Cooperation Between Rivals:
Informal Know-How Trading
Eric von Hippel
March, 1986
WP # 1759-86
Publication Information: von Hippel, Eric (1987) "Cooperation Between Rivals: Informal Know-How Trading," Research Policy 16: 291-302.
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This research is supported by a grant from the Division of Policy Research and Analysis, The National Science Foundation.
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ABSTRACT
"Informal" know-how trading is the extensive exchange of proprietary know-how by informal networks of process engineers in rival (and non-rival) firms. I have observed such know-how trading networks to be very active in the US steel minimill industry and elsewhere, and they appear to represent a novel form of cooperative R&D.
When one examines informal know-how trading in the framework of a
"Prisoner's Dilemma", real-world conditions can be specified where this behavior both does and does not make economic sense from the point of view of participating firms. Data available to date on the presence and absence of such trading seem to be roughly in accordance with the predictions of this simple model.
Although presently documented only as a firm-level phenomenon involving the trading of proprietary technical know-how, informal know-how trading seems relevant to (and may currently exist in), many other types of situation. Indeed, it may be applicable to any situation in which individuals or organizations are involved in a competition where possession of proprietary know-how represents a form of competitive advantage.
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Cooperation Between Rivals:
Informal Know-How Trading
1.0: Introduction
It has long been recognized that it is difficult for an innovating firm to fully appropriate the benefits arising from its innovations, and that desired research might therefore not be performed (1). One sometimes possible solution to this dilemma is cooperative R&D conducted by firms who share the costs and benefits of particular R&D projects (2).
In this paper I explore a novel type of cooperative R&D: the informal trading of proprietary know-how between rival (and non-rival) firms. I have observed this behavior to be widespread in one industry. I propose that the phenomenon makes economic sense, and that it may be present in many industries. Indeed, it may be applicable to any situation in which individuals or organizations are involved in a competition where possession of proprietary knowhow represents a form of competitive advantage.
I begin by briefly characterizing informal know-how trading as I have observed it to date (section 2). Next, I present a case study of the phenomenon involving the trading of proprietary process know-how among US steel minimill firms (section 3). Then, I explore whether and when technology trading between direct competitors is an economically advantageous form of cooperative R&D
from the viewpoint of participating firms (section 4). I then place know-how trading in the context of other forms of R&D cooperation (section 5) and, finally, I 4
discuss how the phenomenon may apply beyond the arena of interfirm trading of R&D-related knowledge (section 6).
2.0: A General Description of Informal Know-How Trading Know-how is the accumulated practical skill or expertise which allows one to do something smoothly and efficiently. The know-how which I focus on here is that held in the minds of a firm's engineers who develop its products and develop and operate its processes. Often, a firm considers a significant portion of such know-how proprietary and protects it as a trade secret.
A firm's staff of engineers is responsible for obtaining or developing the know-how its firm needs. When required know-how is not available in-house, an engineer typically cannot find what he needs in publications either: Much is very specialized and not published anywhere. He must either develop it himself or learn what he needs to know by talking to other specialists. Since in-house development can be time-consuming and expensive, there can be a high incentive to seek the needed information from professional colleagues. And often, logically enough, engineers in firms which make similar products or use similar processes are the people most likely to have that needed information. But are such professional colleagues willing to reveal their proprietary know-how to employees of rival firms? Interestingly, it appears that the answer is quite uniformly "yes" in at least one industry, and quite probably in many.
The informal proprietary know-how trading behavior which I have observed to date appears to involve informal trading "networks" which develop between engineers having common professional interests. Network formation begins when, at conferences and elsewhere, an engineer makes private judgements as to the areas of expertise and abilities of those he meets, and builds his personal informal list of possibly useful expert contacts. Later, when "Engineer A"
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encounters a product or process development problem he finds difficult, he activates his network by calling Engineer B, an appropriately knowledgeable contact who works for a directly competing (or non-competing) firm, for advice.
B makes a judgment as to the competitive value of the information A is requesting. If it seems to him vital to his own firm's competitive position, he will not provide it. However, if it seems useful but not crucial - and if A seems to be a potentially useful and appropriately knowledgeable expert who may be of future value to B - B will answer his request as well as he can and/or refer him to other experts of his acquaintance. B may go to considerable lengths to help A: He may, for example, run a special simulation for him on his firm's computer system.
