The Nature of Innovation - Essay Example

INNOVATION There is a saying that all things change except change itself. Innovations are the products of human endeavour and ingenuity, ever since the invention of the wheel. It is innate in humans to seek new and better goods, processes, or aggrupations that benefit our existence and make our lives better. This paper is a discussion on innovation, and focuses on one innovation that has changed the way we live – the credit card. 1.0 Academic Literature Review 1.1 The Nature of Innovation Innovation is described as “the quintessential feature of commercial, political, economic, and business development” (Courvisanos, 2009, p. 1117). The social obsession with innovation began in the mid-20th century when systematic innovation as business activity was established as one aspect of industrial policy. The regulations on the issuance of patent rights, government procurement, research and development, established innovation as a continuous organized activity of business rather than a random foray into intermittent flashes of creativity. Today, it is more than an industrial undertaking; it is, rather, a priority in national, and international, economic development. Probably the first cogent definition of innovation is that advanced by Schumpeter (1938, pp. 63-66) as falling into one of five forms, namely: (1) product innovation, or new products from the viewpoint of consumers; (2) process innovation, involving either new methods of production or new ways of managing the distribution and flow of commodities; (3) new markets opened up; (4) new sources of raw materials or intermediate goods; and (5) new organisation of an industry’s competitive structure. According to Schumpeter, these five forms all involve the transformation process attendant to innovation because they lead to “creative destruction” - that is, old forms are destroyed and new ones emerge to take their place. Other authors tend to categorize differently although generally along the same lines; for instance, the more recent study of Frame and White (2004) classifies innovation into four categories: new products, new services, new processes, and new organizational forms. 1.2 Technology and Financial Innovation: The Credit Card Of special interest in this discussion is that interface between technological and financial innovation, and how the product of this fusion is used in the advancement of economic activity. While the term technological innovation has been so common understood as to be almost a redundancy, the concept of “financial innovation” is still unfamiliar to many and nebulous to many more. The term’s import could be deduced from the primary function of finance, which is the facilitation of the “allocation and deployment of economic resources in an uncertain environment” (Merton, 1992 as cited in Frame & White, 2004, p.117). It encompasses the establishment of a payment system wherein resources are transferred from savers to users of the resources, through borrowings or investment. Financial innovation is thus the creation of new products, services, processes or organizational structures that tend to advance the transfer of funds from savers to users. 1.3 History of Credit Money In this area, there is hardly any development that has surpassed the creation and proliferation of the credit card as an instrument for advancing commerce and business through provision of fast and easy credit for the consumer. Thomas, Oliver and Hand (2005) traced the need for consumer credit to the 1920s, when Henry Ford, pioneer in automated mass production, and AP Sloan recognized that speedy and efficient creation of goods and services was pointless if consumers did not possess the facility to finance their purchases. Their efforts to expand the automotive market led to the development of finance houses such as GE Capital and GM Finance. By the 1960s, the credit card became a generally accepted means of payment, and consumers found a greater facility in financing their credit purchases from groceries to holiday trips. During that early time, sliders and carbon paper were used to record credit card information at the point of sale, but this proved wieldy and prone to credit card fraud. It was not long before the sliders were replaced with the magnetic strip, and in recent years the use of smart cards and embedded chips on the card may eventually spell the demise of the magnetic strip (Thom, 2006). The use of credit (and debit) cards replaced in large part cash and check payments, and has greatly influenced the development of money transmission mechanisms other than just payment (Humphrey, 2004). A good example is transactions via the internet, where credit card usage dominates. 