Lead Markets, Innovation Differentials
and GrowthbyMarian Beise
Research Institute for Economics and Business Administration
Kobe University, Kobe, Japan
April 13, 2004
Abstract: This article suggests that the specialization of countries in the international trade is determined by the lead-lag market pattern of national markets. Many internationally successful innovations have been adopted first in one
country while other countries initially either preferred other designs or an established product. A model for the international diffusion of innovations is presented
in which nationally preferred innovation designs compete to become a globallydominant design. In this model, there are country-specific market attributes that
increase the likelihood that the choice a country makes among alternative technologies is adopted around the world. It is argued that technological knowledge
gaps are not the origin of an international competitive advantage. Instead, acountry gains a competitive advantage because a specific innovation design was
adopted earlier than in any other country. This gives local firms a head startin producing, gather marketing intelligence and securing the property rights of a
globally successful innovation. In countries with lag market characteristics, domestic innovations are less likely to get adopted worldwide. They often switchfrom a domestic innovation design to a foreign innovation design, which increases
imports. The lead-lag market explanation of trade specialization has implications
for national policies. In this model domestic innovations do not always foster exports; idiosyncratic innovations induced by lag market contexts can hamper theexport chances of local firms and in the end lead to an increase in imports. It issuggested that in order to increase exports, national policies have to distinguishbetween a domestic lead and lag market context in each industry. While in a leadmarket context, traditional policy instruments that enhance the rate of innovations are effective, in a lag market situation national follower strategies are more
appropriate.
Keywords: Competing Technologies, International Diffusion of innovation
JEL Classification: O33, O38
Address: Kobe University
Research Institute for Economics and Business Administration
2-1 Rokkodai, Nada-ku, Kobe-shi
657-8501 Japan
phone: +81-78-8037032 & fax: +81-78-8037059
e–mail: rian@rieb.kobe-u.ac.jp

1

Introduction

In 1993 the US company Kodak, the largest producer of photographic film, introduced a new film format, the Advanced Photo System (APS). It had invested
nearly one billion dollars in research and development and won major camera
manufacturers over to developing appropriate cameras that could use the APS
film. Before, Kodak had conducted extensive market research to find out what
the consumers wanted to have improved. Yet, after years of weak sales, Kodak
ceased the production of APS cameras in 2003. Overall, APS was a market failure. In 1995 the digital camera started to appeal to a wider audience and at
the end of the 1990s it became apparent that the consumer market in advanced
countries would shift to the digital camera. APS was not technically inferior todigital imagery. On the contrary, the quality of pictures of silver halide films isstill better than those made by the best digital cameras. However, digital cameras have other advantages such as compatibility with computers. In the end,
consumers decided to trade those advantages for lower image quality. Kodak wasaware of the potential of digital imagery. In the 1980s, Kodak had invested billions of dollars into digital technology and introduced digital cameras in the US
but its market acceptance was low expect for a niche in the professional market.
It was perceived that Kodak moved too fast into digital photography, but when
digital camera sales suddenly took off, Japanese camera producers were flooding the world market with a vast number of advanced models. Today, Japanesecompanies dominate more than 90% of the world market for digital cameras.
The reason for the success of the Japanese camera industry was not a technological knowledge gap but a home market advantage. Initially there was notechnological knowledge lead between the US and Japan. Considerable licencepayments of Japanese camera producers to Kodak even suggest that Kodak wastechnologically in the lead for some time. Indeed, most components of digital
cameras have been invented in the US, such as the sensor heart of the camera,
the CCD (see e.g. Johnstone 1999). The Japanese market turned to digital
cameras at relative price levels of digital cameras at which other countries still
preferred the traditional camera design. Until 1999 it was worldwide the biggest
market for digital cameras. In 2001, it was the first country where more digital
cameras were sold than silver halide cameras. The US and the European markets
followed in 2003 after prices of cameras plummeted. Since Kodak was not present
in the Japanese market with its own cameras, Japanese camera producers had ahead start in responding to and interacting with their home market by developinga string of different digital camera models trying vigorously to grasp consumer
preferences and improving the models respectively. The interaction process withthe market, the cost reduction through mass production, and the learning thathas taken place in due course enabled the Japanese companies to be better positioned to offer cameras even in countries where market preferences are slightly
different.
The origins of the international specialisation of the industrialized countries
are still puzzling. Obviously, countries have gained a competitive advantage in1

certain products. But why has Finland specialized in mobile telecommunications? Why Germany in automobiles, Japan in facsimile machines and the USA
in personal computers? It has been suggested before that the specialization ofcountries and subsequently national growth is a result of differences in the number of blueprints and technological capabilities. Yet, mobile phones were invented
in the USA, and the global market leader, Nokia of Finland, used to be a chemical company as recently as twenty years ago. Fax machines were invented in
the USA and Germany. At the advent of the computer industry both the US
and Europe had equal scientific competence (Bresnahan, Malerba 1999); the first
personal computer was even developed in France. It is often difficult to identify
international disparities in scientific knowledge and technological capabilities thathave originally caused international. The OECD notes already in the 1960s thatdifferences between OECD countries in the scientific capabilities are less marked.
Many fundamental scientific findings and inventions originate in Europe. Since
then, many case studies, the newest probably Johnstone (1999), have found ample
evidence that most successful innovations in the Japanese semiconductor industry
have been developed in the US and Europe. In this article it is argued that thecompetitiveness of nations in particular technologies or products results from acertain context of the home market compared to those of other countries’ markets.
While scientific publications, patents and R&D employees of a country canbe counted, market opportunities are hard to measure. It appears, however, thatmarket opportunities are often sufficient to gain international competitiveness if
the local market plays a leading role in the world market. Even if technical knowledge diffuses only slowly, companies are often able to utilize knowledge generated
in foreign countries. It often takes several years or even decades for new technologies to appeal to the market (Gort, Klepper 1982), enough for most countries
to close a scientific knowledge gap. The OECD, like others thereafter, concludes
that not inventions but the ability of turning inventions into commercially successful products is a main determinant of an international competitiveness gap(OECD 1968, p. 17). It is not clear, however, why companies of one country
would be better able to commercialize new technology than companies of otherindustrialized countries. Yet, demand for particular technologies and products
often emerges in a single country, while the markets in other countries are morereluctant. Market opportunities emerge regionally and firms in the local market
often perceive customer needs and preferences first and conduct the most efficient
communication with the market. 1
Historic studies such as Vernon (1966), Franko (1976), Tilton (1971) andthe case studies collected in Mowery, Nelson (1999) have indeed found that the1

