When do markets choose innovative entrepreneurship over technology transfer to incumbents? To address the Question of Creative Destruction, this chapter and Chapters 6, 7, and 8 consider a strategic innovation game with endogenous entrepreneurship. An inventor and an existing firm choose between cooperation and competition. When the inventor and the existing firm cooperate, the inventor transfers technology to the existing firm. When the inventor and the existing firm choose competition, the inventor becomes an entrepreneur and establishes a firm that competes with the existing firm. The strategic innovation game illustrates the trade-offs between entrepreneurship and technology transfer.

Creative destruction is an efficient form of innovation if there are net benefits from entry and growth of new firms and displacement of existing firms. Creative destruction can be inefficient if there are greater benefits from growing and restructuring existing firms than from establishing new firms. Entrepreneurs innovate by establishing new firms that embody new products, manufacturing processes, transaction patterns, and business methods. Existing firms can innovate by commercializing products and processes developed through their internal R&D laboratories and collaboration with R&D partners. Existing firms also can innovate by acquiring or licensing new technologies from independent inventors and other firms and by acquiring start-ups. This chapter shows that transaction costs and imperfect protections for IP rights generate market frictions that favor creative destruction over cooperation.