When and how to shift gears: Dynamic trade‐offs among adjustment, opportunity, and transaction costs in response to an innovation shock

Abstract

Research SummaryThis study explores incumbent responses to the architectural innovation shock of index shifting in the bicycle component industry. Incumbents differed by when they imitated and by organization of production—some integrated while others outsourced components—and many of these decisions changed over time, which are not explained by extant theory. This paper develops a theory that predicts timing of imitation and organizational choice for component manufacturing that highlights a dynamic trade‐off among adjustment, opportunity, and transaction costs that explains timing of imitation, organizational structure of component manufacturing, and changes in organizational structure. Empirical analysis finds support for a fundamental trade‐off among these costs in response to an innovation shock.Managerial SummaryAn innovation shock presents managers both an opportunity to reposition and gain advantage against competitors and creates competitive pressure to do so. When and how should firms respond to such shocks? This paper develops a comparative approach to help managers decide when and how to imitate an innovation shock. The paper recommends comparatively assessing adjustment costs, opportunity costs of moving late, and initially outsourcing to imitate quickly even though doing so may be costly and problematic over the long‐run. The paper also predicts when firms should integrate to produce more efficiently. These findings are illustrated through the introduction and adoption of index shifting in the sport bicycling market from 1980 through 1995.