At the same time, A realizes that in asking for and accepting the help, he is incurring an obligation to provide similar help to B - or to another referred by B -
at some future date. No explict accounting of favors given and received is kept in instances studied to date, but the obligation to return a favor seems strongly felt by recipients - "... a gift always looks for recompense" (3).
3.0: Case Study: Informal Trading of Proprietary Process Know-How Among US
"Minimill" Steel Producers
To date, information on informal know-how trading between rivals is most complete in the instance of process know-how trading in the US steel minimill industry. I present it here as an existence test of the general phenomenon we are discussing, and as a means of conveying its flavor.
Minimills, unlike "integrated" steel plants, do not produce steel from iron ore. Rather, they begin with steel scrap which they melt in an electric arc furnace.
Then, they adjust the chemistry of the molten steel, cast it in continuous casters and roll it into steel shapes. Modern facilities and relatively low labor, capital and 6
materials costs have enabled US steel minimill firms to compete extremely effectively against the major integrated US steel producers in recent years.
Indeed, they have essentially driven US integrated producers out of the market for many commodity products.
The term minimill is not precisely defined, and is becoming less so as
"minimill" plants grow in size and complexity. Early minimills were relatively small (50,000 - 150,000 tons per year capacity) and produced primarily commodity products such as the reinforcing bar used in the construction industry.
Today, however, some individual plants approach 1,000,000 tons annual capacity and many are reaching far beyond commodity products into forging quality, alloy steel, stainless steel and "nearly any steel grade capable of being melted in an electric furnace" (4).
There are approximately 60 steel minimill plants (and approximately 40
producers) in the US today. The most productive of these have surpassed their Japanese competitors in terms of tons of steel per labor hour input, and are regarded as among the world leaders in this process.
3.1 Methods
The sample of minimills studied here is a subset of a recent listing of minimill plants published in Iron and Steel Engineer. This listing (5) contained 45
US firms with one or more minimill plants. I selected the four firms with the largest annual molten steel production capacity ("melt capacity") from this list, and then added six others selected at random from the same list. Later, some interviewees in these firms suggested that I also study Quanex Corporation (because it was viewed as an industry outlier in terms of know-how trading behavior) and so I also added this firm. All firms included in the study sample are identified in Table 1.
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Table 1: US Steel Minimill Firm Sample
STEEL MINIMILL FIRM MELT CAPACITYa (Tons/Year,000)
Four Largest Firms
Chaparral, Midllothian, TX
1,400
Florida Steel, Tampa, Fla
1,578
North Star, Salt Lake City, UT
2,300
Nucor, Charlotte, NC
2,000
Other (Randomly Selected)
Bayou Steel, LaPlace, LA
650
Cascade Steel Rolling Mills, McMinnville, OR
250
Charter Electric Melting, Chicago, IL
130
Kentucky Electric Steel, Ashland, KY
280
Marathon Steel, Tempe, Arizb
185
Raritan River Steel, Perth Amboy, NJ
500
Specially Selected Outlier
Quanex, Houston, TX
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a Source: Edward L. Nemeth, "Mini-Midi Mills - U.S., Canada and Mexico", Iron and Steel Engineer 61:6 (June 1984), Table 1, pp. 30-34.
b Firm closed in July, 1985.
Interviews were conducted with plant managers and other managers with direct knowledge of manufacturing and manufacturing process engineering at each firm in the study sample. The questioning, mostly by telephone, was focused by an interview guide, and addressed two areas primarily: (1) Has your firm / does your firm develop proprietary know-how which would be of interest to your competitors? If so, give concrete examples of process or product improvements 8
which you have developed, and some estimate of their value. (2) Do you trade proprietary know-how with your competitors? With whom? Do you hold anything back? What? Why? Give concrete examples.
The source of major, well-known innovations claimed by interviewees was cross-checked by asking interviewees in several firms, "Which firm developed x?" The accuracy of self-reported trading behavior could not be so checked. I nevertheless have confidence in the pattern found because interviewees in all but one of the sampled firms provided independent, detailed discussions of very similar trading behavior.
3.2: Results
Personnel at all firms except Quanex (selected for study specifically because its behavior differed from the norm) reported routinely trading proprietary process know-how - sometimes with direct competitors. This finding strikes me as impressive, because conventional wisdom might suggest that know-how trading between rivals is rare.
