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strategy and business
 / First Quarter 1997 / Issue 6(originally published by Booz & Company)


An Interview with Paul M. Romer

S&B: So how do you price knowledge? What is the model?

Paul Romer: There is nothing so far that is perfectly neat and clean. My guess, however, is that the answer lies between the two extremes of the market system and the tax-and-subsidy system. My guess is that we're going to start to find much richer institutional arrangements to control the flow of information.

For example, firms are doing things like making people in the R.&D. units go out and spend time with the divisions, just so that they communicate more closely with people in the divisions. Firms are even making R.&D. people go out on sales calls to talk to the customers, to see what they are
really interested in.

This is one way to get people in the R.&D. unit focused on their markets, their market opportunities and their final customers. It's a weak, but apparently effective, way to impose a kind of market discipline on what the researchers do.

But it is an institutional arrangement, not an explicit price system. Firms could eventually augment an institutional arrangement like this with things like promotion and compensation systems, which reward being attentive to customers, as opposed to more traditional systems, which just give rewards for the number of scholarly publications, or the number of patents, whether they are useful or not. So what I expect is that there will be a lot more experimentation with arrangements that are neither pure market systems nor pure tax-and-subsidy systems.

S&B: Another model is to view the R.&D. department as the center of the firm and the rest of the company as the channel for getting the discoveries of the R.&D. department to market.

Paul Romer: Imbedded in your question is what people call the linear model of science and discovery. It was one in which the people in the research lab said, "Look, the whole game is to create knowledge. That's where value comes from. We're the center of that process. We're going to create the knowledge. Once we've created that knowledge, we'll give it to you, so you can market it and make a profit for us."

In practice, that turned out to be a very bad way to structure corporations and a very bad way to think about economic activity. The problem is that it is not well guided. There are many different kinds of knowledge that researchers can produce. Some of these will be more valuable than others, and researchers may not be in the best position to tell which ones are the most valuable ones. So what's happened is that we've kind of turned this process around.

The new perspective says, "Look, the most valuable things we could do will be things we learn about from the problems we are facing in the field." In terms of information flows, that means it goes from the customer to the operating people to the R.&D. people.

The point I am making is that the problem-solving agenda should not be determined by the R.&D. unit, but by somebody else. So even though we now recognize that knowledge creation is really central to the business process, we don't think of it as being a kind of pyramid model, where the R.&D. unit is at the top and everybody else is kind of subservient to it.

It is very important to realize that the immense potential for new discovery brings with it an even more immense potential for wasted effort. Discovery is therefore associated with really hard choices. For example, what's the set of all possible software programs that could be written? If you just do a simple mathematical calculation about how many bit strings could fit on a CD-ROM, it is an unbelievably large number, far larger than the total number of particles in the universe. It's larger than any physical quantity that we can understand. Most of these possible bit strings would be useless junk. A few of them will be the "killer apps" of the future.

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