Soft but Strong: Software-Based Innovation and Product Differentiation in the IT Hardware Industry

Abstract

It has been argued in recent years that software is a significant value-creating factor within the manufacturing sector, leading to an increased interest in understanding the mechanisms by which firms may benefit from software-based innovation. Empirical work in evaluating these mechanisms, however, remains underdeveloped. In this paper, we examine one such process through which software-based innovation may provide value for information technology hardware firms in the U.S. Specifically, we examine the influence of software patents on the extent to which firms are able to benefit from product differentiation in their product markets. Using data on over 380,000 patent grants for innovations filed by 730 public IT hardware firms over the time period 1996-2015, we find that greater levels of software-based innovation within the firm are associated with higher levels of product differentiation in product markets: increases in the intensity of software patents within the firm’s patent stock, which we refer to as software intensity, are associated with lower total similarity of product offerings, relative to those offered by rivals, as well as fewer effective competitors in the market. Furthermore, using a different dataset consisting of 23,000 new IT hardware product announcements, we show that firms with greater software intensity subsequently launch a higher number of new products. Moreover, these firms are more likely to launch products that are not only differentiated from those of rivals but also distinct from their own product lines. Our research contributes to the emerging literature on software-based innovation by substantiating an important mechanism through which software helps transform industry sectors, specifically through product differentiation.