Table 2: Know-How Trading Patterns
In-House
Steel Minimill Firm Process Devel? Know-How Trade?
Four Largest Firms
Chaparral
MAJOR
Yes
Florida Steel
Minor
Yes
North Star
Minor
Yes
Nucor
MAJOR
Yes
Other
Bayou Steel
Minor
Yes
Cascade Steel
Minor
Yes
Charter Elec
Minor
Yes
Kentucky Electric
Minor
Yes
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Marathon Steel
Minor
Yes
Raritan River
Minor
Yes
Quanex
Minor NO
Interestingly, reported know-how trading often appeared to go far beyond an arms-length exchange of data at conferences. Interviewees reported that, sometimes, operating employees of competitors were trained (at no charge), firm personnel were sent to the plants of competitors to help set up unfamiliar equipment, etc.
Of course, the firms which report informal know-how trading with competitors in Table 2 do not trade with every competitor, and do not necessarily trade with each other. (The interviewed firms differ widely in technical accomplishment and, as we will see later, it is reasonable that a firm will only offer to trade valuable know-how with those who can reciprocate in kind.) Before turning to consider why the trading of proprietary process know-how occurs in the steel minimill industry, let us examine that behavior in more detail under three headings: (1) Did minimills studied in fact develop/have proprietary process know-how of potential value to direct competitors; (2) did firms possessing know-how sometimes trade it with direct competitors (rivals); and (3) was know-how in fact "traded", as opposed to simply revealed without expectation of a return of similarly valuable know-how?
3.2.1: Valuable Know-How?
Since many minimill products are commodities, it is logical that process innovations which save production costs will be of significant value to innovating firms, and of significant interest to direct competitors. Barnett and Schorsch (6) 10
report US minimill 1981 costs to manufacture wire rod (a reasonably representative commodity minimill product) to be as shown in Table 3.
Table 3: Minimill Costs Per Ton (Wire Rod, 1981) Cost Category Dollars per Ton Percent of Total Labor
$60
21%
Steel Scrap
93
33%
Energy
45
16%
Other Operatinga 65 23%
Total Operating $263
Depreciation
11
4%
Interest
7
2%
Misc. Tax
3 1%
TOTAL COSTSb $284
100%
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Source: Donald F. Barnett and Louis Schorsch, Steel: Upheaval in a Basic Industry (Cambridge, MA: Ballinger, 1983), Table 4-3, p.95.
a Includes alloying agents, refractories, rolls, etc.
b Excluding any return on equity.
On the basis of Table 3 data, it seems reasonable that all minimills would have a keen interest in know-how which would reduce their labor and/or energy costs. And, indeed, all interviewed reported making in-house improvements to methods or equipment in order to reduce these costs. In addition, some reported making process innovations which increased the range of products which they could produce.
Nucor and Chaparral conduct major and continuing in-house process development efforts (conducted, interestingly, by their production groups rather 11
than by separate R&D departments). Thus, Nucor is now investing millions in a process to continuously cast thin slabs of steel. If successful, this process will allow minimills to produce wide shapes as well as narrow ones, and will perhaps double the size of the market open to minimill producers - an advance of tremendous value to the industry.
The in-house know-how development efforts of other interviewed minimills are much less ambitious, consisting mainly of relatively small refinements in process equipment and technique. For example, one firm is experimenting with a water-cooled furnace roof which is more horizontal (has less pitch) than that of other minimill firms. (The effect of the flatter furnace roof is expected to be increased clearance and faster furnace loading times, a cost advantage.) Other firms develop modified rollers for their rolling mills which allow them to make better or different steel shapes, and so forth. While many such process refinements have only a small individual impact on production costs, their collective impact can be large (7).
In sum, then, most steel minimill firms do appear to develop proprietary know-how which would be of significant value to at least some of their competitors.
3.2.2: Direct Competitors?
Our next question is: Are steel minimill firms which trade know-how in fact direct competitors (rivals)? If they are, we have found informal know-how trading to exist under conditions where, on the face of it, it would seem least likely.
Direct competitors would seem to be the type of firm most able to turn traded proprietary know-how to a trader's direct disadvantage.