1.4 Socio-economic Impact of the Credit Card There is a branch of study on the credit (or payment) card phenomenon that had to do with consumer psychology and behaviour, in effect having repercussions on those who are excluded as well as those who are able to avail of the service (Simpson & Buckland, 2009; Montgomerie, 2006). In an early study, the relationship between utility maximization and rational evaluation of available credit card alternatives provided the framework by which card user behaviour was determined and empirically described. Kara, Kaynak & Kucukemiroglu (1996) used multiple factors pertaining to the users (social, psychological, legal and economic factors) and product-service attributes. The study came up with four dimensions of credit card attitude. First, the credit card prone, believe that the credit card is a highly effective tool necessary in modern society. The second, the credit card aversive, include those that believe that shopping with credit cards is an incorrect approach and a bad habit. The third, the outer-directed attitude, pertain to those people who use the credit card as a status symbol, for prestigious reasons. Finally, the felt-involved attitude, describe individuals who are careful spenders and make sure to pay the amount in full at the end of the grace period in order to avoid the finance charges imposed by the issuer. This last segment use a very limited number of cards (one or two at most), and the only reason that prompts them to use their card is for security purposes. These factor patterns provide a useful framework for businesses and financial institutions that issue cards to formulate their policies by. Along this same vein, Brito and Hartley (1995) observed that customers were engaging in irrational behaviour by borrowing on credit cards that had, admittedly, higher interest rates than other forms of debt, such as bank loans. This appears to defy the theory of consumer behaviour, that consumers (in this case, borrowers) will seek the alternative with the lowest cost (interest rates). The study shows, however, that individuals consciously choose to pay credit cards’ higher interest rates, because these consumers not only aim to provide for transaction costs which are uncertain, but also because the credit card allows them the opportunity to smooth a deterministic income or consumption stream, such as to make a series of smaller, regular payments than one large outlay. For instance, credit cards are often used to tide the consumer over intermittent periods of high expenditure, like vacations and Christmases. Brito and Hartley’s findings run counter to those of Ausubel (1990, p.50) that consumers fail to anticipate that there is a high probability they would be paying interest on their card balances. On the other hand, Brady (2008) approaches the question of consumption smoothing from the point of view of structural change in consumer credit. His results tended to confirm Brito and Hartley’s findings, that consumption smoothing is evident in data from the mid-1980s until well into the 21st century for which data is available. He concludes that this bears directly on the effectiveness of monetary and fiscal policy, and the decline in macroeconomic volatility (i.e., stabilization in the markets) in the 1980s. 1.5 Dynamics of relationship among consumers, merchants, and card issuers Credit card usage has redefined modern economic exchange because of the various economic incentives made available to all parties involved for the adoption of electronic payments schemes; for businesses, this is necessary in order to keep up with the competition (Choudhary & Tyagi, 2009). There comes a point, however, where increase in credit card use tends to be disadvantageous for all concerned. (Berlin & Mester, 2004; Ayadi, 1997). In general, credit card use tends to increase sales because it increases credit-worthy but liquidity-constrained consumers’ ability to purchase, and all else being equal, merchants would rather close a sale today than tomorrow. This has interesting consequences for the consumer, the merchants and the credit card companies. In the case where card issuers make credit available more widely and to more people, merchants tend to increase sales to illiquid customers, which in turn increases the chances of default by consumers (Chakravorti & To, 2007). The usage of credit cards is, to be sure, a love-hate relationship. The shopper enjoys the utility of not having to carry cash around and to have the buying power to purchase merchandise that would have been out of reach. Unfortunately, bills payment and claims exchanged among issuer, merchant and cardholder are not pleasant experiences. Issacharoff and Delaney (2006) deliver a commentary on the perils of credit card availment, focusing attention on practices that, while legal, exacerbate effects of card indebtedness and the frustration faced by consumers entangled in disadvantageous card deals. Their study, however, found that while initially new cardholders enticed by easily accessible credit are vulnerable to the resultant high compounding interest rates and finance charges, should they successfully avoid default, would turn into seasoned consumers whose past unpleasant experience ensures a repeat of the error. Cardholders who understand the workings of the system will be able to use it to their advantage. Thos who find themselves at the losing end of cost misestimations and accumulation of late fees may chalk it up to experience, but if the claims reach unconscionable levels, the legal systems of most countries afford some form of redress where the card issuer can be made accountable for an abuse of contractual formalism. 