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Course Learning Outcomes-Covered
Recognize the dynamics and the importance of managing technological innovation strategically. (LO 1)

Reference Source:
Schilling M.A (2020),Strategic Management of Technology Innovation (6th Edition). Mc-Graw Hill Education. Electronic Version: ISBN-13: 978-1260087956 ISBN-10: 1260087956, Printed Version: ISBN-13: 978-1260087956 ISBN-10: 1260087956
Weight: 10 Marks
Students are required to refer to chapter 1 ‘Introduction’ of their textbook.
Clear understanding of the chapter along with continuous critical analyzation of each topic and subtopic is highly recommended.
Based on the knowledge and information gathered by referring to the textbook and the students own thorough research write an essay on “The Significance of Technological Innovation in Industries”
Introduction (1 Mark)
Provide a brief overview of the importance of technological innovation in today’s world.
Body (7 Marks)
1-Definition of Technological Innovation (1 Mark)
Define what technological innovation is and why it matters to businesses and industries.
2-Importance of Technological Innovation (2 Marks)
Discuss why technological innovation is crucial for the growth and competitiveness of industries.
Explain how it can lead to increased productivity, cost reduction, and improved quality of products or services.
3. Role of Technological Innovation in Different Industries (2 Marks)
Choose two specific industries (e.g., healthcare, automotive, information technology) and explain how technological innovation has impacted them.
Provide real-world examples of innovative technologies that have transformed these industries.
4. Benefits and Challenges of Innovation in Industries (2 Marks)
Analyse the benefits that industries can reap from successful technological innovation.
Discuss the challenges and risks that organizations may face when implementing new technologies.
Conclusion (1 Mark)
Summarize the key points made in the assignment.
Reiterate the significance of technological innovation for industries.
References (1 Mark)
Cite at least three reputable sources to support your arguments and claims.
Use proper citation formatting.
Formatting and Presentation.
Ensure proper formatting, grammar, and spelling.
Use clear headings and subheadings to organize the content.
Include cover page with your name, student ID and course title.
All students are encouraged to use their own words.
The assignment should be approximately 800-1000 words in length.
Use Saudi Electronic University academic writing standards and APA style guidelines.
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Support your submission with course material concepts, principles, and theories from the textbook and at least two scholarly, peer-reviewed journal articles unless the assignment calls for more.
It is strongly encouraged that you submit all assignments into the safe assignment Originality Check prior to submitting it to your instructor for grading and review the grading rubric to understand how you will be graded for this assignment.

sch87956_fm_i-xviii.indd i 11/16/18 12:02 PMStrategic Management of Technological InnovationFinal PDF to printer
sch87956_fm_i-xviii.indd ii 11/16/18 12:02 PMFinal PDF to printer
sch87956_fm_i-xviii.indd iii 11/16/18 12:02 PMStrategic Management of Technological InnovationSixth EditionMelissa A. SchillingNew York UniversityFinal PDF to printer
sch65793_fm_ise.indd iv 12/04/18 11:25 AMSTRATEGIC MANAGEMENT OF TECHNOLOGICAL INNOVATIONPublished by McGraw-Hill Education, 2 Penn Plaza, New York, NY 10121. Copyright © 2020 by McGraw-Hill Education. All rights reserved. Printed in the United States of America. No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of McGraw-Hill Education, including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning.Some ancillaries, including electronic and print components, may not be available to customers outside the United States.This book is printed on acid-free paper.1 2 3 4 5 6 7 8 9 LCR 21 20 19ISBN 978-1-260-56579-9MHID 1-260-56579-3Cover Image: ©Shutterstock/iSam iSmileAll credits appearing on page or at the end of the book are considered to be an extension of the copyright page.The Internet addresses listed in the text were accurate at the time of publication. The inclusion of a website does not indicate an endorsement by the authors or McGraw-Hill Education, and McGraw-Hill Education does not guarantee the accuracy of the information presented at these
vsch87956_fm_i-xviii.indd v 11/16/18 12:02 PMAbout the AuthorMelissa A. Schilling, Ph.D.Melissa Schilling is the John Herzog family professor of management and organiza-tions at New York University’s Stern School of Business. Professor Schilling teaches courses in strategic management, corporate strategy and technology, and innova-tion management. Before joining NYU, she was an Assistant Professor at Boston University (1997–2001), and has also served as a Visiting Professor at INSEAD and the Bren School of Environmental Science & Management at the University of California at Santa Barbara. She has also taught strategy and innovation courses at Siemens Corporation, IBM, the Kauffman Foundation Entrepreneurship Fellows program, Sogang University in Korea, and the Alta Scuola Polytecnica, a joint institu-tion of Politecnico di Milano and Politecnico di Torino.Professor Schilling’s research focuses on technological innovation and knowl-edge creation. She has studied how technology shocks influence collaboration activ-ity and innovation outcomes, how firms fight technology standards battles, and how firms utilize collaboration, protection, and timing of entry strategies. She also stud-ies how product designs and organizational structures migrate toward or away from modularity. Her most recent work focuses on knowledge creation, including how breadth of knowledge and search influences insight and learning, and how the struc-ture of knowledge networks influences their overall capacity for knowledge creation. Her research in innovation and strategy has appeared in the leading academic journals such as Academy of Management Journal, Academy of Management Review, Man-agement Science, Organization Science, Strategic Management Journal, and Journal of Economics and Management Strategy and Research Policy. She also sits on the edi-torial review boards of Academy of Management Journal, Academy of Management Discoveries, Organization Science, Strategy Science, and Strategic Organization. She is the author of Quirky: The Remarkable Story of the Traits, Foibles, and Genius of Breakthrough Innovators Who Changed the World, and she is coauthor of Strategic Management: An Integrated Approach. Professor Schilling won an NSF CAREER award in 2003, and Boston University’s Broderick Prize for research in 2000.Final PDF to printer
visch87956_fm_i-xviii.indd vi 11/16/18 12:02 PMPrefaceInnovation is a beautiful thing. It is a force with both aesthetic and pragmatic appeal: It unleashes our creative spirit, opening our minds to hitherto undreamed of possibili-ties, while accelerating economic growth and providing advances in such crucial human endeavors as medicine, agriculture, and education. For industrial organizations, the pri-mary engines of innovation in the Western world, innovation provides both exceptional opportunities and steep challenges. While innovation is a powerful means of competitive differentiation, enabling firms to penetrate new markets and achieve higher margins, it is also a competitive race that must be run with speed, skill, and precision. It is not enough for a firm to be innovative—to be successful it must innovate better than its competitors.As scholars and managers have raced to better understand innovation, a wide range of work on the topic has emerged and flourished in disciplines such as strategic man-agement, organization theory, economics, marketing, engineering, and sociology. This work has generated many insights about how innovation affects the competitive dynamics of markets, how firms can strategically manage innovation, and how firms can implement their innovation strategies to maximize their likelihood of success. A great benefit of the dispersion of this literature across such diverse domains of study is that many innovation topics have been examined from different angles. However, this diversity also can pose integration challenges to both instructors and students. This book seeks to integrate this wide body of work into a single coherent strategic framework, attempting to provide coverage that is rigorous, inclusive, and accessible.Organization of the BookThe subject of innovation management is approached here as a strategic process. The outline of the book is designed to mirror the strategic management process used in most strategy textbooks, progressing from assessing the competitive dynamics of the situation, to strategy formulation, and then to strategy implementation. The first part of the book covers the foundations and implications of the dynamics of innovation, helping managers and future managers better interpret their technological environ-ments and identify meaningful trends. The second part of the book begins the pro-cess of crafting the firm’s strategic direction and formulating its innovation strategy, including project selection, collaboration strategies, and strategies for protecting the firm’s property rights. The third part of the book covers the process of implementing innovation, including the implications of organization structure on innovation, the management of new product development processes, the construction and manage-ment of new product development teams, and crafting the firm’s deployment strat-egy. While the book emphasizes practical applications and examples, it also provides systematic coverage of the existing research and footnotes to guide further reading.Complete Coverage for Both Business and Engineering StudentsThis book is designed to be a primary text for courses in the strategic management of innovation and new product development. Such courses are frequently taught in both Final PDF to printer
Preface viisch87956_fm_i-xviii.indd vii 11/16/18 12:02 PMbusiness and engineering programs; thus, this book has been written with the needs of business and engineering students in mind. For example, Chapter Six (Defining the Organization’s Strategic Direction) provides basic strategic analysis tools with which business students may already be familiar, but which may be unfamiliar to engineer-ing students. Similarly, some of the material in Chapter Eleven (Managing the New Product Development Process) on computer-aided design or quality function deploy-ment may be review material for information system students or engineering students, while being new to management students. Though the chapters are designed to have an intuitive order to them, they are also designed to be self-standing so instructors can pick and choose from them “buffet style” if they prefer.New for the Sixth EditionThis sixth edition of the text has been comprehensively revised to ensure that the frameworks and tools are rigorous and comprehensive, the examples are fresh and exciting, and the figures and cases represent the most current information available. Some changes of particular note include:Six New Short CasesThe Rise of “Clean Meat”. The new opening case for Chapter Two is about the development of “clean meat”—meat grown from animal cells without the animal itself. Traditional meat production methods are extremely resource intensive and produce large amounts of greenhouse gases. Further, the growing demand for meat indicated an impending “meat crisis” whereby not enough meat could be produced to meet demand. “Clean meat” promised to enable meat production using a tiny fraction of the energy, water, and land used for traditional meat production. Its production would create negligible greenhouse gases, and the meat itself would have no antibiotics or steroids, alleviating some of the health concerns of tradi-tional meat consumption. Furthermore, it would dramatically reduce animal suf-fering. If successful, it would be one of the largest breakthroughs ever achieved in food production.Innovating in India: The Chotukool Project. Chapter Three opens with a case about the Chotukool, a small, inexpensive, and portable refrigerator developed in India. In rural India, as many as 90 percent of families could not afford household appliances, did not have reliable access to electricity, and had no means of refrigeration. Godrej and Boyce believed that finding a way to provide refrigeration to this segment of the population offered the promise of both a huge market and making a meaningful differ-ence in people’s quality of life.UberAIR. Chapter Five now opens with a case about UberAIR, Uber’s new service to provide air transport on demand. Uber had already become synonymous with on-demand car transport in most of the Western world; it now believed it could develop the same service for air transport using electric vertical take-off and landing aircraft (eVTOLs). There were a lot of pieces to this puzzle, however. In addition to the technology of the aircraft, the service would require an extensive network of land-ing pads, specially trained pilots (at least until autonomous eVTOLs became practi-cal), and dramatically new air traffic control regulations and infrastructure. Was the time ripe for on-demand air transport, or was UberAIR ahead of its time?Final PDF to printer
viii Prefacesch87956_fm_i-xviii.indd viii 11/16/18 12:02 PMTesla Inc. in 2018. Chapter Six opens with a new case on Tesla, no longer just an electric vehicle company. This case reviews the rise of Tesla, and then explores the new businesses Tesla has entered, including solar panel leasing and installation (Solar City), solar roof production, and energy storage systems (e.g., Powerwall). Why did the company move into these businesses, and would synergies betweeen them help to make the company more successful?Where Should We Focus Our Innovation Efforts? An Exercise. Chapter Seven now opens with an exercise that shows how firms can tease apart the dimensions of value driving technological progress in an industry, map the marginal returns to further investment on each dimension, and prioritize their innovation efforts. Using numerous examples, the exercise helps managers realize where the breakthrough opportunities of the future are likely to be, and where the firm may be currently overspending.Scrums, Sprints, and Burnouts: Agile Development at Cisco Systems. Chapter Eleven opens with a case about Cisco’s adoption of the agile development method now com-monly used in software development. The case explains what agile development is, how it differs from other development methods (such as stage-gated methods), and when (and why) a firm would choose agile development versus gated development for a particular innovation.Cases, Data, and Examples from around the WorldCareful attention has been paid to ensure that the text is global in its scope. The opening cases and examples feature companies from China, India, Israel, Japan, The Netherlands, Kenya, the United States, and more. Wherever possible, statistics used in the text are based on worldwide data.More Comprehensive Coverage and Focus on Current Innovation TrendsIn response to reviewer suggestions, the new edition now provides an extensive discussion of modularity and platform competition, crowdsourcing and customer co-creation, agile development strategies, and more. The suggested readings for each chapter have also been updated to identify some of the more recent publications that have gained widespread attention in the topic area of each chapter. Despite these addi-tions, great effort has also been put into ensuring the book remains concise—a feature that has proven popular with both instructors and students.SupplementsThe teaching package for Strategic Management of Technological Innovation is avail-able online from Connect at and includes:∙ An instructor’s manual with suggested class outlines, responses to discussion ques-tions, and more.∙ Complete PowerPoint slides with lecture outlines and all major figures from the text. The slides can also be modified by the instructor to customize them to the instructor’s needs.∙ A testbank with true/false, multiple choice, and short answer/short essay questions.∙ A suggested list of cases to pair with chapters from the text.Final PDF to printer
sch87956_fm_i-xviii.indd ix 11/16/18 12:02 PMSUCCESSFUL SEMESTERS INCLUDE CONNECTYou’re in the driver’s seat.Want to build your own course? No problem. Prefer to use our turnkey, prebuilt course? Easy. Want to make changes throughout the semester? Sure. And you’ll save time with Connect’s auto-grading too.65%Less Time GradingThey’ll thank you for it.Adaptive study resources like SmartBook® help your students be better prepared in less time. You can transform your class time from dull definitions to dynamic debates. Hear from your peers about the benefits of Connect at it simple, make it affordable. Connect makes it easy with seamless integration using any of the major Learning Management Systems—Blackboard®, Canvas, and D2L, among others—to let you organize your course in one convenient location. Give your students access to digital materials at a discount with our inclusive access program. Ask your McGraw-Hill representative for more information.Students—study more efficiently, retain more and achieve better outcomes. Instructors—focus on what you love—teaching.Solutions for your challenges.A product isn’t a solution. Real solutions are affordable, reliable, and come with training and ongoing support when you need it and how you want it. Our Customer Experience Group can also help you troubleshoot tech problems—although Connect’s 99% uptime means you might not need to call them. See for yourself at ©Hill Street Studios/Tobin Rogers/Blend Images LLCFor InstructorsFinal PDF to printer