The home market advantage of firms was first suggested by Linder (1961) followed byAnderson et. (1981), Lundvall (1988) and Fagerberg (1992). It assumes that domestic demand
gives local firms an advantage over foreign firms in perceiving local demand preferences anddeveloping innovations because user-producer interaction is more efficient within countries. In
management science, customer interaction has been identified as one of the most importantsuccess factors of innovation, see e.g. Rothwell et al. (1974), Cooper, Kleinschmidt (1987),
Gruner, Homburg (2000).

2diffusion of a globally successful innovation from country to country has been
induced by a demand gap and that this demand gap has caused a technology
gap, which is mostly a productivity gap. Firms in early markets have lower
production costs and better products than firms in countries in which demand
emerged later. Demand for an innovation normally emerges because of a specificmarket context that makes an innovation beneficial for local users or cheaper.
Yet, it has to be explained why demand in other countries emerges after the
innovation has been adopted in a particular country. Keeping in mind that eachcountry is specialized in different product lines or technologies it is difficult toargue that a different willingness to adopt innovations in general can explain thelead-lag market pattern.
The lead-lag market model presented in this article is based on various studies of internationally successful innovations (see Beise 2001). It can be observedthat while one country favors an innovation design that later becomes a globally
successful innovation early on, other countries initially preferred other innovation
variants or an established product based on their particular market context before eventually switching over. It is suggested here that various country specificmarket attributes can increase the probability that the local technological choice
is followed by other countries. A country that prefers a specific technology thatlater becomes adopted in other countries as well, can be called a lead market,
countries that follow lag markets. In this model, export success does not originate from technological supremacy; innovation disparities are rather a result of
an international adoption process in which most countries follow the technological choice of the lead market and reduce or abandon their own initial choice. An
initial knowledge ’lead’ in a technology can therefore not only be insignificant but
also be detrimental to competitive advantage, if a country follows an idiosyncratic
technological trajectory that it later has to abandon.
In the next section, the article discusses the lead market phenomenon startingwith traditional technological gap models. In the following section a simple modelof the lead-lag market pattern is presented to demonstrate the various internationalization mechanisms of innovations and the country specific attributes that
support the internationalization of locally preferred innovation designs. In the
fourth section I discuss the question of how policies can support the competitive
advantage of a country given the lead-lag market pattern of innovation success.

2

From technological gap to adoption lead

Since the 1980s the idea that ”firms worldwide compete in the industrial researchlab and that research successes generate competitive advantages that can be exploited in world product markets” (Grossman, Helpman 1991: 177) is common in
the innovation and growth literature. It is argued that a country can gain national
competitiveness via R&D activities because new technological knowledge generated by a firm diffuses slower among firms of different countries than among firms
located in the same country (knowledge capital as a national public good). As
3

knowledge leaks out of the country and is used by firms of other countries as well,
the country loses its competitive advantage. The national competitive advantage
is, therefore, based on a temporary technological knowledge monopoly. This is thebasis of the technological gap theory, first introduced by Posner (1961). Posnerassumes that pioneering innovations occur either randomly, out of entrepreneurial
vigor, or they are correlated with former innovations and investments which alsostabilize the technological lead of a country. It is commonly assumed that scientific advances and basic inventions contribute less to a national technologicallead because scientific findings diffuse much faster internationally while it takes
longer to transfer them into innovations.
Formal models of knowledge gaps only partly explain the specialization patterns of trade with country characteristics because the set of country attributes
that are used is very narrow. National characteristics can explain why a country
specializes in R&D intensive goods in general. Broadly, the higher the endowment with human capital the higher the specialization in R&D intensive goods(Grossman, Helpman 1991). Furthermore, the size of the market is suggested tofacilitate a technology lead because the larger the market the higher the profitability of R&D. In addition, specialization patterns have been attributed to public
R&D subsidies for selected technologies that governments expected to have a highgrowth potential, most pronounced probably for Japan (Johnson 1982).
A consequence of the technology gap theory is that all nation-specific factorsthat are related to the rate of innovations in a country are determinants of competitive advantage. Demand-pull theories since Schmookler’s (1966) empirical worksuggest that shifts in demand are the main explanation for the firms’ growth ofinventions. The view that science and demand factors of technical change are interrelated has been widely shared in the literature since the 1980s (see Dosi 1988;
Freeman, Soete 1997). Besides its size, the national market is seldom considered
as a source of comparative advantage because it is regularly assumed in growth
and technology gap models that consumer preferences are equal worldwide, that
there is a demand for product variety in every country, or that all companies haveequal access to potential users of innovations worldwide. Yet, in the tradition of
the home market hypothesis of Linder (1961) several local demand factors havebeen suggested to increase the innovation rate of a country. While Linder (1961)
assumes that increasing income generated the demand for most innovations, others have suggested that the perception of the needs of users can vary from country
to country. If successful innovations require close interaction with customers, theability and the vigorousness of customers to convey their needs to manufacturers
increases the innovation output of the manufacturers. So far, Porter (1990) has
most prominently stressed the demand conditions in a country as a competitive
advantage. He observes that buyers in one country can be more sophisticatedand demanding than in any other and that this pressures local firms to come up
with innovations. Fagerberg (1995) speaks of advanced domestic users and suggests that customers that operate in a competitive market are more demanding
towards their suppliers. Originally, Porter (1990) introduced the idea that competition in a national market increases the rate of innovations. And, indeed, there4