2.0 Report on the Innovation Case Study of Choice 2.1 Innovations in the Credit Card 2.1.1 Technological Innovations The credit card is, as mentioned earlier, both a technological and financial innovation, both being instrumental in instituting social change (Linstone, 2009). The constant research and development in conventional and smart card technology has made possible advances in card design that enhance consumers’ use of credit and debit cards. One such innovation that occurred a while back and which is now standard in most systems is the use of the smart card, which Amex adopted in 1999 with the launching of its Blue Card, in order to improve its service quality in attending to the needs of customers. Amex was prompted to take this strategic step to capture the competitive advantage over its competitors, particularly in the integration of internet access and payment. (Wonglimpiyarat, 2004). A new card with in-built display is currently being tried by Visa in its European market (Visa, Card Technology Today 2008). The new technology is ISO-compliant, and is able to generate a one-time code and display it via a built-in alphanumeric display. Likewise, MasterCard is designing a system that will work on PINs instead of a static (and theft-prone) password, for purposes of online purchases. The PIN is a four-digit number associated with the particular card. If the PIN is correctly entered, the card generates an eight-digit number (the SecureCode) which is unique to the type of transaction and may not be used any further. The customer will be able to verify the number on the display, and use this as a control for verifying transaction integrity. This innovation comes ahead of MasterCard’s advanced authentication for chip that negates the need to reissue cards. This latter innovation is made available in markets that do not support PIN verification (MasterCard, Card Technology Today, 2008). 2.1.2 Concerns and Disadvantages While there are many advantages associated with the innovations of the use of the credit card, which are incorporated in the preceding discussion, There are certain and disadvantages associated with credit cards. Aside from the obvious fact that certain inexperienced and ill-informed users may suffer large interest and service charges, there are disadvantages to the use of the card itself because of its technology. A recent study by Markantonakis, Tunstall, Hancke, Askoxylakis and Mayes (2009) explored the various methods by which smart card systems, despite their higher level security capabilities, could be attacked. This is attributable to the tenacity of hackers and researchers who constantly test the new systems for equally new issues and vulnerabilities. Aside from technical sources of security breaches, there are systemic weakness that deal with the failures of legislative frameworks to address the security issue. An earlier study by Epstein and Brown (2008) concerning cyber security and the payment card industry, scored the weaknesses in the legal system to overcome the political pressures and regulatory glitches that bear on the electronic payment industry mentioned at the beginning of this paper. The reason for weaknesses in statutory regulation is the fact that at its core, the use of the payment card rests on voluntary decisions by consumers, merchants, and the banks or financial institutions with which they interact, and regulation of these relationships may be interpreted as government intervention. Other than technical and institutional concerns about the use of credit cards, Szmigin and Foxall (1998) examined those concerns that have to do with personal resistance to the electronic payment methods. The non-acceptance of innovations is, after all, not confined to the use of credit cards, but to all types of innovations. Generally, the resistance to change is attributed to the failure of so-called “laggards” to keep abreast of change. Laggards, in this sense, are persons who prefer the safety of the status quo to the uncertainties of change. There are three varieties of innovation resistance associated to new payment schemes: rejection, postponement, and opposition. The study of Szmigin and Foxall suggest that resistance in these modern times no longer should be regarded as a potentially negative factor of target markets for innovative products and services, but rather is a response based on rational choices. When management exerts efforts to try and understand the reasons for this resistance, it provides insight into the internal processes of product design and development. 