Many minimills do compete directly with each other today, although this was not always the case. When minimills began to emerge in the late 1950's to 12
late 1960's, they were usually located in smaller regional markets and were protected by transportation costs from severe competition with other minimills.
Today, however, there are many minimill firms and significant competition between neighboring plants. In addition, the production capacity of minimill plants has steadily increased, and the larger facilities "define their markets as widely as do integrated [steel mill] facilities" (8).
Some minimill interviewees report that they do trade know-how with personnel from directly competing plants. Others report that they "try to" avoid direct transfer to such rivals - but are aware that they cannot control indirect transfer. (Since traders cannot control the behavior of those who acquire their information, the noncompeting firms they select to trade with may later transfer that information to direct competitors.)
3.2.3: Is It Really Trading?
Proprietary know-how is only a subject for trading if free diffusion can be prevented. Therefore I asked interviewees: "Could the proprietary know-how you develop in-house in fact be kept secret if you wanted to do this?"
In the instance of know-how embodied in equipment and visible in a plant tour, free diffusion was considered hard to prevent. Many people visit minimill plants. Members of steelmaking associations visit by invitation, and association members include direct competitors. In principle, such visits could be prevented, but the value of doing so is unclear, since two other categories of visitors could not be as easily excluded. First, suppliers of process equipment often visit plants for reasons ranging from sales to repair to advice. They are expert at detecting equipment modification, and are quick to diffuse such information around the industry. Second, customers often request plant tours in order to assure 13
themselves of product quality, and may notice and/or request information on process changes.
On the other hand, interviewees seem to believe that they can effectively restrict access to know-how if they really want to, and there is evidence for this on a general level. Thus, Nucor and Chaparral both attempt to exert some control over their process innovations, and interviewees at other firms think they have some success. Quanex does not allow plant visits at all, and feels it effectively protects its know-how thereby.
Data on this matter are also available at the level of specific innovations, although we have not yet collected it systematically. As an example, however, a firm with a policy of being generally open reported that it nevertheless was able to successfully restrict access to a minor rolling innovation for several years. (That firm reported gaining an "extra" $140 per ton because it was the only minimill able to roll a particular shape desired by some customers. It apparently only lost control of its innovation when production people explained it to a direct competitor at a professional association meeting.)
Interviewees, including top management, were aware of know-how exchange patterns in their industry and emphasized that they were not giving know-how away - they were consciously trading information whose value they recognized. Thus, Bayou Steel: "How much is exchanged depends on what the other guy knows - must be reciprocal". Chaparral Steel: "If they don't let us in [to their plant] we won't let them in [to ours] - must be reciprocal". Such statements appear to me to have weight because most interviewees who did engage in information exchange had clearly thought about whom to trade with and why.
When asked, they were able to go into considerable detail about the types of firms they did and did not deal with, and why dealing with a given firm would or would not involve a valuable two-way exchange of know-how.
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Know-how trading in the steel minimill industry is not centrally controlled beyond (sometimes) the provision of general guidelines by top management.
Also, no one appears to be explicitly counting up the precise value of what is given or received by a firm, and a simultaneous exchange of valuable information is not insisted upon. However, in an informal way, participants seemed to strive to keep a balance in value given and received, without resorting to explicit calculation. On average over many transactions, a reasonable balance may in fact be achieved, although individual errors in judgment are easy to cite. (For example, in the instance of the minor rolling innovation mentioned above, the innovating firm's sales department was furious when, in their view, engineering
"simply gave" the unique process know-how, and the associated monopoly profit, away.)
3.2.4: Quanex, The Exception
Quanex was the sole exception to the minimill trading norm which I found.
The firm was not on the list of minimills which I used to generate the study sample, and I only became aware of it and its outlier status because I routinely asked each firm interviewed if it knew of any firm whose trading behavior differed from its own.
When contacted, Quanex explained its behavior by saying that, first, it did not trade because it felt it had nothing to learn from competing firms (a contention disputed by some interviewees). Second, it said that, while it did produce steel by a minimill-like process, it produced specialty steels and considered its real rivals to be other specialty steel producers (e.g., Timkin) and not minimills. And, Quanex reported, it was not an outlier with respect to specialty steel producers where, it said, secrecy rather than trading was the norm. (I think this latter point very interesting, but will not pursue it here. If confirmed, it suggests that know-15
how trading patterns may differ between closely related industries. This in turn opens the way to empirical study of the underlying causes of know-how trading under well-controlled conditions.)