is some evidence that local competition is correlated with export success, even ina country like Japan which is suspected of cartels and governmental intervention(Okimoto 1989, Sakakibara and Porter 2001). In addition, he suggests that thesegment structure at home can shape the attention and priorities of a nation’s
firm. The ability to innovate close to the market needs is the main argument forinternational competitiveness.
In a similar approach that takes the national market more into account, it
was suggested that national growth results from the early adoption and diffusionof new technologies within a country (Hall 2001). Countries that lead innovation and adoption in radical industrial technologies and new sectors drive thegrowth of the world economy when the innovations diffuse to the rest of theworld (Reuveny, Thompson 2004). Indeed, global innovations have regularly
been adopted first in one country or region before other countries adopted them
(Dekimpe et al. 2000). However, technical progress is not one-dimensional. Somecountries adopted new technologies that failed on the world market. In contrast
to the common perception of globalization, in most industries market conditions
and preferences do vary considerably from country to country. Countries usually
have different environmental conditions, different needs, different preferences, different prices of goods and factors. A firm that intends to export normally has
to adapt each product more or less to the foreign market conditions. One of thebiggest challenges of a multinational firm is to develop a globally standardized
product. Although multinational firms aim to develop global innovation designs,
few have succeeded (see the global marketing literature such as Kotabe, Helsen
2001, Johansson 2000, Cateora, Graham 2002). Globally successful innovations
are frequently not the result of a firm’s product development efforts but the resultof a process of international standardization that often had not been predicted
or even intended.
Innovations are induced through increases in the incomes of potential users,
environmental conditions and price changes of goods and factors (Binswanger,
Ruttan 1978). Therefore, initially, the global diversity in market conditions generates a variety of innovations and different designs of innovations. An innovation
design is a technical specification of an innovation idea. Different designs of an
innovation have similar functions but different appearances, use different technologies or complementary goods, and have a different mixture of attributes suchas size, quality performance, precision, energy consumption, etc. (see Utterback
1994, p. 18). For instance, the facsimile machine and the teletypewriter are
distinct innovation designs of a communication device for transmitting pictorial
information. An Apple personal computer and an IBM mainframe computer are
different designs of a computer. Mobile cellular telephony, satellite systems andpagers are different designs of mobile communications. A Cadillac and a Mercedes are two different designs of a luxurious car. Different designs can often
not be distinguished by technological superiority or quality. They are all hightech, but they have their advantages and disadvantages depending on the regional
conditions. Facsimile machines have advantages in countries with pictorial letters such as Japan, while the teletypewriter is superior in countries that use the5roman type. Satellites are ideal for countries with low population density suchas the USA compared to cellular systems which have their highest merit in theEuropean population density.
Countries favor different innovation designs because of differences in the environmental context or because of different social contexts and traditions. Sociologists speak of the social shaping of technology (MacKenzie, Wajcman 1985).
For instance, it was suggested that personal computers, having no real technological advantage over mainframe computers, invaded large companies in the US
in the 1980s through the back door because the engineers were more individualistic compared, for instance, to Japanese ones, who were happy to share a large
computer with their colleagues (Freiberger, Swain 1984, Ceruzzi 1996). Innovations are induced by local market contexts even in industries that are seemingly
global in nature. A historic example of the effect of regional market context
on innovation designs in the aircraft industry is given by Cateora and Graham(2002: 382): ”American manufactures [of jet aircraft] built the engines slung below the wings whereas the British competitor built the engines into the wings.
The American design made for easier access and saved on repair and servicing
costs, and the British design reduced aerodynamic drag and saved on fuel costs.
Both designs were high quality for their respective markets. At the time labor
was relatively expensive in the United States and fuel relatively expensive in the
United Kingdom.” A recent example is given by Porter (1990), who notes thatthe innovative Airbus design was induced by the European geographic context.
Regulation, laws and traditions shape innovations as well. The pharmaceuticalindustry, for example, faces varying markets from country to country. The market context is a complex system of users’ perceptions, mediators and institutions.
In Germany, physicians are traditionally educated in herbal medicines and oftenprescribe them in contrast to the fixation on pharmaceutics in the US. In the traditional Chinese medicine, treatments and substance mixtures are used that are
rejected in the western world. Furthermore, the health care system and the cooperation with clinical personnel is differently organized which leads to different
new pharmaceutical products and medical equipment.
A consequence of globalization is that nationally preferred innovation designs
are available instantly on the world market and compete against each other.
Many countries offer innovation designs on the same technological and quality
level. There is often no technologically better design. Competition between innovation designs occurs on different levels. For instance, the European cellular
telephone standard GSM competes against other cellular mobile telephone standards as well as against pagers and satellites. As different designs of a nuclear
reactor compete, so does nuclear energy compete against wind energy. The term
designs of an innovation used here, therefore, encompasses all technologies thatcan be more or less substituted with each other, and includes not only tangible
technical products but also software, the formula of a soft drink, a technology
or even a technological trajectory. For instance, Denmark has chosen a distinct
technical development path from generator generation to generator generation,
starting with small generator types in the 1980s to bigger ones in the 1990s (Beise,
6