sch87956_fm_i-xviii.indd x 11/16/18 12:02 PMEffective, efficient studying.Connect helps you be more productive with your study time and get better grades using tools like SmartBook, which highlights key concepts and creates a personalized study plan. Connect sets you up for success, so you walk into class with confidence and walk out with better grades.Study anytime, anywhere.Download the free ReadAnywhere app and access your online eBook when it’s convenient, even if you’re offline. And since the app automatically syncs with your eBook in Connect, all of your notes are available every time you open it. Find out more at“I really liked this app—it made it easy to study when you don’t have your text-book in front of you.”- Jordan Cunningham, Eastern Washington UniversityLearning for everyone. McGraw-Hill works directly with Accessibility Services Departments and faculty to meet the learning needs of all students. Please contact your Accessibility Services office and ask them to email, or visit for more information.No surprises.The Connect Calendar and Reports tools keep you on track with the work you need to get done and your assignment scores. Life gets busy; Connect tools help you keep learning through it all.Chapter 12 QuizChapter 11 QuizChapter 7 QuizChapter 13 Evidence of EvolutionChapter 11 DNA TechnologyChapter 7 DNA Structure and Gene…and 7 more…1314©Shutterstock/wavebreakmediaFor StudentsFinal PDF to printer
xisch87956_fm_i-xviii.indd xi 11/16/18 12:02 PMAcknowledgmentsThis book arose out of my research and teaching on technological innovation and new product development over the last decade; however, it has been anything but a lone endeavor. I owe much of the original inspiration of the book to Charles Hill, who helped to ignite my initial interest in innovation, guided me in my research agenda, and ultimately encouraged me to write this book. I am also very grateful to colleagues and friends such as Rajshree Agarwal, Juan Alcacer, Rick Alden, William Baumol, Bruno Braga, Gino Cattanni, Tom Davis, Sinziana Dorobantu, Gary Dushnitsky, Douglas Fulop, Raghu Garud, Deepak Hegde, Hla Lifshitz, Tammy Madsen, Rodolfo Martinez, Goncalo Pacheco D’Almeida, Joost Rietveld, Paul Shapiro, Jaspal Singh, Deepak Somaya, Bill Starbuck, Christopher Tucci, and Andy Zynga for their sug-gestions, insights, and encouragement. I am grateful to director Mike Ablassmeir and marketing manager Lisa Granger. I am also thankful to my editors, Laura Hurst Spell and Diana Murphy, who have been so supportive and made this book possible, and to the many reviewers whose suggestions have dramatically improved the book:Joan AdamsBaruch Business School (City University of New York)Shahzad AnsariErasmus UniversityRajaram B. BaligaWake Forest UniversitySandy BeckerRutgers Business SchoolDavid BerkowitzUniversity of Alabama in HuntsvilleJohn BersVanderbilt UniversityPaul BierlyJames Madison UniversityPaul CheneyUniversity of Central FloridaPete DaileyMarshall UniversityRobert DeFillippiSuffolk UniversityDeborah DoughertyRutgers UniversityCathy A. EnzCornell UniversityRobert FinklesteinUniversity of Maryland–University CollegeSandra FinklesteinClarkson University School of BusinessJeffrey L. FurmanBoston UniversityCheryl GaimonGeorgia Institute of TechnologyElie GeislerIllinois Institute of TechnologySanjay GoelUniversity of Minnesota in DuluthAndrew HargadonUniversity of California, DavisSteven HarperJames Madison UniversityFinal PDF to printer
xii Acknowledgmentssch87956_fm_i-xviii.indd xii 11/16/18 12:02 PMI am also very grateful to the many students of the Technological Innovation and New Product Development courses I have taught at New York University, INSEAD, Boston University, and University of California at Santa Barbara. Not only did these students read, challenge, and help improve many earlier drafts of the work, but they also contributed numerous examples that have made the text far richer than it would have otherwise been. I thank them wholeheartedly for their patience and generosity.Melissa A. SchillingDonald E. HatfieldVirginia Polytechnic Institute and State UniversityGlenn HoetkerUniversity of IllinoisSanjay JainUniversity of Wisconsin–MadisonTheodore KhouryOregon State UniversityRajiv KohliCollege of William and MaryAija LeiponenCornell UniversityVince LutheranUniversity of North Carolina—WilmingtonSteve MarkhamNorth Carolina State UniversitySteven C. MichaelUniversity of IllinoisMichael MinoClemson UniversityRobert NashVanderbilt UniversityAnthony PaoniNorthwestern UniversityJohannes M. PenningsUniversity of PennsylvaniaRaja RoyTulane UniversityMukesh SrivastavaUniversity of Mary WashingtonLinda F. TegardenVirginia TechOya TukelCleveland State UniversityAnthony WarrenThe Pennsylvania State UniversityFinal PDF to printer
sch87956_fm_i-xviii.indd xiii 11/16/18 12:02 PMxiiiPreface vi 1 Introduction 1PART ONEIndustry Dynamics of Technological Innovation 13 2 Sources of Innovation 15 3 Types and Patterns of Innovation 43 4 Standards Battles, Modularity, and Platform Competition 67 5 Timing of Entry 95PART TWOFormulating Technological Innovation Strategy 113 6 Defining the Organization’s Strategic Direction 115 7 Choosing Innovation Projects 141 8 Collaboration Strategies 167 9 Protecting Innovation 197PART THREEImplementing Technological Innovation Strategy 22310 Organizing for Innovation 22511 Managing the New Product Development Process 24912 Managing New Product Development Teams 27713 Crafting a Deployment Strategy 297INDEX 327Brief ContentsFinal PDF to printer
xivsch87956_fm_i-xviii.indd xiv 11/16/18 12:02 PMChapter 1Introduction 1The Importance of Technological Innovation 1The Impact of Technological Innovation on Society 2Innovation by Industry: The Importance of Strategy 4The Innovation Funnel 4The Strategic Management of Technological Innovation 6Summary of Chapter 9Discussion Questions 10Suggested Further Reading 10Endnotes 10PART ONEINDUSTRY DYNAMICS OF TECHNOLOGICAL INNOVATION 13Chapter 2Sources of Innovation 15The Rise of “Clean Meat” 15Overview 19Creativity 20Individual Creativity 20Organizational Creativity 22Translating Creativity Into Innovation 24The Inventor 24Innovation by Users 26Research and Development by Firms 27Firm Linkages with Customers, Suppliers, Competitors, and Complementors 28Universities and Government-Funded Research 30Private Nonprofit Organizations 32Innovation in Collaborative Networks 32Technology Clusters 33Technological Spillovers 36Summary of Chapter 37Discussion Questions 38Suggested Further Reading 38Endnotes 39Chapter 3Types and Patterns of Innovation 43Innovating in India: The Chotukool Project 43Overview 46Types of Innovation 46Product Innovation versus Process Innovation 46Radical Innovation versus Incremental Innovation 47Competence-Enhancing Innovation versus Competence-Destroying Innovation 48Architectural Innovation versus Component Innovation 49Using the Dimensions 50Technology S-Curves 50S-Curves in Technological Improvement 50S-Curves in Technology Diffusion 53S-Curves as a Prescriptive Tool 54Limitations of S-Curve Model as a Prescriptive Tool 55Technology Cycles 56Summary of Chapter 62Discussion Questions 63Suggested Further Reading 63Endnotes 64ContentsFinal PDF to printer
Contents xvsch87956_fm_i-xviii.indd xv 11/16/18 12:02 PMChapter 4Standards Battles, Modularity, and Platform Competition 67A Battle for Dominance in Mobile Payments 67Overview 71Why Dominant Designs Are Selected 71Learning Effects 72Network Externalities 73Government Regulation 76The Result: Winner-Take-All Markets 76Multiple Dimensions of Value 77A Technology’s Stand-Alone Value 78Network Externality Value 78Competing for Design Dominance in Markets with Network Externalities 83Modularity and Platform Competition 87Modularity 87Platform Ecosystems 89Summary of Chapter 91Discussion Questions 92Suggested Further Reading 92Endnotes 93Chapter 5Timing of Entry 95UberAIR 95Overview 98First-Mover Advantages 98Brand Loyalty and Technological Leadership 98Preemption of Scarce Assets 99Exploiting Buyer Switching Costs 99Reaping Increasing Returns Advantages 100First-Mover Disadvantages 100Research and Development Expenses 101Undeveloped Supply and Distribution Channels 101Immature Enabling Technologies and Complements 101Uncertainty of Customer Requirements 102Factors Influencing Optimal Timing of Entry 104Strategies to Improve Timing Options 108Summary of Chapter 108Discussion Questions 109Suggested Further Reading 109Endnotes 110PART TWOFORMULATING TECHNOLOGICAL INNOVATION STRATEGY 113Chapter 6Defining the Organization’s Strategic Direction 115Tesla, Inc. in 2018 115Overview 123Assessing the Firm’s Current Position 123External Analysis 123Internal Analysis 127Identifying Core Competencies and Dynamic Capabilities 131Core Competencies 131The Risk of Core Rigidities 132Dynamic Capabilities 133Strategic Intent 133Summary of Chapter 137Discussion Questions 138Suggested Further Reading 139Endnotes 139Chapter 7Choosing Innovation Projects 141Where Should We Focus Our Innovation Efforts? An Exercise 141Overview 146The Development Budget 146Quantitative Methods For Choosing Projects 149Discounted Cash Flow Methods 149Real Options 152Disadvantages of Quantitative Methods 154Final PDF to printer
xvi Contentssch87956_fm_i-xviii.indd xvi 11/16/18 12:02 PMQualitative Methods for Choosing Projects 154Screening Questions 155The Aggregate Project Planning Framework 157Q-Sort 159Combining Quantitative and Qualitative Information 159Conjoint Analysis 159Data Envelopment Analysis 161Summary of Chapter 163Discussion Questions 163Suggested Further Reading 164Endnotes 164Chapter 8Collaboration Strategies 167Ending HIV? Sangamo Therapeutics and Gene Editing 167Overview 175Reasons for Going Solo 1751. Availability of Capabilities 1762. Protecting Proprietary Technologies 1763. Controlling Technology Development and Use 1764. Building and Renewing Capabilities 177Advantages of Collaborating 1771. Acquiring Capabilities and Resources Quickly 1772. Increasing Flexibility 1783. Learning from Partners 1784. Resource and Risk Pooling 1785. Building a Coalition around a Shared Standard 178Types of Collaborative Arrangements 178Strategic Alliances 179Joint Ventures 181Licensing 182Outsourcing 183Collective Research Organizations 184Choosing a Mode of Collaboration 184Choosing and Monitoring Partners 187Partner Selection 187Partner Monitoring and Governance 191Summary of Chapter 192Discussion Questions 193Suggested Further Reading 193Endnotes 194Chapter 9Protecting Innovation 197The Digital Music Distribution Revolution 197Overview 201Appropriability 202Patents, Trademarks, and Copyrights 202Patents 203Trademarks and Service Marks 207Copyright 208Trade Secrets 210The Effectiveness and Use of Protection Mechanisms 211Wholly Proprietary Systems versus Wholly Open Systems 212Advantages of Protection 213Advantages of Diffusion 215Summary of Chapter 218Discussion Questions 219Suggested Further Reading 219Endnotes 220PART THREEIMPLEMENTING TECHNOLOGICAL INNOVATION STRATEGY 223Chapter 10Organizing for Innovation 225Organizing for Innovation at Google 225Overview 227Size and Structural Dimensions of the Firm 228Size: Is Bigger Better? 228Structural Dimensions of the Firm 230Centralization 230Formalization and Standardization 231Mechanistic versus Organic Structures 232Size versus Structure 234The Ambidextrous Organization: The Best of Both Worlds? 234Final PDF to printer
Contents xviisch87956_fm_i-xviii.indd xvii 11/16/18 12:02 PMModularity and “Loosely Coupled” Organizations 236Modular Products 236Loosely Coupled Organizational Structures 237Managing Innovation Across Borders 240Summary of Chapter 243Discussion Questions 244Suggested Further Reading 244Endnotes 245Chapter 11Managing the New Product Development Process 249Scrums, Sprints, and Burnouts: Agile Development at Cisco Systems 249Overview 252Objectives of the New Product Development Process 252Maximizing Fit with Customer Requirements 252Minimizing Development Cycle Time 253Controlling Development Costs 254Sequential versus Partly Parallel Development Processes 254Project Champions 257Risks of Championing 257Involving Customers and Suppliers in the Development Process 259Involving Customers 259Involving Suppliers 260Crowdsourcing 260Tools for Improving the New Product Development Process 262Stage-Gate Processes 262Quality Function Deployment (QFD)—The House of Quality 265Design for Manufacturing 267Failure Modes and Effects Analysis 267Computer-Aided Design/Computer-Aided Engineering/Computer-Aided Manufacturing 268Tools for Measuring New Product Development Performance 269New Product Development Process Metrics 271Overall Innovation Performance 271Summary of Chapter 271Discussion Questions 272Suggested Further Reading 272Endnotes 273Chapter 12Managing New Product Development Teams 277Innovation Teams at the Walt Disney Company 277Overview 279Constructing New Product Development Teams 280Team Size 280Team Composition 280The Structure of New Product Development Teams 285Functional Teams 285Lightweight Teams 286Heavyweight Teams 286Autonomous Teams 286The Management of New Product Development Teams 288Team Leadership 288Team Administration 288Managing Virtual Teams 289Summary of Chapter 292Discussion Questions 292Suggested Further Reading 293Endnotes 293Chapter 13Crafting a Deployment Strategy 297Deployment Tactics in the Global Video Game Industry 297Overview 306Launch Timing 306Strategic Launch Timing 306Optimizing Cash Flow versus Embracing Cannibalization 307Licensing and Compatibility 308Pricing 310Final PDF to printer
xviii Contentssch87956_fm_i-xviii.indd xviii 11/16/18 12:02 PMDistribution 312Selling Direct versus Using Intermediaries 312Strategies for Accelerating Distribution 314Marketing 316Major Marketing Methods 316Tailoring the Marketing Plan to Intended Adopters 318Using Marketing to Shape Perceptions and Expectations 320Summary of Chapter 323Discussion Questions 324Suggested Further Reading 324Endnotes 325Index 327Final PDF to printer
1sch87956_ch01_001-012.indd 1 11/02/18 02:10 PMChapter OneIntroductionTHE IMPORTANCE OF TECHNOLOGICAL INNOVATIONIn many industries, technological innovation is now the most important driver of competitive success. Firms in a wide range of industries rely on products developed within the past five years for almost one-third (or more) of their sales and profits. For example, at Johnson & Johnson, products developed within the last five years account for over 30 percent of sales, and sales from products developed within the past five years at 3M have hit as high as 45 percent in recent years.The increasing importance of innovation is due in part to the globalization of markets. Foreign competition has put pressure on firms to continuously innovate in order to produce differentiated products and services. Introducing new products helps firms protect their margins, while investing in process innovation helps firms lower their costs. Advances in information technology also have played a role in speeding the pace of innovation. Computer-aided design and computer-aided manu-facturing have made it easier and faster for firms to design and produce new prod-ucts, while flexible manufacturing technologies have made shorter production runs economical and have reduced the importance of production economies of scale.1 These technologies help firms develop and produce more product variants that closely meet the needs of narrowly defined customer groups, thus achieving dif-ferentiation from competitors. For example, in 2018, Toyota offered 22 different passenger vehicle lines under the Toyota brand (e.g., Camry, Prius, Highlander, and Tundra). Within each of the vehicle lines, Toyota also offered several different mod-els (e.g., Camry L, Camry LE, Camry SE, Camry Hybrid SE, etc.) with different features and at different price points. In total, Toyota offered 193 car models rang-ing in price from $15,635 (for the Yaris three-door liftback) to $84,315 (for the Land Cruiser), and seating anywhere from three passengers (e.g., Tacoma Regular Cab truck) to eight passengers (Sienna Minivan). On top of this, Toyota also pro-duced a range of luxury vehicles under its Lexus brand. Similarly, in 2018 Samsung produced more than 30 unique smartphones. Companies can use broad portfolios of product models to help ensure they can penetrate almost every conceivable mar-ket niche. While producing multiple product variations used to be expensive and technological innovationThe act of introducing a new device, method, or material for application to commercial or practical objectives.Final PDF to printer
