful answers. The result? At best, legal services are rendered irrelevant and at worst, they function as a distraction or are potentially damaging to a firm’s prospects of achieving sustained success.

Lawyers that Matter

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As such, strategic legal solutions operates in a space between ”law” and “business”, and is looking to drive innovation in companies, communities, countries and regions. This is a fitful, challenging space comprising complex, ambiguous transactions where uncertainties abound. Operating effectively in this space requires a different skill set and a broader perspective than that usually associated with lawyers. Nevertheless, this is the reality where lawyers and legal advisors must now operate and the aim should be establishing legal service providers and legal departments that can identify opportunities to exploit the advantages of their structural position in order to work in partnership with their clients to build innovative firms that shape the future.

Session 9: Role of the Lawyer in Innovation II

Forthcoming work Kaal and Vermeulen

Session 10: Student Presentations