Figure 1: International Diffusion of Competing National Designs
100

Penetration rate
in percent

90
80

Innovation design B
in lead m arket

Innovation design B
in lag m arket

70
60
50
40
30
20
10

Innovation design A
in lag m arket
Innovation design
A in lead m arket

0tRennings 2003). Innovation designs compete not only against other innovation
designs but also against traditional designs that are incrementally improved. For
instance, in the automobile industry the fuel cell-powered car envisioned as thenext generation competes against hybrid cars as well as improved combustion
motors (Beise, Rennings 2004).
The observation that globally standardized products and processes exist, however, does not imply that preferences are equal. The competition between nation
specific innovation designs and between innovation designs and established products can lead to the emergence of dominant designs 2 as well in the way thatcountry after country adopts or switches over to the same design out of economically reasonable motives. In studying several successful innovations I have foundthat countries that are late in adopting a specific innovation design that becomesa global success often do so because they have first preferred a different design.
Figure 1 depicts a stylized international adoption pattern with competing innovation designs in which one design emerges as a globally successful innovation.
Despite adopting an innovation design earlier than the lead market, the ’lag’
market switches over to the lead market design. An example is the competition
between the facsimile machine and the teletypewriter (figure 2). According to Peterson (1995), technological knowledge in fax technology was equally distributed
among the United States, Japan and Germany in the 1980s and early products
from these countries were equally advanced. Yet, the fax machine started its hugemarket success in Japan long after it was introduced in the western market; it was
initially rejected because the teletypewriter was considered as more appropriate.
Globally dominant innovation designs, therefore, mean that the market context of one country has shaped the world market. The lead market concept of2

A dominant design is defined as a design that is adopted by a majority of users (Utterback
1994, p. 24) and a global dominant design is the design that is adopted by most countries, incontrast to national dominant designs, that are only widely adopted within a country.

7

Figure 2: Competition between fax and teletypewriter
5

Telex per 1,000 People
Fax per 1,000 people
FAX inJapan

4

Fax inGermany

3

Telex in Germany

2

1
Telex in
Japan
0
70

72

74

76

78

80

82

84

86

88

90

92

94

96

Source: ITU, Scherer (1992), Yoffie (1997)

technology reads failures of innovations as having been induced by lag markets.
We can even go further: When an innovation fails to substitute an establishedproduct (for instance synthetic leather failed to substitute leather, see Freeman,
Soete 1997), then countries that opted for the established product and rejected
the innovation can be interpreted as lead markets in the sense that their initialtechnical choice prevailed on the world market. A more general definition of leadmarkets is a market whose technical choice is followed by other countries.
In the next section, the reasons why local technical choices are followed byother countries are discussed in detail. It is suggested that certain characteristics
of regional market conditions increase the probability that the technology choicesa country makes on the basis of its market context for a particular product line
become internationally accepted.
Firms in the country that first adopted the globally dominant innovation design garner a competitive advantage because they have a lead in gathering designspecific knowledge: Knowledge about the product and manufacturing technology,
knowledge about user preferences and applications. In addition, specific innovation designs can be better protected by patents and trademarks than basic technological knowledge that can be used to developed various specific designs. For
instance, all cellular mobile systems are based on fundamental technical principles
invented by the Bell labs. These technical fundamentals are not proprietary incontrast to the specific systems that have been derived. The worldwide success of
the GSM mobile system, however, entails that manufacturers have to offer GSM
compatible equipment by following its exact specifications. Companies that did
8not participate in the development of GSM have experienced higher costs thantheir competitors (Beise 2001).
Lag markets are disadvantaged in many respects. Countries that have initially
preferred a different innovation design (or an established design) than the globallydominant design not only fail to export their own innovation design but arealso in danger of losing their home market to the foreign innovation design, asituation which entails increased imports. Countries that switch from one design
to another have to bear the switching costs (Klemperer 1987). Investments in
R&D, infrastructure and training for the development and implementation of
idiosyncratic designs represent losses and hamper the adoption of the innovation.
It is argued here that the origin of competitiveness of a country is not the
number of innovations a country generates or that a specific innovation is preferred and adopted early, but that the same innovation design that is nationally
preferred becomes adopted worldwide. Yet, technological capabilities are not insignificant for competitiveness. A condition for competitiveness is that companies
keep track of new technological knowledge and are able to utilize technical knowledge and scientific findings generated abroad. This commonly requires their own
research activities that are the basis for an absorption capacity (Keller 1996).
The hypothesis of lead markets neither disputes science-push theories of technical change nor is it a pure demand-pull theory itself. It argues that technicaladvancement is not the origin of national competitive advantage in many productdomains. Lead markets exist even if technical progress overall is mainly basedon scientific advance. Some science-push theories consider the market as being
reluctant to adopt new technology. The market has to be persuaded to accept
new technology. If so, local markets can be more or less reluctant to adopt atechnology that will prevail on the world market later because of its technicaladvantage. Companies in the most willing market get an advantage even if they
have not generated the technological knowledge. Second, if producers are not(perfectly) informed about demand preferences, but innovate instead on the basis of scientific findings alone, demand does not induce technical change directly
but rather selects the technology within a variety of innovations during the diffusion process. Users will select the variant that fits their purposes best - or is ”thelesser of the various evils on offer” (Grupp, Maital 1998, p. 74). If demand andenvironmental conditions vary, the benefit of technology alternatives may differ
from country to country and different alternatives might fit local conditions best.
As a result, users in one country will select a different technology than users inother countries. If demand conditions in one country are highly idiosyncraticcompared to other countries, it is likely that demand would at least ’bend’ thetechnological progress of local firms towards an idiosyncratic direction, if not in
the invention phase then in the diffusion phase.
After a new innovation is successfully commercialized in a specific national
context it has to overcome international differences. It has to prove that it isprofitable in other market contexts as well. In the next section a simple consumption model demonstrates why countries follow another country in adopting
a specific innovation design that it has initially rejected.
9