sch87956_ch01_001-012.indd 2 11/02/18 02:10 PM2 Chapter 1 Introductiontime-consuming, flexible manufacturing technologies now enable firms to seam-lessly transition from producing one product model to the next, adjusting production schedules with real-time information on demand. Firms further reduce production costs by using common components in many of the models.As firms such as Toyota, Samsung, and others adopt these new technologies and increase their pace of innovation, they raise the bar for competitors, triggering an industry-wide shift to shortened development cycles and more rapid new prod-uct introductions. The net results are greater market segmentation and rapid product obsolescence.2 Product life cycles (the time between a product’s introduction and its withdrawal from the market or replacement by a next-generation product) have become as short as 4 to 12 months for software, 12 to 24 months for computer hard-ware and consumer electronics, and 18 to 36 months for large home appliances.3 This spurs firms to focus increasingly on innovation as a strategic imperative—a firm that does not innovate quickly finds its margins diminishing as its products become obsolete.THE IMPACT OF TECHNOLOGICAL INNOVATION ON SOCIETYIf the push for innovation has raised the competitive bar for industries, arguably mak-ing success just that much more complicated for organizations, its net effect on society is more clearly positive. Innovation enables a wider range of goods and services to be delivered to people worldwide. It has made the production of food and other neces-sities more efficient, yielded medical treatments that improve health conditions, and enabled people to travel to and communicate with almost every part of the world. To get a real sense of the magnitude of the effect of technological innovation on society, look at Figure 1.1, which shows a timeline of some of the most important technologi-cal innovations developed over the last 200 years. Imagine how different life would be without these innovations!The aggregate impact of technological innovation can be observed by looking at gross domestic product (GDP). The gross domestic product of an economy is its total annual output, measured by final purchase price. Figure 1.2 shows the average GDP per capita (i.e., GDP divided by the population) for the world from 1980 to 2016. The figures have been converted into U.S. dollars and adjusted for inflation. As shown in the figure, the average world GDP per capita has risen steadily since 1980. In a series of studies of economic growth conducted at the National Bureau of Economic Research, economists showed that the historic rate of economic growth in GDP could not be accounted for entirely by growth in labor and capital inputs. Economist Robert Merton Solow argued that this unaccounted-for residual growth represented technological change: Technological innovation increased the amount of output achievable from a given quantity of labor and capital. This explanation was not immediately accepted; many researchers attempted to explain the residual away in terms of measurement error, inaccurate price deflation, or labor improvement. gross domestic product (GDP)The total annual output of an economy as measured by its final purchase price.Final PDF to printer
sch87956_ch01_001-012.indd 3 11/02/18 02:10 PMChapter 1 Introduction 3But in each case the additional vari-ables were unable to eliminate this residual growth component. A consensus gradually emerged that the residual did in fact cap-ture technological change. Solow received a Nobel Prize for his work in 1981, and the residual became known as the Solow Residual.4 While GDP has its shortcomings as a measure of standard of living, it does relate very directly to the amount of goods consumers can purchase. Thus, to the extent that goods improve quality of life, we can ascribe some beneficial impact of technological innovation.Sometimes technological innova-tion results in negative externalities. Production technologies may create pollution that is harmful to the surrounding communities; agri-cultural and fishing technologies can result in erosion, elimination of natural habitats, and depletion of ocean stocks; medical technologies can result in unanticipated conse-quences such as antibiotic-resistant strains of bacteria or moral dilemmas regarding the use of genetic modifi-cation. However, technology is, in its purest essence, knowledge— knowledge to solve our problems and pursue our goals.5 Technologi-cal innovation is thus the creation of new knowledge that is applied to practical problems. Sometimes this knowledge is applied to prob-lems hastily, without full consid-eration of the consequences and alternatives, but overall it will probably serve us better to have more knowledge than less.externalitiesCosts (or benefits) that are borne (or reaped) by individuals other than those responsible for creating them. Thus, if a business emits pollutants in a community, it imposes a nega-tive externality on the commu-nity members; if a business builds a park in a community, it creates a posi-tive externality for community members.1800 – 1800—Electric battery – 1804—Steam locomotive – 1807—Internal combustion engine – 1809—Telegraph – 1817—Bicycle1820 – 1821—Dynamo – 1824—Braille writing system – 1828—Hot blast furnace – 1831—Electric generator – 1836—Five-shot revolver1840 – 1841—Bunsen battery (voltaic cell) – 1842—Sulfuric ether-based anesthesia – 1846—Hydraulic crane – 1850—Petroleum refining – 1856—Aniline dyes1860 – 1862—Gatling gun – 1867—Typewriter – 1876—Telephone – 1877—Phonograph – 1878—Incandescent lightbulb1880 – 1885—Light steel skyscrapers – 1886—Internal combustion automobile – 1887—Pneumatic tire – 1892—Electric stove – 1895—X-ray machine1900 – 1902—Air conditioner (electric) – 1903—Wright biplane – 1906—Electric vacuum cleaner – 1910—Electric washing machine – 1914—Rocket1920 – 1921—Insulin (extracted) – 1927—Television – 1928—Penicillin – 1936—First programmable computer – 1939—Atom fission1940 – 1942—Aqua lung – 1943—Nuclear reactor – 1947—Transistor – 1957—Satellite – 1958—Integrated circuit1960 – 1967—Portable handheld calculator – 1969—ARPANET (precursor to Internet) – 1971—Microprocessor – 1973—Mobile (portable cellular) phone – 1976—Supercomputer1980 – 1981—Space shuttle (reusable) – 1987—Disposable contact lenses – 1989—High-definition television – 1990—World Wide Web protocol – 1996—Wireless Internet2000 – 2003—Map of human genome FIGURE 1.1Timeline of Some of the Most Important Technological Innovations in the Last 200 YearsFinal PDF to printer
sch87956_ch01_001-012.indd 4 11/02/18 02:10 PM4 Chapter 1 IntroductionFIGURE 1.2Gross Domestic  Product per Capita, 1989– 2016 (in Real 2010 $US Billions)Source: USDA Eco-nomic Research Service,, accessed April 16th, 2018.90,00080,00070,00060,00050,00040,00030,00020,00010,0001980198219841986198819901992199419961998200020022004200620082010201220142016–INNOVATION BY INDUSTRY: THE IMPORTANCE OF STRATEGYAs will be shown in Chapter Two, the majority of effort and money invested in tech-nological innovation comes from industrial firms. However, in the frenetic race to innovate, many firms charge headlong into new product development without clear strategies or well-developed processes for choosing and managing projects. Such firms often initiate more projects than they can effectively support, choose projects that are a poor fit with the firm’s resources and objectives, and suffer long development cycles and high project failure rates as a consequence (see the accompanying Research Brief for a recent study of the length of new product development cycles). While innova-tion is popularly depicted as a freewheeling process that is unconstrained by rules and plans, study after study has revealed that successful innovators have clearly defined innovation strategies and management processes.6The Innovation FunnelMost innovative ideas do not become successful new products. Many studies suggest that only one out of several thousand ideas results in a successful new product: Many projects do not result in technically feasible products and, of those that do, many fail to earn a commercial return. According to a 2012 study by the Product Development and Management Association, only about one in nine projects that are initiated is suc-cessful, and of those that make it to the point of being launched to the market, only about half earn a profit.7 Furthermore, many ideas are sifted through and abandoned before a project is even formally initiated. According to one study that combined data from prior studies of innovation success rates with data on patents, venture capital Final PDF to printer
sch87956_ch01_001-012.indd 5 11/02/18 02:10 PMChapter 1 Introduction 5funding, and surveys, it takes about 3000 raw ideas to produce one significantly new and successful commercial product.8 The pharmaceutical industry demonstrates this well—only one out of every 5000 compounds makes it to the pharmacist’s shelf, and only one-third of those will be successful enough to recoup their R&D costs.9 Further-more, most studies indicate that it costs at least $1.4 billion and a decade of research to bring a new Food and Drug Administration (FDA)–approved pharmaceutical product to market!10 The innovation process is thus often conceived of as a funnel, with many potential new product ideas going in the wide end, but very few making it through the development process (see Figure 1.3).Research Brief How Long Does New Product Development Take?aIn a large-scale survey administered by the Prod-uct Development and Management Association (PDMA), researchers examined the length of time it took firms to develop a new product from initial con-cept to market introduction. The study divided new product development projects into categories rep-resenting their degree of innovativeness: “radical” projects, “more innovative” projects, and “incremen-tal” projects. On average, incremental projects took only 33 weeks from concept to market introduction. More innovative projects took significantly longer, clocking in at 57 weeks. The development of radical products or technologies took the longest, averaging 82 weeks. The study also found that on average, for more innovative and radical projects, firms reported significantly shorter cycle times than those reported in the previous PDMA surveys conducted in 1995 and 2004.a Adapted from Markham, S. K., and H. Lee, “Product Devel-opment and Management Association’s 2012 Compara-tive Performance Assessment Study,” Journal of Product Innovation Management 30, no. 3 (2013): 408–29.FIGURE 1.3The New Prod-uct Develop-ment Funnel in Pharmaceuticals125Leads2–3 drugs tested1 drugRx5000CompoundsDiscovery & Preclinical3–6 yearsClinical Trials6–7 yearsApproval½–2 yearsFinal PDF to printer
sch87956_ch01_001-012.indd 6 11/02/18 02:10 PM6 Chapter 1 IntroductionThe Strategic Management of Technological InnovationImproving a firm’s innovation success rate requires a well-crafted strategy. A firm’s innovation projects should align with its resources and objectives, leveraging its core competencies and helping it achieve its strategic intent. A firm’s organizational struc-ture and control systems should encourage the generation of innovative ideas while also ensuring efficient implementation. A firm’s new product development process should maximize the likelihood of projects being both technically and commercially successful. To achieve these things, a firm needs (a) an in-depth understanding of the dynamics of innovation, (b) a well-crafted innovation strategy, and (c) well-designed processes for implementing the innovation strategy. We will cover each of these in turn (see Figure 1.4).In Part One, we will cover the foundations of technological innovation, gaining an in-depth understanding of how and why innovation occurs in an industry, and why some innovations rise to dominate others. First, we will look at the sources of innova-tion in Chapter Two. We will address questions such as: Where do great ideas come from? How can firms harness the power of individual creativity? What role do cus-tomers, government organizations, universities, and alliance networks play in creating innovation? In this chapter, we will first explore the role of creativity in the generation of novel and useful ideas. We then look at various sources of innovation, including the role of individual inventors, firms, publicly sponsored research, and collaborative networks.In Chapter Three, we will review models of types of innovation (such as radical versus incremental and architectural versus modular) and patterns of innovation (including s-curves of technology performance and diffusion, and technology cycles). We will address questions such as: Why are some innovations much harder to create and implement than others? Why do innovations often diffuse slowly even when they appear to offer a great advantage? What factors influence the rate at which a technol-ogy tends to improve over time? Familiarity with these types and patterns of innovation will help us distinguish how one project is different from another and the underlying factors that shape the project’s likelihood of technical or commercial success.In Chapter Four, we will turn to the particularly interesting dynamics that emerge in industries characterized by network externalities and other sources of increas-ing returns that can lead to standards battles and winner-take-all markets. We will address questions such as: Why do some industries choose a single dominant stan-dard rather than enabling multiple standards to coexist? What makes one techno-logical innovation rise to dominate all others, even when other seemingly superior technologies are offered? How can a firm avoid being locked out? Is there anything a firm can do to influence the likelihood of its technology becoming the dominant design? When are platform ecosystems likely to displace other forms of competition in an industry?In Chapter Five, we will discuss the impact of entry timing, including first-mover advantages, first-mover disadvantages, and the factors that will determine the firm’s optimal entry strategy. This chapter will address such questions as: What are the advan-tages and disadvantages of being first to market, early but not first, and late? What determines the optimal timing of entry for a new innovation? This chapter reveals a number of consistent patterns in how timing of entry impacts innovation success, and Final PDF to printer
sch87956_ch01_001-012.indd 7 11/02/18 02:10 PMChapter 1 Introduction 7FIGURE 1.4The Strategic Management of Technological InnovationPart 3: Implementing TechnologicalInnovation Strategy Part 1: Industry Dynamics ofTechnological Innovation Part 2: Formulating TechnologicalInnovation Strategy Chapter 4Standards Battles,Modularity, andPlatform CompetitionChapter 2Sources ofInnovationChapter 5Timing of EntryChapter 3Types and Patternsof InnovationChapter 6Defining the Organization’sStrategic DirectionChapter 9Protecting InnovationChapter 8CollaborationStrategiesChapter 7Choosing InnovationProjectsChapter 10Organizing forInnovationChapter 13Crafting a DeploymentStrategyChapter 12Managing NewProductDevelopment TeamsChapter 11Managing the NewProduct DevelopmentProcessFeedbackFinal PDF to printer
sch87956_ch01_001-012.indd 8 11/02/18 02:10 PM8 Chapter 1 Introductionit outlines what factors will influence a firm’s optimal timing of entry, thus beginning the transition from understanding the dynamics of technological innovation to formu-lating technology strategy.In Part Two, we will turn to formulating technological innovation strategy. Chapter Six reviews the basic strategic analysis tools managers can use to assess the firm’s current position and define its strategic direction for the future. This chapter will address such questions as: What are the firm’s sources of sustainable competitive advantage? Where in the firm’s value chain do its strengths and weaknesses lie? What are the firm’s core competencies, and how should it leverage and build upon them? What is the firm’s strategic intent—that is, where does the firm want to be 10 years from now? Only after the firm has thoroughly appraised where it is currently can it formulate a coherent technological innovation strategy for the future.In Chapter Seven, we will examine a variety of methods of choosing innovation projects. These include quantitative methods such as discounted cash flow and options valuation techniques, qualitative methods such as screening questions and balancing the research and development portfolio, as well as methods that combine qualitative and quantitative approaches such as conjoint analysis and data envelopment analysis. Each of these methods has its advantages and disadvantages, leading many firms to use a multiple-method approach to choosing innovation projects.In Chapter Eight, we will examine collaboration strategies for innovation. This chapter addresses questions such as: Should the firm partner on a particular project or go solo? How does the firm decide which activities to do in-house and which to access through collaborative arrangements? If the firm chooses to work with a partner, how should the partnership be structured? How does the firm choose and monitor part-ners? We will begin by looking at the reasons a firm might choose to go solo versus working with a partner. We then will look at the pros and cons of various partnering methods, including joint ventures, alliances, licensing, outsourcing, and participat-ing in collaborative research organizations. The chapter also reviews the factors that should influence partner selection and monitoring.In Chapter Nine, we will address the options the firm has for appropriating the returns to its innovation efforts. We will look at the mechanics of patents, copyright, trademarks, and trade secrets. We will also address such questions as: Are there ever times when it would benefit the firm to not protect its technological innovation so vigorously? How does a firm decide between a wholly proprietary, wholly open, or partially open strategy for protecting its innovation? When will open strategies have advantages over wholly proprietary strategies? This chapter examines the range of protection options available to the firm, and the complex series of trade-offs a firm must consider in its protection strategy.In Part Three, we will turn to implementing the technological innovation strategy. This begins in Chapter Ten with an examination of how the organization’s size and structure influence its overall rate of innovativeness. The chapter addresses such ques-tions as: Do bigger firms outperform smaller firms at innovation? How do formaliza-tion, standardization, and centralization impact the likelihood of generating innovative ideas and the organization’s ability to implement those ideas quickly and efficiently? Is it possible to achieve creativity and flexibility at the same time as efficiency and reliability? How do multinational firms decide where to perform their development Final PDF to printer