3.0 Discussion and Reflection The credit card is, in itself, a means by which modern life has dramatically evolved. Once, men have exchanged real value for real value in the form of gold or silver coins, and later in legal tender, the former on the basis of its intrinsic value, the latter because sovereign law has declared it so. Now people are able to transact on the basis of an IOU, a promise to pay at some future date. Tust in the system and the the institutional frameworks have enabled goods and services to move faster, funds transfer more efficiently, more people have jobs and the benefits of modern conveniences and facilities that are a subject of such transactions. The technological innovations cited in the preceding section are, like the card itself, man’s response to the evolving social and economic milieu he finds himself in. As the literature review has shown history to point out, efficiencies that have brought down the costs in production have made it necessary for goods to be moved more quickly to the market and sold as soon as possible among people whose lives would be improved by them. Finance thus became a critical consideration; but people’s incomes are variable, and a manger of smoothing must be undertaken to as to ensure a constant and reliable demand. Thus the invention of the credit card. Now too, with the advent of internet transactions and online movement of goods and services, the credit card with enhanced cyber security features enable our economic systems to continue to develop and evolve. The credit card, however, also presents the opportunity for malice and unlawful personal interests, because of which constant problems emerge. As a technical device backed by a technological system, the credit card is prone to attacks by persons who possess specialized knowledge in electronic hardware and software and who consider it a challenge to their talents to break the system, usually with the intention of obtaining a windfall. The weaknesses are not only in the technology, but also the institutions that make up our social structure. Inadequacy of laws and regulations are pitted against the need for governments not to be seen interfering in what are international financial arrangements. Lastly, the relationships and common acquiescence among consumers, merchants, and card issuers define the parameters by which continued innovation in electronic payment systems may be undertaken. As seen in the literature review, consumers behave differently and regard credit cards with differing attitudes and behaviours. Likewise too, the markets react differently to the massive and widespread adoption of card systems, maintaining a strength and robustness with its proper use, but, as the present crisis has shown, becoming risky and untenuous with the abuse or misuse of credit. 4.0 Conclusion In the end, the credit card as an innovative tool has become an important element in the way modern economies function, and societies conduct their lives. The use of credit for the past 40 years has also shown how individuals have matured and gained sophistication in their attitudes towards finance. Where once regarded as a stigma, personal debt is now thought of as a tool: for conducting business, for managing personal finances, and even for showing off one’s standing (for as the reason goes, only a person who is creditworthy is extended any credit). The credit card is an invention of our commercial systems, not created by laws nor having intrinsic value of its own. It is thus an indicator of how far our global community has come, that persons from across the world could transact with each other on the basis of a number and a promise, and be fully confident of finding satisfaction in their obligations. The importance of the credit card can be summarized in this wise: if tomorrow the credit card system were to be abolished, would economies continue to function as efficiently as they do today, with all the attendant benefits to the members of society? Not very likely. References Ausubel, L M 1991 The Failure of Competition in the Credit Card Market. A.E.R. 81, March, pp. 50-81. Ayadi, O F 1997 Adverse selection, search costs and sticky credit card rates. Financial Services Review, Volume 6, Issue 1, 1997, Pages 53-67 Berlin, M & Mester, L J 2004 Credit card rates and consumer search. Review of Financial Economics, vol. 13, pp. 179-198 Brady, R R 2008 Structural breaks and consumer credit: Is consumption smoothing finally a reality? Journal of Macroeconomics, vol. 30, pp. 1246-1268 Brito, D L & Hartley, P R 1995 Consumer Rationality and Credit Cards. The Journal of Political Economy, vol. 103, no. 2, April, pp. 400-433 Calem, P S; Gordy, M B; & Mester, L J 2006 Switching costs and adverse selection in the market for credit cards: New evidence. Journal of Banking and Finance, vol. 30, pp. 1653-1685 Chakravorti, S & To, T 2007 A theory of credit cards. International Journal of Industrial Organization, vol. 25, pp. 583-595 Choudhary, V & Tyagi, R K 2009 Economic incentives to adopt electronic payment schemes under competition. Decision Support Systems, vol. 46, pp. 552-561 Courvisanos, J 2009 Political aspects of innovation. Research Policy, vol. 38, pp. 1117-1124 Epstein, R A & Brown, T P 2008 Cybersecurity in