Innovation Economics and Endogenous Growth Theory: How SaaS Clusters Drive Knowledge Spillovers and Productivity Gains

Over the past few decades, the software-as-a-service (SaaS) model has gone from being an obscure concept to a global phenomenon. At the heart of this phenomenon is the economic principle of endogenous growth theory which states that over the long run economic growth is primarily caused by investment in human capital, innovation and knowledge generated within the economy itself. Endogenous growth theory is evident in dense innovation stimulating ecosystems where SaaS development companies are headquartered and operated.

These clusters, such as Silicon Valley in California, Berlin’s Silicon Allee and Tel Aviv’s tech corridor, are informal settings for knowledge spillovers where ideas, skills and technologies are transferred from one firm to another often unnoticed. This continuous transfer will increase experimentation and innovation and decrease the marginal cost of experimentation. In software ecosystems knowledge is non-rivalrous: once a piece of code, user interface idea or integration technique has been developed it can be copied, integrated and iterated upon without depletion of the original value. In essence knowledge acts like a public good, a major tenet of innovation economics.

Take for example Langate enterprise software development: a custom software and SaaS platform provider. (Langate’s success is dependent on an innovation ecosystem; open-source libraries, cloud services and community knowledge and practices to speed up their product development cycles. There are hundreds of thousands of developers writing code and contributing to projects such as Node.js, React and Kubernetes as a community. These projects are iterated upon by the community to refine the tools used to build modern day SaaS platforms. Langate—and its customers—benefit from the spillovers of the external innovation without making the investment into research and development.)

Why is this happening?

There are many economic drivers at play:

·       Decreasing marginal cost of software: After building a software product the incremental cost of coordinating distribution to new users is near zero, which drives very rapid growth and the reinvestment of profits into R&D.

·       Modularity and API driven design: Most current SaaS does not consist of monolithic code bases that one company conceives and executes upon. Instead SaaS is composed of interoperable modules and cloud based services, enabling decentralized innovation where multiple companies work on separate pieces of an entire ecosystem and benefit from the improvements and innovations of their peers.

·       Labor mobility and digital collaboration tools: Developers are mobile, they change companies more often than other professions, therefore much knowledge is transferred to new companies when developers change jobs. Collaboration tools like GitHub and Stack Overflow allow fresh best practices and new ideas to be shared across company boundaries.

·       Open-source development and adoption: GitHub’s Octoverse Report states that in 2023 there were over 94 million developers contributing to open-source projects. Many commercial SaaS projects — from Stripe to Shopify — are built on top of open-source projects and similar systems. When private development is combined with open-source collaboration the opportunities for innovation become virtuous.

This allows for faster product development, lower barriers to entry to start companies and better tools for all companies, regardless of size. Small startups can now use enterprise grade technology through SaaS platforms without needing big IT departments. This is democratization of innovation.

The implications are exciting and maybe scary. Customers get exogenous innovation at lower quality and price, but the positive network effects that generate knowledge spillovers can also lead to winner takes most dynamics. By having more users, more data and more influence, established platforms like Salesforce or AWS make it harder for small competitors to build momentum for their offerings even though the system is theoretically open.

But I see the SaaS boom as an endorsement of endogenous growth theory from an academic perspective. Innovation is no longer in an R&D lab or ivory tower; it’s in code repos, developer forums and API docs. Langate enterprise software development is an example of how when companies use global knowledge networks the whole economy moves at a different pace.

The new economics of innovation continues to shape how we build, share and grow in today’s digital knowledge economy where knowledge is no longer power alone but a scalable infrastructure.