sch87956_ch01_001-012.indd 9 11/02/18 02:10 PMChapter 1 Introduction 9activities? How do multinational firms coordinate their development activities toward a common goal when the activities occur in multiple countries? This chapter examines how organizations can balance the benefits and trade-offs of flexibility, economies of scale, standardization, centralization, and tapping local market knowledge.In Chapter Eleven, we will review a series of “best practices” that have been identi-fied in managing the new product development process. This includes such questions as: Should new product development processes be performed sequentially or in paral-lel? What are the advantages and disadvantages of using project champions? What are the benefits and risks of involving customers and/or suppliers in the development process? What tools can the firm use to improve the effectiveness and efficiency of its new product development processes? How does the firm assess whether its new prod-uct development process is successful? This chapter provides an extensive review of methods that have been developed to improve the management of new product devel-opment projects and to measure their performance.Chapter Twelve builds on the previous chapter by illuminating how team composi-tion and structure will influence project outcomes. This chapter addresses questions such as: How big should teams be? What are the advantages and disadvantages of choosing highly diverse team members? Do teams need to be colocated? When should teams be full time and/or permanent? What type of team leader and management prac-tices should be used for the team? This chapter provides detailed guidelines for con-structing new product development teams that are matched to the type of new product development project under way.Finally, in Chapter Thirteen, we will look at innovation deployment strategies. This chapter will address such questions as: How do we accelerate the adoption of the tech-nological innovation? How do we decide whether to use licensing or OEM agree-ments? Does it make more sense to use penetration pricing or a market-skimming price? When should we sell direct versus using intermediaries? What strategies can the firm use to encourage distributors and complementary goods providers to sup-port the innovation? What are the advantages and disadvantages of major marketing methods? This chapter complements traditional marketing, distribution, and pricing courses by looking at how a deployment strategy can be crafted that especially targets the needs of a new technological innovation. 1. Technological innovation is now often the single most important competitive driver in many industries. Many firms receive more than one-third of their sales and profits from products developed within the past five years. 2. The increasing importance of innovation has been driven largely by the globaliz-ation of markets and the advent of advanced technologies that enable more rapid product design and allow shorter production runs to be economically feasible. 3. Technological innovation has a number of important effects on society, includ-ing fostering increased GDP, enabling greater communication and mobility, and improving medical treatments.Summary of ChapterFinal PDF to printer
sch87956_ch01_001-012.indd 10 11/02/18 02:10 PM10 Chapter 1 Introduction 4. Technological innovation may also pose some negative externalities, including pollution, resource depletion, and other unintended consequences of technological change. 5. While government plays a significant role in innovation, industry provides the majority of R&D funds that are ultimately applied to technological innovation. 6. Successful innovation requires an in-depth understanding of the dynamics of innovation, a well-crafted innovation strategy, and well-developed processes for implementing the innovation strategy. 1. Why is innovation so important for firms to compete in many industries? 2. What are some advantages and disadvantages of technological innovation? 3. Why do you think so many innovation projects fail to generate an economic return?Discussion QuestionsClassicsArrow, K. J., “Economic welfare and the allocation of resources for inventions,” in The Rate and Direction of Inventive Activity: Economic and Social Factors, ed. R. Nelson (Princeton, NJ: Princeton University Press, 1962), pp. 609–25.Baumol, W. J., The Free Market Innovation Machine: Analyzing the Growth Miracle of Capitalism (Princeton, NJ: Princeton University Press, 2002).Mansfield, E., “Contributions of R and D to economic growth in the United States,” Science CLXXV (1972), pp. 477–86.Schumpeter, J. A., The Theory of Economic Development (1911; English translation, Cambridge, MA: Harvard University Press, 1936).Recent WorkAhlstrom, D., “Innovation and Growth: How Business Contributes to Society,” Academy of Management Perspectives (August 2010): 10–23.Lichtenberg, F. R., “Pharmaceutical Innovation and Longevity Growth in 30 Devel-oping and High-Income Countries, 2000–2009,” Health Policy and Technology 3 (2014):36–58.“The 25 Best Inventions of 2017,” Time (December 1, 2017).Schilling, M. A., “Towards Dynamic Efficiency: Innovation and Its Implications for Antitrust,” Antitrust Bulletin 60, no. 3 (2015): 191–207.Suggested Further Reading 1. J. P. Womack, D. T. Jones, and D. Roos, The Machine That Changed the World (New York: Rawson Associates, 1990). 2. W. Qualls, R. W. Olshavsky, and R. E. Michaels, “Shortening of the PLC—An Empirical Test,” Journal of Marketing 45 (1981), pp. 76–80. 3. M. A. Schilling and C. E. Vasco, “Product and Process Technological Change and the Adoption of Modular Organizational Forms,” in Winning Strategies in a Deconstructing World, eds. R. Bresser, M. Hitt, R. Nixon, and D. Heuskel (Sussex, England: John Wiley & Sons, 2000), pp. 25–50.EndnotesFinal PDF to printer
sch87956_ch01_001-012.indd 11 11/02/18 02:10 PMChapter 1 Introduction 11 4. N. Crafts, “The First Industrial Revolution: A Guided Tour for Growth Economists,” The American Economic Review 86, no. 2 (1996), pp. 197–202; R. Solow, “Technical Change and the Aggregate Production Function,” Review of Economics and Statistics 39 (1957), pp.  312–20; and N. E. Terleckyj, “What Do R&D Numbers Tell Us about Technological Change?” American Economic Association 70, no. 2 (1980), pp. 55–61. 5. H. A. Simon, “Technology and Environment,” Management Science 19 (1973), pp. 1110–21. 6. S. Brown and K. Eisenhardt, “The Art of Continuous Change: Linking Complexity Theory and Time-Paced Evolution in Relentlessly Shifting Organizations,” Administrative Science Quarterly 42 (1997), pp. 1–35; K. Clark and T. Fujimoto, Product Development Performance (Boston: Harvard Business School Press, 1991); R. Cooper, “Third Generation New Product Processes,” Journal of Product Innovation Management 11 (1994), pp. 3–14; D. Doughery, “Reimagining the Differentiation and Integration of Work for Sustained Product Innovation,” Organization Science 12 (2001), pp. 612–31; and M. A. Schilling and C. W. L. Hill, “ Managing the New Product Development Process: Strategic Imperatives,” Academy of Management Exec-utive 12, no. 3 (1998), pp. 67–81. 7. Markham, SK, and Lee, H. “Product Development and Management Association’s 2012 com-parative performance assessment study,” Journal of Product Innovation Management 30 (2013), issue 3:408–429. 8. G. Stevens and J. Burley, “3,000 Raw Ideas Equals 1 Commercial Success!” Research Technol-ogy Management 40, no. 3 (1997), pp. 16–27. 9. Standard & Poor’s Industry Surveys, Pharmaceutical Industry, 2008. 10. DiMasi, J. A., H. G. Grabowski, and R. W. Hansen, “Innovation in the Pharmaceutical Industry: New Estimates of R&D Costs,” Journal of Health Economics 47 (May 2016):20–33.Final PDF to printer
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sch87956_ch02_013-042.indd 13 11/05/18 01:32 PMPart OneIndustry Dynamics of Technological InnovationIn this section, we will explore the industry dynamics of technological innovation, including: ∙ The sources from which innovation arises, including the roles of individuals, organizations, government institutions, and networks. ∙ The types of innovations and common industry patterns of technological evo-lution and diffusion. ∙ The factors that determine whether industries experience pressure to select a dominant design, and what drives which technologies to dominate others. ∙ The effects of timing of entry, and how firms can identify (and manage) their entry options.This section will lay the foundation that we will build upon in Part Two, Formulat-ing Technological Innovation Strategy.Final PDF to printer
sch87956_ch02_013-042.indd 14 11/05/18 01:32 PMPart 1: Industry Dynamics of Technological InnovationChapter 2Sources of InnovationChapter 5Timing of EntryChapter 4Standards Battles,Modularity, andPlatform CompetitionChapter 3Types and Patternsof InnovationPart 2: Formulating TechnologicalInnovation StrategyChapter 6Defining the Organization’s Strategic DirectionChapter 9Protecting InnovationChapter 8CollaborationStrategiesChapter 7Choosing InnovationProjectsPart 3: Implementing TechnologicalInnovation StrategyChapter 10Organizing for InnovationChapter 13Crafting a DeploymentStrategyChapter 11Managing the NewProduct DevelopmentProcessChapter 12Managing NewProductDevelopment TeamsFeedbackIndustry Dynamics of Technological InnovationFinal PDF to printer
15sch87956_ch02_013-042.indd 15 11/05/18 01:32 PMChapter TwoSources of InnovationThe Rise of “Clean Meat”aIn late 2017, Microsoft founder Bill Gates and a group of other high-powered investors—who comprise Breakthrough Energy Ventures, such as Amazon’s Jeff Bezos, Alibaba’s Jack Ma, and Virgin’s Richard Branson—announced their intention to fund a San Francisco–based start-up called Memphis Meats with an unusual business plan: it grew “clean” meat using stem cells, eliminating the need to breed or slaughter animals. The company had already produced beef, chicken, and duck, all grown from cells.bThere were many potential advantages of growing meat without animals. First, growth in the demand for meat was skyrocketing due to both population growth and development. When developing countries become wealthier, they increase their meat consumption. While humanity’s population had doubled since 1960, consumption of animal products had risen fivefold and was still increasing. Many scientists and economists had begun to warn of an impending “meat crisis.” Even though plant protein substitutes like soy and pea protein had gained enthusias-tic followings, the rate of animal protein consumption had continued to rise. This suggested that meat shortages were inevitable unless radically more efficient methods of production were developed.Large-scale production of animals also had a massively negative effect on the environment. The worldwide production of cattle, for example, resulted in a larger emissions of greenhouse gases than the collective effect of the world’s automobiles. Animal production is also extremely water intensive: To produce each chicken sold in a supermarket, for example, requires more than 1000 gallons of water, and each egg requires 50 gallons. Each gallon of cow’s milk required 900 gallons of water. A study by Oxford University indicated that meat grown from cells would produce up to 96 percent lower greenhouse gas emissions, use 45 percent less energy, 99 percent less land, and 96 percent less water.cScientists also agreed that producing animals for consumption was simply inefficient. Estimates suggested, for example, that it required roughly 23 calo-ries worth of inputs to produce one calorie of beef. “Clean” meat promised to bring that ratio down to three calories of inputs to produce a calorie of beef—more than seven times greater efficiency. “Clean” meat also would not contain Final PDF to printer
sch87956_ch02_013-042.indd 16 11/05/18 01:32 PM16 Part One Industry Dynamics of Technological Innovationantibiotics, steroids, or bacteria such as E. coli—it was literally “cleaner,” and that translated into both greater human health and lower perishability.The Development of Clean MeatIn 2004, Jason Matheny, a 29-year-old recent graduate from the John Hopkins Public Health program decided to try to tackle the problems with production of animals for food. Though Matheny was a vegetarian himself, he realized that convincing enough people to adopt a plant-based diet to slow down the meat crisis was unlikely. As he noted, “You can spend your time trying to get people to turn their lights out more often, or you can invent a more efficient light bulb that uses far less energy even if you leave it on. What we need is an enormously more efficient way to get meat.”dMatheny founded a nonprofit organization called New Harvest that would be dedicated to promoting research into growing real meat without animals. He soon discovered that a Dutch scientist, Willem van Eelen was exploring how to culture meat from animal cells. Van Eelen had been awarded the first patent on a cultured meat production method in 1999. However, the eccentric scientist had not had much luck in attracting funding to his project, nor in scaling up his production. Matheny decided that with a little prodding, the Dutch government might be persuaded to make a serious investment in the development of meat-culturing methods. He managed to get a meeting with the Netherland’s minister of agriculture where he made his case. Matheny’s efforts paid off: The Dutch government agreed to invest two million euros in exploring methods of creating cultured meat at three different universities.By 2005, clean meat was starting to gather attention. The journal Tissue Engi-neering published an article entitled “In Vitro-Cultured Meat Production,” and in the same year, the New York Times profiled clean meat in its annual “Ideas of the Year.” However, while governments and universities were willing to invest in the basic science of creating methods of producing clean meat, they did not have the capabilities and assets needed to bring it to commercial scale. Matheny knew that to make clean meat a mainstream reality, he would need to attract the interest of large agribusiness firms.Matheny’s initial talks with agribusiness firms did not go well. Though meat producers were open to the idea conceptually, they worried that consumers would balk at clean meat and perceive it as unnatural. Matheny found this criti-cism frustrating; after all, flying in airplanes, using air conditioning, or eating meat pumped full of steroids to accelerate its growth were also unnatural.Progress was slow. Matheny took a job at the Intelligence Advanced Research Projects Activity (IARPA) of the U.S. Federal Government while continuing to run New Harvest on the side. Fortunately, others were also starting to realize the urgency of developing alternative meat production methods.Enter Sergey Brin of GoogleIn 2009, the foundation of Sergey Brin, cofounder of Google, contacted Matheny to learn more about cultured meat technologies. Matheny referred Brin’s Final PDF to printer