the Payment Card Industry. The University of Chicago Law Review, vol. 75, no. 1, pp. 203-223 Evans, J W 2008 Challenging Confucius: Western banks in the Chinese credit card market. Business Horizons, vol. 51, pp. 519-527 Frame W S & White, L J 2004 Empirical Studies of Financial Innovation: Lots of Talk, Little Action? Journal of Economic Literature, vol. 42 no. 1, March, pp. 116-144 Grablowsky, B 1975 An environmental model of risk in consumer credit. Journal of Behavioral Economics, Volume 4, Issue 1, Summer 1975, Pages 107-144 Humphrey, D B 2004 Replacement of cash by cards in US consumer payments. Journal of Economics and Business, vol. 56, pp. 211-225 Issacharoff, S & Delaney, E F 2006 Credit Card Accountability. The University of Chicago Law Review, vol. 73, no. 1, Symposium: Homo Economicus, Homo Myopicus, and the Law and Economics of Consumer Choice, pp. 157-182 Jeacle, I & Walsh, E J 2002 From moral evaluation to rationalization: accounting and the shifting technologies of credit. Accounting, Organizations and Society, vol. 27, pp. 737 – 761 JCB announces contactless credit card. Card Technology Today, May 2004, p. 6 Kara, A; Kaynak, E; & Kucukemiroglu, O 1996 An Empirical Investigation of US Credit Card Users: Card Choice and Usage Behavior. International Business Review, vol. 5, no. 2, pp. 209-230 Kuckertz, A 2006 Book Review: Jarunee Wonglimpiyarat, Strategies of Competition in the Bank Card Business, Innovation Management in a Complex Economic Environment. Technovation, vol. 26, p. 820 Linstone, H A 2009 A 21st century crisis: Relearning some systems lessons. Technological Forecasting and Social Change, doi:10.1016/j.techfore.2009.07.005 Madan M S & Reid, M A 1992 Data processing aspects of the integrated circuit and magnetic stripe cards. Information & Management, vol. 22, pp. 41-52 Markantonakis, K; Tunstall, M; Hancke, G; Askoxylakis, I; & Mayes, K 2009 Attacking smart card systems: Theory and practice. Information Security Technical Report, vol. 14, pp 46-56 Markose, S M & Loke, Y J 2003 Network Effects on Cash-Card Substitution in Transactions and Low Interest Rate Regimes. The Economic Journal, vol. 113, no. 487, April, pp. 456-476 MasterCard launches advanced authentication for chip – negates the need to reissue cards. Card Technology Today, November/December 2008, p. 5 M’Chirgui, Z 2006 Oligopolistic competition and concentration in the smart card industry. Telematics and Informatics, vol. 23, pp. 227-252 M’Chirgui, Z 2009 Dynamics of R&D networked relationships and mergers and acquisitions in the smart card field. Research Policy vol. 38 pp. 1453-1467 Montgomerie, J 2006 Giving Credit where it's Due: Public Policy and Household Debt in the United States, the United Kingdom and Canada. Policy and Society, Volume 25, Issue 3, 2006, Pages 109-141 M’Raihi, D & Yung, M 2001 E-commerce applications of smart cards. Computer Networks, vol. 36, pp. 453-472 Pennings, J M & Harianto, F 1992 Technological Networking and Innovation Implementation. Organization Science, vol. 3, no. 3, Focused Issue: Management of Technology, August, pp. 356-382 Paisittanand, S & Olson, D L 2006 A simulation study of IT outsourcing in the credit card business. European Journal of Operational Research, vol. 175, pp. 1248-1261. Roberts, P W & Amit, R 2003 The Dynamics of Innovative Activity and Competitive Advantage: The Case of Australian Retail Banking, 1981-1995. Organization Science, vol. 14, no. 2, March-April, pp. 107-122 Schumpeter, J A 1939 Business Cycles: A Theoretical, Historical and Statistical Analysis of the Capitalist Process, vols. I & II. McGraw-Hill, New York. Simpson, W & Buckland, J 2009 Examining evidence of financial and credit exclusion in Canada from 1999 to 2005. The Journal of Socio-Economics, vol. 38, pp. 966-976. Stango, V 2003 Strategic Responses to Regulatory Threat in the Credit Card Market. Journal of Law and Economics, vol. 46, no. 2, pp. 427-452 Szmigin, I & Foxall, G 1998 Three forms of innovation resistance: the case of retail payment methods. Technovation, vol. 18, issue 6/7, pp. 459-468 Thom, C 2006 Change is always in the cards. Card Technology Today, Volume 18, Issues 11-12, November-December 2006, Page 10 Thomas, L C; Oliver, R W & Hand, D J. 2005 A Survey of the Issues in Consumer Credit Modelling Research. The Journal of the Operational Research Society, vol. 56, no. 9, Sept., pp. 1006-1015 Truman, G E; Sandoe, K; & Rifkin, T 2003 An empirical study of smart card technology. Information & Management, vol. 40, pp. 591-606 Visa announces trials of card with in-built display. Card Technology Today, vol. 20, issues 11-12, November/December 2008, pp. 5-6 Wonglimpiyarat, J 2004 Amex’s strategies for launching the smart card innovation. Technovation, vol. 24, pp. 773-777 Wonglimpiyarat, J (a) 2005 Does complexity affect the speed of innovation? Technovation, vol. 25 pp. 865-882 Wonglimpiyarat, J (b) 2005 Standard competition: Is collaborative strategy necessary in shaping the smart card market? Technological Forecasting and Social Change, vol. 72, pp. 1001-1010 Read More