3.3: Other Empirical Evidence Regarding Know-How Trading Is know-how trading unique to the US minimill industry? Or is it a significant form of R&D cooperation in many industries?
At the moment, I am aware of only three sources of empirical data on this important matter - and these tend to suggest that informal know-how trading exists in many industries.
First, my students and I have now conducted pilot interviews in several US
industries in addition to steel minimills. And, on an anecdotal basis, I can report that we have found informal know-how trading apparently quite common in some industries, and essentially absent in others. Thus, self-report by interviewees suggests that trading is widespread among aerospace firms and waferboard manufacturing mills, but rare or absent among powdered metals fabricators and producers of the biological enzyme klenow. (Interestingly, however, trading seems a more quasi-covert, secretive activity by engineering staffs in some of these industries than was the case in steel minimills. In minimills, top management was typically aware of trading and approved. This does not seem to be necessarily the case in all industries where significant trading is present.) Second, data in a study by Thomas Allen, et al. (9), of a sample of Irish, Spanish and Mexican firms appears consistent with what I am calling informal know-how trading. Allen examined the "most significant change, in either product or process" which had occurred in each of 102 firms during recent years.
Interviews were conducted with innovation participants to determine the source of the initial idea for the innovation and important sources of help used in 16
implemention. Coding of the data showed that approximately 23% of the important information in these categories came from some form of personal contact with "apparent competitors".
T. Allen elaborates on the behavior observed:
In a typical scenario, the manager from one of these firms might visit a trade show in another country, and be invited on plant visit by representatives of a foreign firm. While there he would encounter some new manufacturing technique that he would later introduce into his own firm. In other cases managers approached apparently competing firms in other countries directly and were provided with surprisingly free access to their technology (10).
Finally, Robert Allen (11) reports on a phenomenon he calls "collective invention" in the nineteenth-century English steel industry - and I think that what he has observed might in fact be an example of informal know-how trading.
Allen explored progressive change in two important attributes of iron furnaces during 1850-1875 in England's Cleveland district: an increase in the height of furnace chimneys, and an increase in the temperature of the "blast" air pumped into an iron furnace during operation. Both types of technical change resulted in a significant and progressive improvement in the energy efficiency of iron production. Next, he examined technical writings of the time, and found that at least some who built new furnaces reaching new chimney heights and/or blast temperatures publicly revealed data on their furnace design and performance in meetings of professional societies and in published material. Thus, it appeared that some firms revealed data of apparent competitive value to both existing and potential rivals, a phenomenon which he called collective invention.
The essential difference between know-how trading and collective invention is that know-how trading involves an exchange of valuable information between 17
traders which is at the same time kept secret from non-traders. In contrast, collective invention requires that all competitors and potential competitors be given free access to proprietary know-how (12). Allen finds that this free access requirement presents interpretive difficulties, however.
(As will be seen later when I discuss the causes of know-how trading, the difficulty Allen notes is not present if the iron manufacturers he examined were actually engaged in know-how trading rather than in collective invention. This seems to me to be possible. Allen deduced that technical data was made available to all because he observed that much was published and presented to technical societies. Certainly, what was published was public: But know-how with trading value might well have been withheld from publication and/or published only when it had lost proprietary status with the passage of time. Both of these suggested behaviors would be difficult to discern via written records but are, in fact, part of the trading behavior of present-day firms.)
4.0: An Economic Explanation for Know-How Trading
I propose that it may be possible to explain both the presence and absence of informal trading of proprietary know-how between rivals in terms of maximizing the profits (rents) which firms reap from it. (Although I will not consider the matter here, benefits and costs experienced by individuals who actually do the trading within firms can also be relevant. I will return to this issue in section 6.) I begin by framing the phenomenon in the context of a Prisoner's Dilemma, and then initially explore the plausibility of such a model by referring to the small amount of real-world information currently available to us.
4.1: Know-How Trading as a Prisoner's Dilemma
Consider know-how trading between rivals as an example of a two-party
"Prisoner's Dilemma". It has been shown that the two parties involved in such a 18
Dilemma are likely to achieve the highest private gain over many interactions,
"moves in the game", if they cooperate (14). However, each player is