sch87956_ch02_013-042.indd 17 11/05/18 01:32 PMChapter 2 Sources of Innovation 17foundation to Dr. Mark Post at Maastricht University, one of the leading scientists funded by the Dutch government’s clean meat investment. Post had succeeded in growing mouse muscles in vitro and was certain his process could be repli-cated with the muscles of cows, poultry, and more. As he stated, “It was so clear to me that we could do this. The science was there. All we needed was fund-ing to actually prove it, and now here was a chance to get what was needed.”e It took more than a year to work out the details, but in 2011, Brin offered Post roughly three quarters of a million dollars to prove his process by making two cultured beef burgers, and Post’s team set about meeting the challenge.In early 2013, the moment of truth arrived: Post and his team had enough cul-tured beef to do a taste test. They fried up a small burger and split it into thirds to taste. It tasted like meat. Their burger was 100 percent skeletal muscle and they knew that for commercial production they would need to add fat and con-nective tissue to more closely replicate the texture of beef, but those would be easy problems to solve after passing this milestone. The press responded enthusiastically, and the Washington Post ran an article headlined, “Could a Test-Tube Burger Save the Planet?”fGoing CommercialIn 2015, Uma Valeti, a cardiologist at the Mayo Clinic founded his own cultured- meat research lab at the University of Minnesota. “I’d read about the ineffi-ciency of meat-eating compared to a vegetarian diet, but what bothered me more than the wastefulness was the sheer scale of suffering of the animals.”g As a heart doctor, Valeti also believed that getting people to eat less meat could improve human health: “I knew that poor diets and the unhealthy fats and refined carbs that my patients were eating were killing them, but so many seemed totally unwilling to eat less or no meat. Some actually told me they’d rather live a shorter life than stop eating the meats they loved.” Valeti began fantasizing about a best-of-both-worlds alternative—a healthier and kinder meat. As he noted, “The main difference I thought I’d want for this meat I was envisioning was that it’d have to be leaner and more protein-packed than a cut of supermarket meat, since there’s a large amount of saturated fat in that meat. . . . Why not have fats that are proven to be better for health and longev-ity, like omega-3s? We want to be not just like conventional meat but healthier than conventional meat.”hValeti was nervous about leaving his successful position as a cardiologist—after all, he had a wife and two children to help support. However, when he sat down to discuss it with his wife (a pediatric eye surgeon), she said, “Look, Uma. We’ve been wanting to do this forever. I don’t ever want us to look back on why we didn’t have the courage to work on an idea that could make this world kinder and better for our children and their generation.”i And thus Valeti’s company, which would later be named Memphis Meats, was born.Building on Dr. Post’s achievement, Valeti’s team began experimenting with ways to get just the right texture and taste. After much trial and error, and a grow-ing number of patents, they hosted their first tasting event in December 2015. On the menu: a meatball. This time the giant agribusiness firms took notice.Final PDF to printer
sch87956_ch02_013-042.indd 18 11/05/18 01:32 PM18 Part One Industry Dynamics of Technological InnovationAt the end of 2016, Tyson Foods, the world’s largest meat producer, announced that it would invest $150 million in a venture capital fund that would develop alternative proteins, including meat grown from self-reproducing cells. In August of 2017, agribusiness giant Cargill announced it was investing in Mem-phis Meats, and a few months later in early 2018, Tyson Foods also pledged investment.That first meatball cost $1200; to make cultured meat a commercial reality required bringing costs down substantially. But analysts were quick to point out that the first iPhone had cost $2.6 billion in R&D—much more than the first cul-tured meats. Scale and learning curve efficiencies would drive that cost down. Valeti had faith that the company would soon make cultured meat not only competitive with traditional meat, but more affordable. Growing meat rather than whole animals had, after all, inherent efficiency advantages.Some skeptics believed the bigger problem was not production economies, but consumer acceptance: would people be willing to eat meat grown with-out animals? Sergey Brin, Bill Gates, Jeff Bezos, Jack Ma, and Richard Branson were willing to bet that they would. As Branson stated in 2017, “I believe that in 30 years or so we will no longer need to kill any animals and that all meat will either be clean or plant-based, taste the same and also be much healthier for everyone.”jDiscussion Questions 1. What were the potential advantages of developing clean meat? What were the challenges of developing it and bringing it to market? 2. What kinds of organizations were involved in developing clean meat? What were the different resources that each kind of organization brought to the innovation? 3. Do you think people will be willing to eat clean meat? Can you think of other products or services that faced similar adoption challenges? a Adapted from a NYU teaching case by Paul Shapiro and Melissa Schilling. b Friedman, Z., “Why Bill Gates and Richard Branson Invested in ‘Clean’ Meat,” Forbes (August 2017). c Tuomisto, H. L., and M. J. de Mattos, “Environmental Impacts of Cultured Meat Production,” Environmental Science and Technology 14(2011): 6117–2123. d Shapiro, P. Clean Meat: How Growing Meat without Animals Will Revolutionize Dinner and the World (New York: Gallery Books, 2018), 35. e Shapiro, P. Clean Meat: How Growing Meat without Animals Will Revolutionize Dinner and the World (New York: Gallery Books, 2018), 60. f “Could a Test-Tube Burger Save the Planet?” Washington Post, August 5, 2013. g Shapiro, P. Clean Meat: How Growing Meat without Animals Will Revolutionize Dinner and the World (New York: Gallery Books, 2018), 113. h Shapiro, P. Clean Meat: How Growing Meat without Animals Will Revolutionize Dinner and the World (New York: Gallery Books, 2018), 115. i Shapiro, P. Clean Meat: How Growing Meat without Animals Will Revolutionize Dinner and the World (New York: Gallery Books, 2018), 118. j Friedman, Z., “Why Bill Gates and Richard Branson Invested in ‘Clean’ Meat,” Forbes (August 2017).Final PDF to printer
sch87956_ch02_013-042.indd 19 11/05/18 01:32 PMChapter 2 Sources of Innovation 19OVERVIEWInnovation can arise from many different sources. It can originate with individu-als, as in the familiar image of the lone inventor or users who design solutions for their own needs. Innovation can also come from the research efforts of universi-ties, government laboratories and incubators, or private nonprofit organizations. One primary engine of innovation is firms. Firms are well suited to innovation activities because they typically have greater resources than individuals and a management system to marshal those resources toward a collective purpose. Firms also face strong incentives to develop differentiating new products and ser-vices, which may give them an advantage over nonprofit or government-funded entities.An even more important source of innovation, however, does not arise from any one of these sources, but rather the linkages between them. Networks of innovators that leverage knowledge and other resources from multiple sources are one of the most powerful agents of technological advance.1 We can thus think of sources of innova-tion as composing a complex system wherein any particular innovation may emerge primarily from one or more components of the system or the linkages between them (see Figure 2.1).In the sections that follow, we will first consider the role of creativity as the under-lying process for the generation of novel and useful ideas. We will then consider how creativity is transformed into innovative outcomes by the separate components of the innovation system (individuals, firms, etc.), and through the linkages between differ-ent components (firms’ relationships with their customers, technology transfer from universities to firms, etc.).innovationThe practical implementation of an idea into a new device or process.FIGURE 2.1Sources of Innovation as a SystemPrivateNonprofitsGovernment-Funded ResearchUniversitiesIndividualsFirmsFinal PDF to printer
sch87956_ch02_013-042.indd 20 11/05/18 01:32 PM20 Part One Industry Dynamics of Technological InnovationCREATIVITYInnovation begins with the generation of new ideas. The ability to generate new and useful ideas is termed creativity. Creativity is defined as the ability to produce work that is useful and novel. Novel work must be different from work that has been previ-ously produced and surprising in that it is not simply the next logical step in a series of known solutions.2 The degree to which a product is novel is a function both of how different it is from prior work (e.g., a minor deviation versus a major leap) and of the audience’s prior experiences.3 A product could be novel to the person who made it, but known to most everyone else. In this case, we would call it reinvention. A product could be novel to its immediate audience, yet be well known somewhere else in the world. The most creative works are novel at the individual producer level, the local audience level, and the broader societal level.4Individual CreativityAn individual’s creative ability is a function of his or her intellectual abilities, knowledge, personality, motivation, and environment.The most important intellectual abilities for creative thinking include intelli-gence, memory, the ability to look at problems in unconventional ways, the ability to analyze which ideas are worth pursuing and which are not, and the ability to articulate those ideas to others and convince others that the ideas are worthwhile. One important intellectual ability for creativity is a person’s ability to let their mind engage in a visual mental activity termed primary process thinking.5 Because of its unstructured nature, primary process thinking can result in combining ideas that are not typically related, leading to what has been termed remote associations or diver-gent thinking. Sigmund Freud noted that primary process thinking was most likely to occur just before sleep or while dozing or daydreaming; others have observed that it might also be common when distracted by physical exercise, music, or other activities. Creative people may make their minds more open to remote associations and then mentally sort through these associations, selecting the best for further consideration. Having excellent working memory is useful here too—individuals with excellent working memory may be more likely or more able to search longer paths through the network of associations in their mind, enabling them to arrive at a connection between two ideas or facts that seem unexpected or strange to others.6 A connection that appears to be random may not be random at all—it is just difficult for other people to see the association because they are not following as long of a chain of associations.Consistent with this, studies by professors Mathias Benedek and Aljoscha Neu-bauer found that highly creative people usually follow the same association paths as less creative people—but they do so with such greater speed that they exhaust the common associations sooner, permitting them to get to less common associations ear-lier than others would.7 Benedek and Neubauer’s research argues that highly creative people’s speed of association is due to exceptional working memory and executive control. In other words, the ability to hold many things in one’s mind simultaneously ideaSomething imag-ined or pictured in the mind.creativityThe ability to produce novel and useful work.Final PDF to printer
sch87956_ch02_013-042.indd 21 11/05/18 01:32 PMChapter 2 Sources of Innovation 21and maneuver them with great facileness enables a person to rapidly explore many possible associations.8The impact of knowledge on creativity is somewhat double-edged. If an individual has too little knowledge of a field, he or she is unlikely to understand it well enough to contribute meaningfully to it. On the other hand, if an individual knows a field too well, that person can become trapped in the existing logic and paradigms, pre-venting him or her from coming up with solutions that require an alternative per-spective. Thus, an individual with only a moderate degree of knowledge of a field might be able to produce more creative solutions than an individual with extensive knowledge of the field, and breakthrough innovations are often developed by outsid-ers to a field.9Consider, for example, Elon Musk. Elon Musk developed a city search Web por-tal called Zip2 in college, then founded an Internet financial payments company that merged with a rival and developed the PayPal financial payment system. Then after selling PayPal, Musk decided to found SpaceX to develop reusable rockets, and also became part of the founding team of Tesla Motors, an electric vehicle company. Tesla subsequently acquired Solar City (a solar panel company that Elon Musk had helped his cousins create) and diversified into energy storage and more. Musk crosses boundaries because he enjoys tackling new, difficult problems. He has been able to be successful in a wide range of industries in part because he challenges the traditional models in those industries.10 For example, SpaceX was able to dramatically decrease the price of rocket components by building them in-house, and Solar City was able to dramatically increase solar panel adoption by offering a business model based on leas-ing that gave customers the option of putting no money down and paying for the panels with part of their energy savings.Another great example is provided by Gavriel Iddan, a guided missile designer for the Israeli military who invented a revolutionary way to allow doctors to see inside a patient’s gastrointestinal system. The traditional approach for obtaining images inside the gut is a camera on the end of a long flexible rod. This method is quite uncomfortable, and cannot reach large portions of the small intestine, but it was the industry standard for many decades. Most gastroenterologists have invested in significant training to use endoscopic tools, and many have also purchased endoscopic equipment for their clinics. Not surprisingly then, most innovation in this domain has focused on incremental improvements in the rod, cameras, and imaging software. Iddan, however, approached the problem of viewing the inside of the gut like a guided missile designer—not a gastroenterologist. He did not have the same assumptions about the need to control the camera with a rod, nor to trans-mit images with a wire. Instead, he invented a capsule (called the PillCam) with a power source, a light source, and two tiny cameras that the patient can swallow. The patient then goes about her day while the camera pill broadcasts images to a video pack worn by the patient. Roughly eight hours later, the patient returns to the doctor’s office to have the images read by a software algorithm that can identify any locations of bleeding (the camera pill exits naturally). The PillCam has proven to be safer and less expensive than traditional endoscopy (the PillCam costs less than $500), and it is dramatically more comfortable. For patients, the camera pill Final PDF to printer
sch87956_ch02_013-042.indd 22 11/05/18 01:32 PM22 Part One Industry Dynamics of Technological Innovationwas a no brainer; getting doctors to adopt it has been slower because of their exist-ing investment and familiarity with endoscopy. The PillCam is now sold in more than 60 countries, and several companies now offer competing products. The cam-era pill is a remarkable solution to a difficult problem, and it is easy to see why it came from an outsider, rather than an endoscope producer.11Outsiders often face resistance and skepticism. People tend to discount generalists and are suspicious of people who engage in activities that seem inconsistent with their identity. Outsiders like Musk, however, bring an advantage that insiders and industry veterans often lack. They aren’t trapped by the paradigms and assumptions that have long become calcified in industry veterans, nor do they have the existing investments in tools, expertise, or supplier and customer relationships that make change difficult and unappealing.The personality trait most often associated with creativity is “openness to experience.”12 Openness to experience reflects an individual’s use of active imagina-tion, aesthetic sensitivity (e.g., the appreciation for art and literature), attentiveness to emotion, a preference for variety, and intellectual curiosity. It is assessed by asking individuals to rate their degree of agreement or disagreement with statements such as “I have a vivid imagination,” “I enjoy hearing new ideas,” “I have a rich vocabu-lary,” “I rarely look for deeper meaning in things” (reversed), “I enjoy going to art museums,” “I avoid philosophical discussions” (reversed), “I enjoy wild flights of fantasy,” and more. Individuals who score high on the openness to experience dimen-sion tend to have great intellectual curiosity, are interested in unusual ideas, and are willing to try new things.Intrinsic motivation has also been shown to be very important for creativity.13 That is, individuals are more likely to be creative if they work on things they are genuinely interested in and enjoy. In fact, several studies have shown that creativity can be undermined by providing extrinsic motivation such as money or awards.14 This raises serious questions about the role played by idea collection systems in organizations that offer monetary rewards for ideas. On the one hand, such extrin-sic rewards could derail intrinsic motivation. On the other hand, if the monetary rewards are small, such systems may be primarily serving to invite people to offer ideas, which is a valuable signal about the culture of the firm. More research is needed in this area to know exactly what kind of solicitation for ideas, if any, is most effective.Finally, to fully unleash an individual’s creative potential usually requires a sup-portive environment with time for the individual to explore their ideas independently, tolerance for unorthodox ideas, a structure that is not overly rigid or hierarchical, and decision norms that do not require consensus.15Organizational CreativityThe creativity of the organization is a function of creativity of the individuals within the organization and a variety of social processes and contextual factors that shape the way those individuals interact and behave.16 An organization’s overall creativity level is thus not a simple aggregate of the creativity of the individuals it employs. The organization’s structure, routines, and incentives could thwart individual creativity or amplify it.Final PDF to printer