3

A model of lead markets

The lead-lag market pattern of adoption of innovations can be explained by a variety of mechanisms. This makes the theory of lead markets eclectic. Rather thanconcentrating on one mechanism that could be the most important one, I would
like to demonstrate the variety of possible mechanisms in a simple consumption
model.
Let us consider two countries that initially demand and prefer two different
product designs which have the same general function so that they compete on theworld market. The two designs represent two different designs of an innovation,or an established product and an innovation that was introduced in order tosubstitute the established design. Both designs are available in the two countries
and reflect state-of-the-art-technology. 3
In this model it is assumed that both countries have the same general willingness to adopt an innovation. Firms respond mainly to their home market context.
They can get access and utilize state-of-the-art technology generated worldwide.
As a result, countries can only gain a technological lead in the form of market andproduction knowledge of a specific innovation design and after they have masscommercialized it. Lastly, national preferences are neither totally equal nor too
different, so that they can be overcome by the advantages of a global standard.
In the first stage of the model, the two countries adopt a different design,
which means each design has a large market share in one country and a low
market share in the other. This means that different properties of a product are
preferred in each country. Different consumption patterns can be a result of (1)different prices of the designs in the two countries, (2) different budget constraints,and (3) different benefits of the two designs in each of the countries. The benefitof a design is determined by the environmental context, traditions and taste, or
local network externalities. In the second stage, both countries prefer the sameinnovation design. There are three general mechanisms that could cause the othercountry, the lag market, to change its adoption pattern: (1) the relative price ofthe design preferred in the lead market could have decreased in the lag country,(2) the available budget of users in the lag country could have increased and (3)the relative benefit of the design adopted in the lead market for users in the lagcountry could have increased.
The first mechanism, a relative price reduction of the design preferred in thelead market for users in the lag market, shifts consumption in the lag market awayfrom the previously preferred design towards the design preferred in the lead market. This price mechanism can be further divided into two sub cases. First ofall, one innovation design becomes adopted by both countries if the price of thedesign preferred in the lead market decreases in relation to the prices of designs
3

The innovative design is therefore not an upgraded established product; it is a new technical specification that competes against the constantly upgraded established product. Several
authors suggest the term radical innovation for these innovations, but I prefer the neutralterm design because of its non-normatively and because the term radical innovation is used inindustrial economics in a different context.

10Figure 3: Price reduction and global adoption of the Fax machine
4

Average Price of a
Fax-Machine in 1000 US $Fax per 1,000 People
10
Japan
8

3
USA
Germ any

6

2
4

1
2

0

0
78

79

80

81

82

83

84

85

86

87

88

89

90

91

92

Source: ITU, Economides, Himmelberg (1995)

preferred by the other country. This price reduction effect is the main argumentof Levitt’s (1983) famous ”globalization of markets” hypothesis. He asserts that
global producers ”attract customers who previously held local preferences andnow capitulate to the attractions of lesser prices”. The price of one design decreases faster than for the other when the lead market is larger in an early stageof the product life cycle, allowing manufacturers to exploit larger economics-ofscale. When economies of scale and learning effects are big, countries with alarge internal market for a specific design have a lead market advantage. Scherer(1992) notes that when the fax machine was a market success in Japan, Japanesemanufacturers were able to exploit economies-of-scale and lower the price to levels on which it became successful in western countries (figure 3). Consumptionof an innovation can also be higher in a country in which the price level of theinnovation is the same but that of other goods is higher than in other countries.
For example, consumers in Japan purchase more expensive consumer electronics
and cars because even affluence does not enable the purchase of a family housein metropolitan areas (Tsuru 1993, p. 169).
In the second case, the price of the lead market design is initially lower in thelead market than in the lag market, but over time the design becomes available forthe lower price in the lag market as well. In this case, the lead market anticipatedfuture world market prices (figure 4). This has happened in the mobile telephonycase. Cellular phones were much cheaper in the Nordic countries in the 1980s
than in any other country. In the 1990s, however, liberalization of the telecom
sector sent prices down worldwide, making cellular phones affordable for a wide
11

Figure 4: Price anticipation in the lead market
Relative
Price

Price path of qlead
in lag market

Price path of qlead
in lead markettconsumer group. 4
Increasing income is another diffusion mechanism for innovations and it is themain explanation given in the classical international product-life-cycle theory by
Vernon (1966). Many commercially successful innovations were developed in the
United States because the per-capita-income in the United States was the highest
in the world and the rising middle class established the demand for convenience
products (Franko 1976). As other countries caught up and reached the previous
levels of per-capita-income of the US, demand for the same new products emergedin these markets as well. Per capita income has indeed been frequently empirically
proven to have a positive effect on the rate and time of adoption (see the literature
review by Dekimpe et al. 2000b). Nowadays, however, this effect seems to be
not as relevant as it was before the 1970s, since per-capita-income converged
within the industrialized countries. However, for selected users markets it canstill be relevant. For instance, the disposable income of the youth, the elderly,or chronically sick considerably varyies internationally. In addition, decreasing
income (e.g. pensions) can generate demand for substitution goods.
The third internationalisation mechanism is when the benefit of a design forusers in the country that initially preferred the other design increases relative tothe preferred design. The benefit can increase due to an international trend or theability of a country to influence other countries into adopting the same innovation
design. 5 Countries at the forefront of an international trend anticipate demand4

For a detailed account of the history of mobile cellular telephony see Beise (2001)
We do not consider the case in which technical improvements drive one design to become
the global dominant design. It is assumed that both designs are open to the same technicalimprovements that are realized when a design is adopted. Therefore, there are no disrup5

