Small firms, big impact

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27 November 2015
Research

Can small innovating firms drive the energy technological transition? Today, the electricity sector is responsible for 40% of the world’s CO2 emissions, twice as much as the transport sector. This is mainly due to the fact that 70% of electricity is still mostly produced from burning highly carbon-intensive fossil-fuels, such as oil, coal and gas. Transforming our energy system will require speeding up the rate of innovation in renewable technologies, so that they can compete with fossil-fuel technologies. New research sheds light on the central role of small innovating firms specialized in renewable technologies in moving our energy systems away from fossil-fuels. 

Our research, looking at patenting activities in electricity generation among 5,500 European firms over the last 30 years, shows important differences among different types of firms. On one side, large and established firms in the electricity generation sector are few in numbers but invest large amounts in R&D. Because they are so large and less financially constrained than smaller firms, they can afford investing in both fossil-fuel and renewable technologies, buying the necessary equipment and machines for both types of technologies. Yet, our study shows that the R&D portfolio of these incumbent firms is largely biased towards fossil-fuel innovation in which they have a long tradition of technological investments. Instead, innovation in renewable technologies only accounts for a very small part of their R&D portfolio.

On the other side, small and young startup firms are large in numbers but they only patent occasionally. Only few of these firms survive over time, while most of them tend to exit the innovation scene very fast. Due to their small size, they also tend to specialize in only one type of technology, either fossil-fuels or renewable energy, as they cannot afford the costs of maintaining several research lines.

Our study shows that these small firms can have a big impact in changing our energy systems: the small innovating firms are responsible for 70% of all renewable patenting activities. In particular, the acceleration in the number of renewable patents in the last 15 years is mainly the result of the entry of small innovating firms, such as clean-tech startups, in renewable technologies. Our econometric analysis analyzes factors affecting entry of these firms, and emphasizes the role of market developments for renewable energy in Europe (and thereby market-pull policies).

A striking result of the research is that innovation by the large established firms - although active in both fossil-fuel and renewables - remains largely concentrated in fossil-fuel technologies, with only a very moderate shift towards renewables over the sample period. These firms do not seem to respond to price or market signals by significantly substituting fossil-fuels with renewable innovation. A potential explanation for this is that these firms are hindered by their long history in fossil-fuel technologies and their large stock of knowledge accumulated in this field. Innovation is a path-dependent process, so that if a firm has innovated a lot in dirty technology in the past, it is more profitable to continue doing so in the future. Changing the path of innovation toward renewables would imply for these firms to forego their knowledge base in fossil-fuels and thereby to cannibalize their core business.
Shell’s strategy to address climate change is illustrative in this respect. In recent years, Shell is strongly advocating the development of carbon capture and storage (CCS) technology to reduce CO2 emissions. While there is no doubt that CCS is a promising technology to address climate change, it also makes  perfect sense for Shell, which owns a lot of patents on drilling technologies,  to invest in this technology in the future. Indeed, as Dirk Smit, vice president of exploration technology at Royal Dutch Shell acknowledges:  "If it is necessary to pump carbon dioxide underground to deal with climate change, no one has a better head start on knowing how to do this than oil companies." 

Instead, small young firms are the core actors of a technological transition in electricity generation. The main challenge is that these firms tend to remain small and disappear quickly. Metaphorically, small specialized firms are the small ships in an ocean of innovation. They change their course more explicitly in the face of changes in drivers of innovation, yet they also go under more easily. Large established firms, in contrast, are the big ships. Their course is more difficult to change; yet, they command a comparatively large share of the ocean and stay afloat much longer. The policy challenge is thus twofold: first, to encourage small specialized firms to start and sustain innovation in renewable technologies (for instance, by helping startup firms to find financing). The second challenge is to make large firms more responsive to drivers of renewable innovation. But “Greening the Goliaths”  may be a much more challenging task.
 

Sectors: 
Energy


The opinions expressed herein are solely those of the authors and do not necessarily reflect the official views of the GGKP or its Partners.

LecturerInternational Economics, Graduate Institute Geneva
Head of ResearchCIES, Graduate Institute Geneva
Assistant Professor, Rutgers Business School, Newark, USA