sch87956_ch02_013-042.indd 23 11/05/18 01:32 PMChapter 2 Sources of Innovation 23The most familiar method of a company tapping the creativity of its individual employees is the suggestion box. In 1895, John Patterson, founder of National Cash Register (NCR), created the first sanctioned suggestion box program to tap the ideas of the hourly worker.17 The program was considered revolutionary in its time. The origina-tors of adopted ideas were awarded $1. In 1904, employees submitted 7000 ideas, of which one-third were adopted. Other firms have created more elaborate systems that not only capture employee ideas, but incorporate mechanisms for selecting and imple-menting those ideas. Google, for example, utilizes an idea management system whereby employees e-mail their ideas for new products and processes to a company-wide data-base where every employee can view the idea, comment on it, and rate it (for more on how Google encourages innovation, see the Theory in Action on Inspiring Innova-tion at Google). Honda of America utilizes an employee-driven idea system (EDIS) whereby employees submit their ideas, and if approved, the employee who submits the idea is responsible for following through on the suggestion, overseeing its progress from concept to implementation. Honda of America reports that more than 75 per-cent of all ideas are implemented.18 Bank One, one of the largest holding banks in the United States, has created an employee idea program called “One Great Idea.” Employ-ees access the company’s idea repository through the company’s intranet. There they can submit their ideas and actively interact and collaborate on the ideas of others.19 Through active exchange, the employees can evaluate and refine the ideas, improving their fit with the diverse needs of the organization’s stakeholders.At Bank of New York Mellon they go a step further—the company holds enterprise- wide innovation competitions where employees form their own teams and compete in coming up with innovative ideas. These ideas are first screened by judges at both the regional and business-line level. Then, the best ideas are pitched to senior manage-ment in a “Shark Tank” style competition that is webcast around the world. If a senior executive sees an idea they like, they step forward and say they will fund it and run with it. The competition both helps the company come up with great ideas and sends a strong signal to employees about the importance of innovation.20Idea collection systems (such as suggestion boxes) are relatively easy and inex-pensive to implement, but are only a first step in unleashing employee creativity. Today companies such as Intel, Motorola, 3M, and Hewlett-Packard go to much greater lengths to tap the creative potential embedded in employees, including investing in creativity training programs. Such programs encourage managers to develop verbal and nonverbal cues that signal employees that their thinking and autonomy are respected. These cues shape the culture of the firm and are often more effective than monetary rewards—in fact, as noted previously, sometimes monetary rewards undermine creativity by encouraging employees to focus on extrinsic rather than intrinsic motivation.21 The programs also often incorporate exercises that encourage employees to use creative mechanisms such as develop-ing alternative scenarios, using analogies to compare the problem with another problem that shares similar features or structure, and restating the problem in a new way. One product design firm, IDEO, even encourages employees to develop mock prototypes of potential new products out of inexpensive materials such as cardboard or styrofoam and pretend to use the product, exploring potential design features in a tangible and playful manner.intranetA private network, acces-sible only to authorized individuals. It is like the Internet but operates only within (“intra”) the organization.Final PDF to printer
24sch87956_ch02_013-042.indd 24 11/05/18 01:32 PMGoogle is always working on a surprising array of proj-ects, ranging from the completely unexpected (such as autonomous self-driving cars and solar energy) to the more mundane (such as e-mail and cloud services).a In pursuit of continuous innovation at every level of the company, Google uses a range of formal and informal mechanisms to encourage its employees to innovate:b20 Percent Time: All Google engineers are encouraged to spend 20 percent of their time working on their own projects. This was the source of some of Google’s most famous products (e.g., Google Mail, Google News).Recognition Awards: Managers were given discretion to award employees with “recognition awards” to cel-ebrate their innovative ideas.Google Founders’ Awards: Teams doing outstand-ing work could be awarded substantial stock grants. Some employees had become millionaires from these awards alone.Adsense Ideas Contest: Each quarter, the Adsense online sales and operations teams reviewed 100 to 200 submis-sions from employees around the world, and selected finalists to present their ideas at the quarterly contest.Innovation Reviews: Formal meetings where manag-ers present ideas originated in their divisions directly to founders Larry Page and Sergey Brin, as well as to CEO Eric Bradbury, D. 2011. Google’s rise and rise. Backbone, Oct:24–27.b Groysberg, B., Thomas, D.A. & Wagonfeld, A.B. 2011. Keep-ing Google “Googley.” Harvard Business School Case 9:409–039.c Kirby, J. 2009. How Google really does it. Canadian Business, 82(18):54–58.Theory in Action Inspiring Innovation at GoogleTRANSLATING CREATIVITY INTO INNOVATIONInnovation is more than the generation of creative ideas; it is the implementation of those ideas into some new device or process. Innovation requires combining a creative idea with resources and expertise that make it possible to embody the creative idea in a useful form. We will first consider the role of individuals as innovators, including innovation by inventors who specialize in creating new products and processes, and innovation by end users. We then will look at innovation activity that is organized by firms, universities, and government institutions.The InventorThe familiar image of the inventor as an eccentric and doggedly persistent scientist may have some basis in cognitive psychology. Analysis of personality traits of inventors suggests these individuals are likely to be interested in theoretical and abstract thinking, and have an unusual enthusiasm for problem solving. One 10-year study of inventors concludes that the most successful inventors possess the follow-ing characteristics: 1. They have mastered the basic tools and operations of the field in which they invent, but they have not specialized solely in that field; instead they have pursued two or three fields simultaneously, permitting them to bring different perspectives to each. 2. They are curious and more interested in problems than solutions.Final PDF to printer
25sch87956_ch02_013-042.indd 25 11/05/18 01:32 PMTheory in Action Dean KamenIn January 2001, an Internet news story leaked that iconoclastic inventor Dean Kamen had devised a fan-tastic new invention—a device that could affect the way cities were built, and even change the world. Shrouded in secrecy, the mysterious device, code-named “Ginger” and “IT,” became the talk of the technological world and the general public, as speculation about the tech-nology grew wilder and wilder. In December of that year, Kamen finally unveiled his invention, the Segway Human Transporter.a Based on an elaborate combi-nation of motors, gyroscopes, and a motion control algorithm, the Segway HT was a self-balancing, two-wheeled scooter. Though to many it looked like a toy, the Segway represented a significant advance in tech-nology. John Doerr, the venture capitalist behind and Netscape, predicted it would be bigger than the Internet. Though the Segway did not turn out to be a mass market success, its technological achieve-ments were significant. In 2009, General Motors and Segway announced that they were developing a two-wheeled, two-seat electric vehicle based on the Segway that would be fast, safe, inexpensive, and clean. The car would run on a lithium-ion battery and achieve speeds of 35 miles per hour.The Segway was the brainchild of Dean Kamen, an inventor with more than 150 U.S. and foreign patents, whose career began in his teenage days of devising mechanical gadgets in his parents’ basement.b Kamen never graduated from college, though he has since received numerous honorary degrees. He is described as tireless and eclectic, an entrepreneur with a seem-ingly boundless enthusiasm for science and technology. Kamen has received numerous awards for his inven-tions, including the Kilby award, the Hoover Medal, and the National Medal of Technology. Most of his inventions have been directed at advancing health-care technol-ogy. In 1988, he invented the first self-service dialysis machine for people with kidney failure. Kamen had rejected the original proposal for the machine brought to him by Baxter, one of the world’s largest medical equipment manufacturers. To Kamen, the solution was not to come up with a new answer to a known problem, but to instead reformulate the problem: “What if you can find the technology that not only fixes the valves but also makes the whole thing as simple as plugging a cassette into a VCR? Why do patients have to continue to go to these centers? Can we make a machine that can go in the home, give the patients back their dignity, reduce the cost, reduce the trauma?”c The result was the HomeChoice dialysis machine, which won Design News’ 1993 Medical Product of the Year award.In 1999, Kamen’s company, DEKA Research, intro-duced the IBOT Mobility System, an extremely advanced wheelchair incorporating a sophisticated balancing sys-tem that enabled users to climb stairs and negotiate sand, rocks, and curbs. According to Kamen, the IBOT “allowed a disabled person, a person who cannot walk, to basically do all the ordinary things that you take for granted that they can’t do even in a wheel-chair, like go up a curb.”d It was the IBOT’s combina-tion of balance and mobility that gave rise to the idea of the Segway.a J. Bender, D. Condon, S. Gadkari, G. Shuster, I. Shuster, and M. A. Schilling, “Designing a New Form of Mobility: Segway Human Transporter,” New York University teaching case, 2003.b E. I. Schwartz, “The Inventor’s Play-Ground,” Technology Review 105, no. 8 (2002), pp. 68–73.c Ibid.d The Great Inventor. Retrieved November 19, 2002, from 3. They question the assumptions made in previous work in the field. 4. They often have the sense that all knowledge is unified. They seek global solutions rather than local solutions, and are generalists by nature.22These traits are demonstrated by Dean Kamen, inventor of the Segway Human Transporter and the IBOT Mobility System (a technologically advanced wheelchair), profiled in the Theory in Action section on Dean Kamen. They are also illustrated in the following quotes by Nobel laureates. Sir MacFarlane Burnet, Nobel Prize–winning Final PDF to printer
sch87956_ch02_013-042.indd 26 11/05/18 01:32 PM26 Part One Industry Dynamics of Technological Innovationimmunologist, noted, “I think there are dangers for a research man being too well trained in the field he is going to study,”23 and Peter Debye, Nobel Prize–winning chemist, noted, “At the beginning of the Second World War, R. R. Williams of Bell Labs came to Cornell to try to interest me in the polymer field. I said to him, ‘I don’t know anything about polymers. I never thought about them.’ And his answer was, ‘That is why we want you.’”24 The global search for global solutions is aptly illustrated by Thomas Edi-son, who did not set out to invent just a lightbulb: “The problem then that I undertook to solve was . . . the production of the multifarious apparatus, methods, and devices, each adapted for use with every other, and all forming a comprehensive system.”25Such individuals may spend a lifetime developing numerous creative new devices or processes, though they may patent or commercialize few. The qualities that make people inventive do not necessarily make them entrepreneurial; many inventors do not actively seek to patent or commercialize their work. Many of the most well-known inventors (e.g., Alexander Graham Bell, Thomas Alva Edison, Albert Einstein, and Benjamin Franklin), however, had both inventive and entrepreneurial traits.26Innovation by UsersInnovation often originates with those who create solutions for their own needs. Users often have both a deep understanding of their unmet needs and the incentive to find ways to fulfill them.27 While manufacturers typically create new product innova-tions in order to profit from the sale of the innovation to customers, user innovators often have no initial intention to profit from the sale of their innovation––they cre-ate the innovation for their own use.28 Users may alter the features of existing prod-ucts, approach existing manufacturers with product design suggestions, or develop new products themselves. For example, the extremely popular small sailboat, the Laser, was designed without any formal market research or concept testing. Instead it was the creative inspiration of three former Olympic sailors, Ian Bruce, Bruce Kirby, and Hans Vogt. They based the boat design on their own preferences: simplicity, maximum performance, transportability, durability, and low cost. The resulting sailboat became hugely successful; during the 1970s and ’80s, 24 Laser sailboats were produced daily.29Another dramatic example is the development of Indermil, a tissue adhesive based on Super Glue. Super Glue is a powerful instant adhesive, and while its strength and speed of action were a great asset in most product applications, these features also caused a key product concern—its tendency to bond skin. Managers at Loctite, the company that developed Super Glue, wondered if this tendency could be exploited to develop an alternative to sutures for surgical applications. In the 1970s, the company experimented with developing a version of the adhesive that could be packaged and sterilized, but the project failed and funding for it was canceled. In 1980, the proj-ect was resurrected when Loctite was approached by a pharmaceutical company that wanted to collaborate on developing a wound closure product. The two companies spent three years attempting to develop special Super Glues that would degrade quickly in the body, but ultimately shelved the project again. By this point most managers in the company no longer wanted to be involved in developing an alternative to sutures—it was considered far too risky. However, in 1988, Bernie Bolger of Loctite was contacted by Professor Alan Roberts, a worldwide figure in reconstructive surgery. Roberts pro-ceeded to give the managers at Loctite a stunning presentation about doctors who had Final PDF to printer
sch87956_ch02_013-042.indd 27 11/05/18 01:32 PMChapter 2 Sources of Innovation 27responded to the Bradford football stadium fire of 1983. Roberts and many other doc-tors had been called in to carry out surgery and skin grafting in makeshift tents around the stadium. Because stitching was too slow and skin damage was such that sutures would be ineffective, the doctors had used standard tubes of Super Glue to repair the skin and stick skin grafts in place! Roberts showed pictures of doctors in green garb standing around with Super Glue tubes stuck to their aprons, and pictures of people with large areas of skin missing and then those same people years later, with almost perfect skin repairs. Roberts begged the Loctite managers to continue their work on developing a version of Super Glue for tissue adhesion. Roberts’s presentation was so compelling that the company again took up the project, this time with support from the CEO and serious funding. Approval from the U.S. Food and Drug Administration was won in 2002, and by 2003 the product was selling well in over 40 countries.30Research and Development by FirmsAcross all nations, one of the most obvious sources of firm innovation is the firm’s own research and development efforts. In most developed countries, firms account for the majority of R&D performed (see Figure 2.2).Though the terms research and development are often lumped together, they actually represent different kinds of investment in innovation-related activities. Research can refer to both basic research and applied research. Basic research is effort directed at increasing understanding of a topic or field without a specific immediate commercial application in mind. This research advances scientific knowledge, which may (or may not) turn out to have long-run commercial implications. Applied research is directed basic researchResearch targeted at increasing scientific knowl-edge for its own sake. It may or may not have any long-term commercial application.applied researchResearch targeted at increasing knowledge for a specific applica-tion or need.FIGURE 2.2Percent of R&D That Is Basic, Applied, or Experimen-tal, by Coun-try, 201590. Basic% Applied% Experimental development% OtherChinaJapanSouthKoreaFranceIndiaUnitedKingdomFinal PDF to printer