12

that will later spread worldwide. A lead market, therefore, has anticipatory buyer
needs (Porter 1990). It is also the main explanation of lead markets for Bartlett
and Ghoshal (1990, p. 243): ”Local innovation in such markets becomes usefulelsewhere as the environmental characteristics that stimulated such innovations
diffuse to other locations”. This points to an external trend, such as a global
demographic, social or environmental trend, but preferences in the lag market
can be directly influenced by the consumer choices of users in the lead market
as well. For instance, an adoption reduces uncertainty about the benefits of an
innovation design. The demonstration effect was long identified as an importantmechanism of diffusion (Mansfield 1968). Potential adopters in a lag country
observe the success of the innovation in the lead market, and this spurs adoptionof the same design in the lag country, even if the design is potentially not thebest for the lag market. Reputable first adopters of an innovation signalling thecredibility of a specific innovation design can further reduce the risk of adoption.
On the other hand, it could be argued as well that the preferences in a leadmarket are shaped by the environment in foreign markets, making the innovations
that are preferred in the lead market more appropriate for foreign markets. Local
market participants might want their innovations to be useful in foreign countries
as well because that would make their use cheaper. Users as well as competitors,
suppliers or banks could pressure local firms into developing innovations that canbe exported by incorporating features that enhance the product’s compatibility
with foreign environments. A country in which the market supports the exportorientation of local firms can, therefore, constitute a lead market as well because
the market increases the chances that local innovations are adopted in foreign
markets. Examples are the preference of Telecom Sweden to adopt equipmentthat can be exported, compared with the doggedness of the telecom operator
in Japan, NTT, to stick with idiosyncratic standards that hampered Japanese
exports in the telecommunication equipment sector. In contrast, in the 1970s theJapanese government supported the export chances of the Japanese automobile
industry when the US regulation for vehicle emissions was introduced a year
earlier in Japan than in the US (Beise, Rennings 2003).
Relaxing the assumption of the consumption model of perfect information onuser preferences leads to an additional argument for the internationalization ofnational innovation designs. Often, preferences are not perfectly known either because users are not aware of or do not effectively articulate their preferences. In
this situation companies test the market with alternative innovation designs. The
more alternatives offered the higher the likelihood of finding the technological design that is the most beneficial and the larger the variety of new applications of an
innovation. This implies that differences in the competitive climate in countries
can lead to different consumption patterns, even if the underlying preferences are
the same internationally. For instance, in a country with a monopolistic producer
or user, fewer alternative designs (or only one) are offered than in a country where
tive technologies (Christensen 1997) that become adopted in all countries because they justhappened to improve faster than the other design.

13

several companies compete. Competitive markets are, therefore, more likely to
discover latent needs and innovation designs that meet the preferences best. If
preferences vary from country country, the initial consumption pattern might notreflect the local preferences when too few alternatives are offered in the market inorder to determine the locally most beneficial design. Fierce competition in one
country may then lead to the discovery of an innovation design that is even more
beneficial for users in other countries than the best among the locally offereddesigns in those countries. A country with more local competitors or tougher
competition is therefore more likely to find a design that is the most beneficial
to both itself and many other countries as well. Local competition has alreadybeen suggested as enhancing international competitiveness; in the lead-lag market context presented here, national competitiveness is not directly caused by
the number of innovations generated in the country but by the more efficientrevelation of preferences in the country.
A fourth possible lead market explanation can be derived from the process
theory of internationalization. Johanson and Vahlne (1977) observed that after
an innovation has been successful in the home market most firms start the internationalization of the product by introducing it in those foreign markets thatare most similar to the home market in terms of preferences, per-capita income
and environmental context. Firms often find that they can introduce the same
product successfully in those markets with only minor adaptations. In general,
this means that the more similar the context of a country is to other countries,
the more it can export. In the two-country model presented above, none of thecountries would gain an advantage through trade to set the standard. If the sizeof the two countries is the same, both would export the same amount to eachother. However, adding another country shows that the similarity of each country to each other can effect national competitiveness. If the degree of similarity
between each pair of countries is different, then exports of each country would
be different as well. The country for which the sum of similarity to the othertwo countries is smaller would export more. For instance, assuming that only
one preference dimension such as product size is important for users, the country
were an average product size is preferred would export more than the countries
which prefer smaller or larger product sizes, since the trade between the countries
that prefer more extreme choices would be small. The country in the middle withthe highest exports would, therefore, gain advantages via global network effects
and economies-of-scale and, therefore, be better positioned to set an international
standard than the other two countries.
If we assume that the choice of a user for a product can be fully modelledwith n product attributes, reflecting the preferences and price situation, eachcountry’s preferred design can be positioned in an n-dimensional space and thesimilarity between the two countries’ choices can be quantified using a distancemeasure. The total weighted average distance of one country to all other countries
is negatively correlated with the exports of that country. There would be countries
with extreme design preferences and countries that lie in the middle between
extreme choices. Countries whose market choice lay in the average of all preferred14designs are thus expected to have the best export performance and, therefore, thehighest lead market advantage.
In this scenario, unlike the attributes of a lead market discussed above andunlike suggestions in the literature, demand in lead markets is not characterized
by extremes but by the average of product characteristics. The lead market is
not the country in which the highest quality, the smallest or the most features
are demanded. In contrast, extreme product requirements make a country an
idiosyncratic market in which products are adopted that are too expensive or”over-engineered” for other countries. Examples can be found in the investment
goods industry in which extreme local quality requirements sometimes hamper
exports. In Japan, consumers pay high prices for high-quality food products that
few outside Japan are willing to pay.
At least two of the country characteristics that have been deducted from thelead market model that increase international competitiveness of a country havebeen already suggested before: the size of a country and the degree of competition.
The lead market model adds several country attributes. Furthermore, the leadmarket and the common theories of international competitiveness lead to different
policy conclusions. In the next section, the policy implications of the lead market
model are discussed.

4

Lead Markets and Technology Policy

Traditionally, governments see their role in strengthening the stream of innovations generated in a country and in supporting a new technology to overcome theinitial impediments to commercialization. However, a new technology normallyhas to overcome two hurdles for international success. It has to become successful in one market context and, second, it has to overcome the differences among
countries. Often, governments focus on the first problem and in doing so worsen
the second problem. They intervene in the local market in order to make a specifictechnology more attractive, but by doing so widen the differences between thelocal market and all other countries’ market contexts. For instance, introducing
regulation or subsidies that favor the local adoption of a particular innovation
increases the local success of the innovation but at the same time makes the local
market more idiosyncratic. An idiosyncratic market is less likely to be followedby other countries, unless other countries introduce the same policy instruments.
6

While the former models of innovation and trade lead to the conclusion thatin order to improve the competitiveness of a country, the government should provide incentives for the generation of technology in general, the lead market model
6

Another lead market mechanism that has been omitted in this paper but that is relevant
for many innovations in regulated industries is international policy diffusion (see Kern et al.
2000, Beise et al. 2003). An innovation design becomes a global design if a policy instrumentthat has induced an innovation design in one country is adopted in other countries as well.
For instance, the catalytic converter became an international standard because the emission
standards have eventually been adopted in most other industrialized countries.

