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

Over recent decades, the software-as-a-service (SaaS) model has transitioned from an esoteric concept to a global economic phenomenon. At the heart of this phenomenon is the economic principle of endogenous growth theory that stipulates that, over the long run, economic growth is primarily caused by investment in human capital, innovation and knowledge, all generated in the economy itself. Endogenous growth theory is evident in dense, innovation-stimulating ecosystems in which SaaS development firms are headquartered and operated.

These clusters, such as Silicon Valley in California, Berlin's Silicon Allee and Tel Aviv's tech corridor, are informal setting to knowledge spillovers, which enable ideas, skills and technologies to transfer from one firm to other firms often unnoticed. This continuous transfer will enhance experimentation and innovation simultaneously decreasing the marginal cost of experimentation. In software ecosystems, knowledge is nonrivalrous: once a piece of code, user interface idea, or integration technique has been developed it can be copied, integrated and iterated on 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 on 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 the research and development.)

Why is this phenomenon occurring?

There are many economic drivers at play:

• Decreasing marginal costs 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, often changing companies far more than other professions, therefore much knowledge is transferred to new companies when developers change jobs. Collaboration tools such as GitHub and Stack Overflow allow for fresh best-practices and novel ideas to be rapidly shared across organizational 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 — leverage open-source projects and similar systems. When private development is coupled with open-source collaboration, the opportunities for innovation become virtuous.

This economic setting allows for more rapid development of products, lower entry barriers to start companies, and better quality of tools available to all companies, regardless of size. Small startups can now use enterprise-grade technology through SaaS platforms while not needing large IT departments. This democratizes innovation.

The implications are exciting and maybe also frightening. While customers obtain an exogenous innovation at lower quality and prices, the positive network effects that generate knowledge spillovers can also lead to winner takes most dynamics. By accumulating more users, more data, and more influence, established platforms like Salesforce or AWS make it more complicated for small competitors to build momentum for their offerings despite the theoretical openness of the system.

However, I view the SaaS boom as endorsement of endogenous growth theory from an academic perspective. Innovation is no longer off in an R&D lab or ivory tower; it is now in code repos, developer forums and API docs. Langate enterprise software development is an example of how when companies use global knowledge networks, the entire economy varies in pace.

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