sch87956_ch02_013-042.indd 28 11/05/18 01:32 PM28 Part One Industry Dynamics of Technological Innovationat increasing understanding of a topic to meet a specific need. In industry, this research typically has specific commercial objectives. Development refers to activities that apply knowledge to produce useful devices, materials, or processes. Thus, the term research and development refers to a range of activities that extend from early explo-ration of a domain to specific commercial implementations. A firm’s R&D intensity (its R&D expenditures as a percentage of its revenues) has a strong positive correlation with its sales growth rate, sales from new products, and profitability.31Figure 2.2 shows the percent of R&D that was basic, applied, or experimental for a selected number of countries in 2015. As shown, China, Japan, and Korea placed much higher emphasis on development than the other countries.During the 1950s and 1960s, scholars of innovation emphasized a science-push approach to research and development.32 This approach assumed that innovation proceeded linearly from scientific discovery, to invention, to engineering, then manufacturing activities, and finally marketing. According to this approach, the primary sources of innovation were discoveries in basic science that were trans-lated into commercial applications by the parent firm. This linear process was soon shown to have little applicability to real-world products. In the mid-1960s, another model of innovation gained prominence: the demand-pull model of research and development. This approach argued that innovation was driven by the perceived demand of potential users. Research staff would develop new products in efforts to respond to customer problems or suggestions. This view, however, was also criticized as being too simplistic. Rothwell, for example, points out that different phases of innovation are likely to be characterized by varying levels of science push and demand pull.33Most current research suggests that firms that are successful innovators utilize mul-tiple sources of information and ideas, including: ∙ In-house research and development, including basic research. ∙ Linkages to customers or other potential users of innovations. ∙ Linkages to an external network of firms that may include competitors, comple-mentors, and suppliers. ∙ Linkages to other external sources of scientific and technical information, such as universities and government laboratories.34Firm Linkages with Customers, Suppliers, Competitors, and ComplementorsFirms often form alliances with customers, suppliers, complementors, and even com-petitors to jointly work on an innovation project or to exchange information and other resources in pursuit of innovation. Collaboration might occur in the form of alliances, participation in research consortia, licensing arrangements, contract research and development, joint ventures, and other arrangements. The advantages and disadvan-tages of different forms of collaboration are discussed in Chapter Eight. Collaborators can pool resources such as knowledge and capital, and they can share the risk of a new product development project.The most frequent collaborations are between firms and their customers, suppliers, and local universities (see Figure 2.3).35 Several studies indicate that firms consider developmentActivities that apply knowledge to produce useful devices, materi-als, or processes.Final PDF to printer
sch87956_ch02_013-042.indd 29 11/05/18 01:32 PMChapter 2 Sources of Innovation 29users their most valuable source of new product ideas. The use of such collaborations is consistent across North America, Europe, and Japan, though Japanese firms may be somewhat more likely to collaborate extensively with their customers (see Figure 2.3).Firms may also collaborate with competitors and complementors. Complementors are organizations (or individuals) that produce complementary goods, such as light-bulbs for lamps, chargers for electric vehicles, or applications for smartphones. In some industries, firms produce a range of goods and the line between competitor and complementor can blur.In some circumstances, firms might be bitter rivals in a particular product category and yet engage in collaborative development in that product category or complemen-tary product categories. For instance, Microsoft competes against Rockstar Games in many video game categories, yet also licenses many Rockstar Games to play on its Xbox models. Rockstar is thus both a competitor and complementor to Microsoft. This can make the relationships between firms very complex—firms may have to manage a delicate balance between its roles of competitor versus complementor, or complemen-tors might refuse to cooperate. For example, when Google bought Motorola Mobility in 2011, makers of mobile phone handsets that used Google’s Android operating system such as Samsung and HTC were watching closely to see if Google would give Motorola handsets preferential access to Google software. Many analysts speculated that Samsung and HTC would begin developing more phones based on Microsoft’s mobile operating system. To avoid the ire and defection of its complementors, Google announced that Motorola would be run as a separate entity and be given no advantages over makers of other Android-powered handsets. Android was to remain an equal-opportunity platform where any handset maker had a shot at making the next great Android phone.36External versus Internal Sourcing of InnovationCritics have often charged that firms are using external sources of technological inno-vation rather than investing in original research. But empirical evidence suggests that external sources of information are more likely to be complements to rather than sub-stitutes for in-house research and development. Research by the Federation of British Industries indicated firms that had their own research and development were also the heaviest users of external collaboration networks. Presumably doing in-house R&D helps to build the firm’s absorptive capacity, enabling it to better assimilate complementorsProducers of complementary goods or services (e.g., for video game console producers such as Sony or Nintendo, game developers) are complementors.absorptive capacityThe ability of an organization to recognize, assimilate, and utilize new knowledge.FIGURE 2.3Percentage of Companies That Report Extensive Collaboration with Customers, Suppliers, and UniversitiesSource: E. Roberts, “Benchmarking Global Strategic Management of Technology,” Research Technology Management, March–April 2001, pp. 25–36. North America (%) Europe (%) Japan (%) Collaborates with: Customers 44 38 52 Suppliers 45 45 41 Universities 34 32 34Final PDF to printer
sch87956_ch02_013-042.indd 30 11/05/18 01:32 PM30 Part One Industry Dynamics of Technological Innovationand utilize information obtained externally.37 Absorptive capacity refers to the firm’s ability to understand and use new information (absorptive capacity is discussed in more detail in Chapter Four).Universities and Government-Funded ResearchAnother important source of innovation comes from public research institutions such as universities, government laboratories, and incubators. A significant share of com-panies report that research from public and nonprofit institutions enabled them to develop innovations that they would not have otherwise developed.38UniversitiesUniversities in the United States performed $64.6 billion worth of R&D in 2015, mak-ing them the second largest performer of R&D in the United States after industry, and making the United States the place where universities spend the most money on R&D, on an absolute basis, in the world (see Figure 2.4). Of that, over $40 billion was for basic research (versus applied research), making universities the number one per-former of basic research in the United States. The nation where universities perform the highest share of R&D, on the other hand, is the United Kingdom, where universities spend $11.9 billion, accounting for 25.6% of total R&D performance in the country. Many universities encourage their faculty to engage in research that may lead to useful innovations. Typically the intellectual property policies of a university embrace both patentable and unpatentable innovations, and the university retains sole discretion over the rights to commercialize the innovation. If an invention is successfully commer-cialized, the university typically shares the income with the individual inventor(s).39 FIGURE 2.4Total R&D Expenditures and Percent of R&D Funds by Perform-ing Sector, by Country 201590. R&D expenditures (PPP $billions)% of total R&D performance0.0UnitedStatesChinaJapanGermanySouthKoreaFranceIndiaUnitedKingdomR&D performance: Share of total (%) BusinessR&D performance: Share of total (%) GovernmentR&D performance: Share of total (%) Higher educationR&D performance: Share of total (%) Private nonprofitTotal R&D Expenditures (PPP $billions)Final PDF to printer
sch87956_ch02_013-042.indd 31 11/05/18 01:32 PMChapter 2 Sources of Innovation 31To increase the degree to which university research leads to commercial innovation, many universities have established technology transfer offices.In the United States, the creation of university technology transfer offices acceler-ated rapidly after the Bayh–Dole Act was passed in 1980. This act allowed universities to collect royalties on inventions funded with taxpayer dollars. Before this, the fed-eral government was entitled to all rights from federally funded inventions.40 Several European and Asian countries subsequently followed the U.S. lead and established legislation similar to Bayh–Dole, including Denmark, Austria, Finland, Norway, Germany, France, United Kingdom, Japan, China, and India. Sweden and Italy, on the other hand, still have a policy of “professor’s privilege” where university faculty retain sole ownership rights over their inventions. While the revenues from the uni-versity technology transfer activities are still quite small in comparison to university research budgets, their importance is growing. Initially, many anticipated that busi-nesses would flock to license the intellectual property created by universities, lead-ing to a substantial flow in licensing revenues. This “if you build it they will come” mindset turned out to be wrong, and licensing revenues were far less than expected. Now universities are taking a much more active role in helping to create start-ups based on their intellectual property, and in proactively forging relationships with the commercial sector.41 Universities also contribute significantly to innovation through the publication of research results that are incorporated into the development efforts of other organizations and individuals.Government-Funded ResearchGovernments of many countries actively invest in research through their own labora-tories, the formation of science parks and incubators, and grants for other public or private research entities. For example, the U.S. Small Business Administration man-ages two programs that enable innovative small businesses to receive funding from federal agencies such as the Department of Defense, the Department of Energy, the Department of Health and Human Services, and others. The first is the Small Busi-ness Innovation Research (SBIR) program. Under the SBIR program, agencies award grants of up to $1,150,000 to small businesses to help them develop and commercial-ize a new innovation. The second is the Small Business Technology Transfer (STTR) program, which awards grants of up to $1,150,000 to facilitate a partnership between a small business and a nonprofit research institution—its objective is to more fully leverage the innovation that takes place in research laboratories by connecting research scientists with entrepreneurs.Notable examples of science parks with incubators include: ∙ Stanford Research Park, established near Stanford University in 1951. ∙ Research Triangle Park, established in North Carolina in 1959. ∙ Sophia Antipolis Park, established in Southern France in 1969. ∙ Cambridge Science Park, established in Cambridge, England, in 1972.These parks create fertile hotbeds for new start-ups and a focal point for the collaboration activities of established firms. Their proximity to university labora-tories and other research centers ensures ready access to scientific expertise. Such centers also help university researchers implement their scientific discoveries in technology transfer officesOffices designed to facilitate the transfer of tech-nology developed in a research environment to an environment where it can be commercially parksRegional dis-tricts, typically set up by govern-ment, to foster R&D collabora-tion between government, universities, and private firms.incubatorsInstitutions designed to nur-ture the develop-ment of new businesses that might otherwise lack access to adequate funding or advice.Final PDF to printer
sch87956_ch02_013-042.indd 32 11/05/18 01:32 PM32 Part One Industry Dynamics of Technological Innovationcommercial applications.42 Such parks often give rise to technology clusters that have long-lasting and self-reinforcing advantages (discussed later in the chapter).Private Nonprofit OrganizationsPrivate nonprofit organizations, such as private research institutes, nonprofit hospi-tals, private foundations, professional or technical societies, academic and industrial consortia, and trade associations, also contribute to innovation activity in a variety of complex ways. Many nonprofit organizations perform their own research and develop-ment activities, some fund the research and development activities of other organiza-tions but do not do it themselves, and some nonprofit organizations do both in-house research and development and fund the development efforts of others.INNOVATION IN COLLABORATIVE NETWORKSAs the previous sections indicate, there is a growing recognition of the importance of collaborative research and development networks for successful innovation.43 Such col-laborations include (but are not limited to) joint ventures, licensing and second- sourcing agreements, research associations, government-sponsored joint research programs, value-added networks for technical and scientific interchange, and informal networks.44 Collaborative research is especially important in high-technology sectors, where it is unlikely that a single individual or organization will possess all of the resources and capabilities necessary to develop and implement a significant innovation.45As firms forge collaborative relationships, they weave a network of paths between them that can act as conduits for information and other resources. By providing mem-ber firms access to a wider range of information (and other resources) than individual firms possess, interfirm networks can enable firms to achieve much more than they could achieve individually.46 Thus, interfirm networks are an important engine of innovation. Furthermore, the structure of the network is likely to influence the flow of information and other resources through the network. For example, in a dense network where there are many potential paths for information to travel between any pair of firms, information diffusion should be fairly rapid and widespread.47Figure 2.5 provides pictures of the worldwide technology alliance network in 1995 and in 2000.48 The mid-1990s saw record peaks in alliance activity as firms scrambled to respond to rapid change in information technologies. This resulted in a very large and dense web of connected firms. The network shown here connects 3856 organiza-tions, predominantly from North America, Japan, and Europe. However, there was a subsequent decline in alliance activity toward the end of the decade that caused the web to diminish in size and splinter apart into two large components and many small components. The large component on the left is primarily made up of organizations in the chemical and medical industries. The large component on the right is primarily made up of organizations in electronics-based industries. If the size and density of the collaboration network influences the amount of information available to organizations that are connected via the network, then the difference between the network shown for 1995 and the network shown for 2000 could have resulted in a substantial change in the amount of information that was transmitted between firms. (The strategic implica-tions for a firm’s position within the network are discussed in Chapter Eight.)Final PDF to printer