15

suggests that not all innovations enhance export performance. It distinguishes
innovations by their likelihood to be subsequently adopted in foreign countries.
Locally-induced innovations are more likely to be exported in considerable quantities in those industries or product lines in which a country has a high lead market
potential. In industries in which a country is a lag market, it is not only unlikelythat indigenous innovation designs can become successful internationally, it isalso possible that over time the indigenous innovation designs are squeezed out
by the design favored in the lead market. Incentives for indigenous innovations
can, therefore, have a negative effect on a country’s competitiveness. In a lag
market context the adoption of locally preferred innovation designs would locka country into an idiosyncratic technology and delay the adoption of a global
standard.
It would be, therefore, highly beneficial for a country to support not only thegeneration of scientific knowledge and inventions, but also its lead market role.
The lead market theory suggests that there are attributes that facilitate the leadmarket role and which could be strengthened. For instance, governmental policies
can strengthen local competition and the export orientation of the local market.
Export orientation can be strengthened by making information on foreign market preferences available, setting regulation that is similar to other countries’
regulations and a procurement policy that prefers technologies and innovations
that can be exported and avoids highly nation-specific designs. National legislation and regulation tend to focus on domestic needs and the local environmental
context. Often this policy does promote the adoption of technologies that fit
domestic context best regardless of the benefit for other countries. Porter (1990,
p. 645) stresses that government specifications ”should be set with an eye towhat will be valued in other advanced nations”. By actively anticipating therequirements for the context of foreign markets and including them in national
regulations and procurement, idiosyncratic country-specific innovations can be
avoided. For instance, state-owned firms and government agencies can demandthat firms develop exportable innovations instead of demanding innovations that
fit the national context best. Promoting the export orientation of domestic firms
can mean sponsoring a design that takes account of demand preferences abroad.
Global trends can also be utilized to support the lead market role of a country.
If a factor price or the price of a complementary good such as infrastructure ismarked by a global trend, a government can try to increase the domestic pricelevel of the factor or the complementary good by raising specific taxes (in the caseof an increasing trend) or decrease the price by lowering taxed or giving subsidies(decreasing trend) and therefore push a country to the forefront of the trend.
Governments, of course, always meant to create a lead market by supporting the generation and adoption of new technology. A traditional approach isto generate early demand through state-owned companies or direct subsidies forthe adoption of a specific innovation design. The aim is that a subsidized domestic market would initiate mass production and drive down the production costthrough economies-of-scale and scope. The reduced cost would then enable the
new technology to become internationally successful. This price reduction effect16

was indeed described as a lead market mechanism. However, there are several
problems with a strategy that solely aims at cost reductions and neglects theother lead market factors.
First of all, potential cost reductions are often too optimistic and not sufficient.
Examples of global innovation designs that have become successful because of
their low prices demonstrate that the price has to come down a long way before it
dominates in foreign markets. In recent cases of environmental technology such as
photovoltaic energy and the fuel cells, the cost reduction estimations have often
been exaggerated (Beise and Rennings 2004, Beise 2004). Governments often
target a particular industry or technology that is expected to have a high growthpotential but in which the country is a lag market.
Second, policy instruments favor specific designs that might not be applicablein other countries. The government as a user, however, has different preferences
and cannot simulate a market selection process. Often, the government selects
a technology on the basis of its own preferences such as high growth potential,
high employment effects. In contrast, information about the best design in amarket context is mainly embodied in a market interaction. This often meansthat the government is ”backing the wrong horse” (Cowan 1990). Third, foreign
governments might react negatively. Public subsidies aimed to stimulate exports
regularly ensue the negative reactions of foreign governments which then could
try to block the adoption of the technology in their countries.
An example for governmental intervention that went wrong is Minitel inFrance. Minitel is an information retrieval service that was tremendously successful in France (Kramer 1993). When the socialists came to power in 1980,
France adopted an even more interventionist industrial policy than before. They
nationalized the electronics and telecommunications industries and merged theminto a few large corporations. R&D expenditures rose and a new technology was
introduced and publicly subsidized to spur adoption. The General Telecommunication Agency (DGT) sought new forms of communication and new products.
Possible offspring from the marriage between telecommunications and computing like teletex, electronic mail, pay-TV, telepayment, and home banking were
supposed to be pursued and adopted early in France. It was thought that thetechnological advances in France would make it possible to export French technology. Minitel was one of the technologies implemented by French governmental
agencies where the adoption was highly subsidized. Yet, corresponding systems
in other European countries (like BTX in Germany) were not successful either.
Instead the Internet, an open non-proprietary technology, became the globallydominant design for information systems. Minitel’s early lead even turned out tobe a disadvantage for France because for a long time the adoption of the Internet
was very slow in France (DTI 1999, p. 28). As late as 1997 France only had
4 Internet hosts per thousand inhabitants compared to an OECD average of 15
and the figure was much lower than in most industrialized countries (OECD 1997,
p. 58). In the competition between different designs, the Minitel system architecture reflects the French market situation of a state-owned telecom provider
that sets up and controls a data network, while the Internet reflects the principle
17

Figure 5: Competition between Minitel and the Internet
500

User per 1000 people
Internetin the USA

400

Internet inGerm any

300

200

100

Internet inFranceMinitel inFrance0
83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00

Source: ITU, Berne (1996), own estimationsof interconnection of different networks without a controlling center. The Internet architecture proved to be more complementary for global adoption. The US
was the lead market in that it provided the highest incentives for users in othercountries to adopt it.
A lag market role of a country, however, does not always mean that the country cannot be competitive at all. The lead market model only suggests that thetechnological design that is preferred locally is not internationally competitive.
Yet, a lag market can gain a competitive advantage if it deliberately abandons
its preferences and follows a lead market quickly in adopting the innovation design favored in the lead market. Lag market firms can often transfer and use
technology from the lead market, monitor the dynamics in the lead market andand participate in learning processes in the lead market and ultimately imitate
the lead market design. Japanese companies have often adopted a fast-follower
strategy when the local market has willingly accepted the lead market role offoreign countries. Anticipating the local market disadvantage, they have built up
the capability to quickly adopt the technology choice of large western markets
and to focus their technical skills instead on superior production technology andservice in order to gain a competitive advantage over the lead market firms. For
instance, while most product innovations in the automobile industry emerge fromthe European and the US market context, Toyota has developed a legendary superior production system that is until today unmatched by competitors (Womack1990).
In industries in which the country is a lag market, a fast follower strategy can
18be more appropriate than a policy that aims at creating a lead market context.
This, however, requires that the market participants not insist on the technical specifications that would be ideal for the local market context but that areidiosyncratic in an international context. Technology policy can support a lag
market by helping the country’s users and manufacturers to swiftly follow thelead market and by lowering the responsiveness of local firms to the local idiosyncratic demand. Governmental policies, regulation and procurement could
strengthen the orientation of local firms on the lead market. National technology policy can encourage cooperation between domestic firms and firms in thelead market. Regulation and public procurement should be open to or even bebiased towards technological designs popular in the lead market. An example forthis strategy is the Japanese telecom operator NTT. After the Japanese mobile
telephone standards failed to be successful outside Japan, the Japanese operator
participated in the development of the 3rd generation mobile system in Europe
and was the first to introduce the new joint standard in the Japanese market.
This gave local mobile phone manufacturers a head start in commercializing theappropriate network technology and mobile phones.
The lead market model suggests that technology policy can be differentiatedaccording to a lead and lag market role of the country. Taking the limitation tocreate lead markets into account, a government could try to identify industries
in which a country has already lead market advantages and shift public researchfunds to research programmes that support innovations in these industries. In
lag market industries, instruments are more appropriate that support the fast
following of a lead market.

5

Conclusions

It is suggested here that an important determinant of the specialization patternof an industrialized country is the lead-lag market characteristic of each industry
of a country. Countries are specialized in industries in which the domestic market
context constitutes a lead market role. Countries are less specialized in industries
in which the country has lag or follower market characteristics. Although not allindustries are characterized by a lead-lag market pattern, a lead-lag environment
has a high impact on specialization, trade and growth because countries can gain
dominance in a particular product line. Cellular phones had a tremendous impact
on the specialization pattern of Finland, as had computers on that of the US andautomobiles on Germany’s pattern.
The lead market role ensues an international competitive advantage for anation because domestic firms can gain a productivity and market intelligencelead over firms in other countries for internationally successful innovations. A
lead market gives domestic firms a head start in terms of learning, economies-ofscale, quality improvements, setting up distribution systems, access to supplies,
brand loyalty and international reputation, product line differentiation and longterm market share (Robinson, Fornell 1985) for a particular innovation design.
19

Lead markets ”catalyze” (Porter 1990, p. 614) the international success of adomestic firm’s innovation activities.
Lead markets demand innovations that subsequently become the preferredchoice of foreign markets as well. Yet, the lead market characteristics discussed
in this article only enhance the likelihood of an international success of a domestically successful innovation. They do not necessarily increase the domestic
success of innovations. It might not be easier for firms in the lead market tocommercialize innovations. But once they have tapped the local market with aninnovation success, export activities are easier than for firms in countries with amore idiosyncratic taste for innovations.
An idiosyncratic market is a disadvantage for domestic firms since the local
market demands innovation designs that cannot be easily exported. Over time local innovations risk being squeezed out of their home market by foreign innovation
designs. Lead markets are therefore associated with exports while lag markets
induce imports. As a result, the lead-lag characteristics of local markets have
implications for growth. It can be expected that the overall growth of a country
depends on the lead-lag market structure of its economy. A country’s growthdepends on the growth of industries and the lead-lag market role of the domestic market in these industries. A country has formidable growth perspectives if
it has lead market characteristics in fast-growing industries, whereas leading instagnant or shrinking industries makes a dent in domestic growth. On the other
hand it is also possible that the lead market role of a country increases the global
growth of an industry. Thus, growth is endogenous. Lead markets often open amass market in industries where only a niche market has been expected before.
A mass market can be enabled by low prices or technical specifications or new
applications of a technology. For instance, until the 1990s mobile telephony wasseen as technology limited to a small group of users. In the Nordic countries, however, a broader market was sensed, targeted and made possible by lowering theprices and enhancing the technology to accommodate more users (Beise 2001).
In Japan, the use of facsimile machines was widened by the public endorsementof faxed official documents.
It can be observed that lead markets are rather persistent over a long time. It
could be argued, though, that while the lead market role is lasting, the competitiveness that emerges from the lead market role ends when production is moved
abroad to countries that offer better factor conditions. It is true that cellular
phones, personal computers and digital cameras are increasingly produced in low
cost countries outside the respective lead markets. However, the industry leaders
such as Dell, Nokia and Canon still employ a large workforce at their home countries. While production can often be outsourced to specialized manufacturers, thelead market role of a country requires a firm to keep the marketing, engineeringand management functions in the lead market.
It is therefore of vital interest for countries to identify their lead and lag roles
within the industry structure. In lead market industries, research and development to generate indigenous technologies are expected to increase exports whilein idiosyncratic lag markets, local firms should refrain from responding too much20

to the local market and seek to follow the lead market abroad.

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