sch87956_ch02_013-042.indd 33 11/05/18 01:32 PMChapter 2 Sources of Innovation 33Technology ClustersSometimes geographical proximity appears to play a role in the formation and inno-vative activity of collaborative networks. Well-known regional clusters such as Silicon Valley’s semiconductor firms, lower Manhattan’s multimedia cluster, and the Modena, Italy, knitwear district aptly illustrate this point. This has spurred consid-erable interest in the factors that lead to the emergence of a cluster. City and state governments, for example, might like to know how to foster the creation of a technol-ogy cluster in their region in order to increase employment, tax revenues, and other economic benefits. For firms, understanding the drivers and benefits of clustering is useful for developing a strategy that ensures the firm is well positioned to benefit from clustering.Technology clusters may span a region as narrow as a city or as wide as a group of neighboring countries.50 Clusters often encompass an array of industries that are linked through relationships between suppliers, buyers, and producers of comple-ments. One primary reason for the emergence of regional clusters is the benefit of proximity in knowledge exchange. Though advances in information technology have technology clustersRegional clusters of firms that have a connection to a common technol-ogy, and may engage in buyer, supplier, and complementor relationships, as well as research collaboration.FIGURE 2.5The Global Technology Collaboration Network, 1995 and 200049Hewlett-Packard Co.IBM Corp.Motorola Inc.1995Final PDF to printer
sch87956_ch02_013-042.indd 34 11/05/18 01:32 PM34 Part One Industry Dynamics of Technological Innovationmade it easier, faster, and cheaper to transmit information great distances, several stud-ies indicate that knowledge does not always transfer readily via such mechanisms.Proximity and interaction can directly influence firms’ ability and willingness to exchange knowledge. First, knowledge that is complex or tacit may require frequent and close interaction to be meaningfully exchanged.51 Firms may need to interact fre-quently to develop common ways of understanding and articulating the knowledge before they are able to transfer it.52 Second, closeness and frequency of interaction can influence a firm’s willingness to exchange knowledge. When firms interact frequently, they can develop trust and reciprocity norms. Firms that interact over time develop greater knowledge of each other, and their repeated interactions give them information as to the likelihood of their partner’s behaving opportunistically. A shared understand-ing of the rules of engagement emerges, wherein each partner understands its obliga-tions with respect to how much knowledge is exchanged, how that knowledge can be used, and how the firms are expected to reciprocate.53Firms that are proximate thus have an advantage in sharing information that can lead to greater innovation productivity. This can, in turn, lead to other self- reinforcing geographical advantages. A cluster of firms with high innovation productivity can lead to more new firms starting up in the immediate vicinity and can attract other firms to the area.54 As firms grow, divisions may be spun off into new firms, tacit knowledgeKnowledge that cannot be readily codified (documented in written form).complex knowledgeKnowledge that has many underlying components, or many inter-dependencies between those components, or both.CSIROElan Corp. PLCMagazine House Co. Ltd.Matsushita Electric IndustrialMonsanto Co.Qualcomm Inc.Seven-Eleven Japan Co. Ltd.Stressgen Biotechnologies Corp.Sun Microsystems Inc.Toyota Motor Corp.Microsoft Corp.Hitachi Ltd.Bayer AG2000FIGURE 2.5 ContinuedFinal PDF to printer
sch87956_ch02_013-042.indd 35 11/05/18 01:32 PMChapter 2 Sources of Innovation 35entrepreneurial employees may start their own enterprises, and supplier and distribu-tor markets emerge to service the cluster. Successful firms also attract new labor to the area and help to make the existing labor pool more valuable by enabling individu-als to gain experience working with the innovative firms. The increase in employment and tax revenues in the region can lead to improvements in infrastructure (such as roads and utilities), schools, and other markets that service the population (shopping malls, grocery stores, health-care providers, etc.). The benefits firms reap by locating in close geographical proximity to each other are known collectively as agglomeration economies.55There are also some downsides to geographical clustering. First, the proximity of many competitors serving a local market can lead to competition that reduces their pricing power in their relationships with both buyers and suppliers. Second, close proximity of firms may increase the likelihood of a firm’s competitors gaining access to the firm’s proprietary knowledge (this is one of the mechanisms of technol-ogy spillovers, discussed in the next section). Third, clustering can potentially lead to traffic congestion, inordinately high housing costs, and higher concentrations of pollution.56A big part of the reason that technologies are often regionally localized is that tech-nological knowledge is, to a large extent, held by people, and people are often only reluctantly mobile. In a well-known study, Annalee Saxenian found that engineers in Silicon Valley were more loyal to their craft than to any particular company, but they were also very likely to stay in the region even if they changed jobs.57 This was due in part to the labor market for their skills in the region, and in part to the disruption in an individual’s personal life if he or she were to move out of the region. Thus, if for some reason an innovative activity commences in a geographic locale, the knowledge and expertise that accumulates might not spread readily into other geographic locales, leading to a localized cluster of technological expertise.58Studies have indicated that while many innovative activities appear to have some geographic component, the degree to which innovative activities are geographically clustered depends on things such as: ∙ The nature of the technology, such as its underlying knowledge base or the degree to which it can be protected by patents or copyright, and the degree to which its communication requires close and frequent interaction. ∙ Industry characteristics, such as the degree of market concentration or stage of the industry life cycle, transportation costs, and the availability of supplier and distribu-tor markets. ∙ The cultural context of the technology, such as the population density of labor or customers, infrastructure development, or national differences in the way technol-ogy development is funded or protected.For example, one study that examined the spatial distribution of technology sec-tors in different countries found that pharmaceutical development was highly clustered in the United Kingdom and France, but much more spatially diffused in Italy and Germany.59 The same study found, however, that the manufacture of clothing demon-strated high clustering in Italy, but not in France, Germany, or the United Kingdom. While the clustering of pharmaceutical development may have been influenced by agglomeration economiesThe benefits firms reap by locating in close geographical proximity to each other.Final PDF to printer
sch87956_ch02_013-042.indd 36 11/05/18 01:32 PM36 Part One Industry Dynamics of Technological Innovationthe national systems of research funding and the need to share complex technological expertise, the formation of textile clusters may have been due more to cultural factors that influenced the historical rise of industrial districts.Technological SpilloversWhile the work on technology clusters has tended to emphasize the “stickiness” of knowl-edge, a related body of research has focused on explaining the spread of knowledge across organizational or regional boundaries. This topic is known as technological spillovers. Technological spillovers occur when the benefits from the research activities of one firm (or nation or other entity) spill over to other firms (or nations or other entities). Spillovers are thus a positive externality of research and develop-ment efforts. Evidence suggests that technology spillovers are a significant influence on innovative activity. For example, in a series of studies conducted in the 1980s and Research Brief Knowledge BrokersAndrew Hargadon and Robert Sutton point out that some firms play a particularly pivotal role in the innovation network—that of knowledge brokers. Knowledge brokers are individuals or firms that transfer information from one domain to another in which it can be usefully applied. The knowledge bro-ker puts existing information to use in new and profit-able ways. Hargadon and Sutton provide the example of Robert Fulton who, after observing the use of steam engines in mines, realized this technology could be used to propel boats and subsequently developed the first successful steamboat.a While Fulton did not claim to have invented the steamboat (there had been at least 30 years of prior development on steamboats), Fulton’s design was the first to combine existing tech-nologies into a successful product.In a network of firms, a knowledge broker may be a firm that connects clusters of firms that would otherwise share no connection. By serving as the bridge between two different knowledge networks, the knowledge broker is in a position to find unique combinations from the knowledge possessed by the two groups. This can enable knowledge brokers to be exceptionally prolific in generating innovation. Consider Thomas Edison’s laboratory. Edison’s strategy of borrowing from different  industries to create products that would ultimately serve many markets resulted in innovations in telegraphs, knowledge brokersIndividuals or organizations that transfer information from one domain to another in which it can be usefully applied.telephones, phonographs, generators, lightbulbs, vacuum pumps, and many others.bKnowledge brokers may not create breakthroughs in any single technology, but instead may exploit the potential synergies of combining existing technolo-gies. While this might at first seem to limit the scope of a knowledge broker’s potential, research sug-gests that most innovation is not due to the discov-ery of something fundamentally new, but is instead the result of novel recombinations of known con-cepts and materials.c Thus, the knowledge broker’s key expertise may lie not in a particular domain of science, but instead in the ability to recognize and capture potential solutions that may be matched to problems in an unexpected way.a A. Hargadon and R. Sutton, “Building an Innovation Factory,” Harvard Business Review May–June, 2000, pp. 157–66.b A. B. Hargadon, “Firms as Knowledge Brokers: Lessons in Pursuing Continuous Innovation,” California Management Review 40, no. 3 (1998), pp. 209–27.c S. C. Gilfillan, The Sociology of Invention (Chicago: Follett, 1935); R. R. Nelson and S. Winter, An Evolutionary Theory of Economic Change (Cambridge, MA: Harvard University Press, 1982); E. G. Penrose, The Theory of the Growth of the Firm (New York: Wiley, 1959); J. A. Schumpeter, The Theory of Economic Development (Cambridge, MA: Harvard University Press, 1934); and A. Usher, A History of Mechanical Inventions (Cambridge, MA: Harvard Uni-versity Press, 1954).Final PDF to printer
sch87956_ch02_013-042.indd 37 11/05/18 01:32 PMChapter 2 Sources of Innovation 371990s, Adam Jaffe and his coauthors found that both a firm’s patenting activities and profits were influenced by the R&D spending of other firms and universities in its geographical region.60Whether R&D benefits will spill over is partially a function of the strength of pro-tection mechanisms such as patents, copyrights, and trade secrets (methods of protect-ing innovation are discussed in greater detail in Chapter Nine). Since the strength of protection mechanisms varies significantly across industries and countries, the likeli-hood of spillovers varies also.61 The likelihood of spillovers is also a function of the nature of the underlying knowledge base (e.g., as explained in the previous section, tacit knowledge may not flow readily across firm boundaries) and the mobility of the labor pool.62technological spilloversA positive externality from R&D resulting from the spread of knowledge across organiza-tional or regional boundaries. 1. Creativity is the underlying process for innovation. Creativity enables individu-als and organizations to generate new and useful ideas. Creativity is considered a function of intellectual abilities, knowledge, thinking styles, personality traits, intrinsic motivation, and environment. 2. Innovation sometimes originates with individual inventors. The most prolific inventors tend to be trained in multiple fields, be highly curious, question pre-viously made assumptions, and view all knowledge as unified. The most well-known inventors tend to have both inventive and entrepreneurial traits. 3. Innovation can also originate with users who create solutions to their own needs. 4. Firms’ research and development is considered a primary driver of innovation. In most countries, firms spend significantly more on R&D than government institu-tions spend on R&D, and firms consider their in-house R&D their most important source of innovation. 5. Firms often collaborate with a number of external organizations (or individuals) in their innovation activities. Firms are most likely to collaborate with customers, suppliers, and universities, though they also may collaborate with competitors, producers of complements, government laboratories, nonprofit organizations, and other research institutions. 6. Many universities have a research mission, and in recent years universities have become more active in setting up technology transfer activities to directly com-mercialize the inventions of faculty. Universities also contribute to innovation through the publication of research findings. 7. Government also plays an active role in conducting research and development (in its own laboratories), funding the R&D of other organizations, and creating institutions to foster collaboration networks and to nurture start-ups (e.g., science parks and incubators). In some countries, government-funded research and devel-opment exceeds that of industry-funded research. 8. Private nonprofit organizations (such as research institutes and nonprofit hospi-tals) are another source of innovation. These organizations both perform their own R&D and fund R&D conducted by others.Summary of ChapterFinal PDF to printer
sch87956_ch02_013-042.indd 38 11/05/18 01:32 PM38 Part One Industry Dynamics of Technological Innovation 9. Probably the most significant source of innovation does not come from indi-vidual organizations or people, but from the collaborative networks that leverage resources and capabilities across multiple organizations or individuals. Collabora-tive networks are particularly important in high-technology sectors. 10. Collaboration is often facilitated by geographical proximity, which can lead to regional technology clusters. 11. Technology spillovers are positive externality benefits of R&D, such as when the knowledge acquired through R&D spreads to other organizations. 1. What are some of the advantages and disadvantages of (a) individuals as innova-tors, (b) firms as innovators, (c) universities as innovators, (d) government institu-tions as innovators, (e) nonprofit organizations as innovators? 2. What traits appear to make individuals most creative? Are these the same traits that lead to successful inventions? 3. Could firms identify people with greater capacity for creativity or inventiveness in their hiring procedures? 4. To what degree do you think the creativity of the firm is a function of the cre-ativity of individuals, versus the structure, routines, incentives, and culture of the firm? Provide an example of a firm that does a particularly good job at nurturing and leveraging the creativity of its individuals. 5. Several studies indicate that the use of collaborative research agreements is increas-ing around the world. What are some reasons collaborative research is becoming more prevalent?Discussion QuestionsClassicsAmabile, T. M., Social Psychology of Creativity (New York: Springer-Verlag, 1983).Chesbrough, H., Open Innovation: The New Imperative for Creating and Profiting from Technology (Boston: Harvard University Press, 2003).Jaffe, A., “Technological Opportunity and Spillovers of R&D: Evidence from Firms’ Pat-ents, Profits, and Market Value,” American Economic Review 76 (1986), pp. 984–1001.Kelley, T., The Art of Innovation: Lessons in Creativity from IDEO, America’s Lead-ing Design Firm (New York: Random House, 2007).Schilling, M. A., and Phelps, C., “Interfirm Collaboration Networks: The impact of Large-Scale Network Structure on Firm Innovation,” Management Science 53 (2007), pp. 1113–1126.Usher, A. P., A History of Mechanical Inventions (New York/London: McGraw-Hill, 1929).Von Hippel, E., Sources of Innovation (New York: Oxford University Press, 1988).Weber, A., Theory of Location of Industries (Chicago: University of Chicago, 1929).Recent WorkHowell, Sabrina T., 2017. “Financing Innovation: Evidence from R&D Grants.” American Economic Review, 107 (4) 2017, pp. 1136–64.Suggested Further ReadingFinal PDF to printer
sch87956_ch02_013-042.indd 39 11/05/18 01:32 PMChapter 2 Sources of Innovation 39Melero, E., and Palomeras, N., “The Renaissance Man Is Not Dead! The Role of Gen-eralists in Teams of Inventors,” Research Policy 44 (2015), pp. 154–167.Schilling, M. A., “Technology Shocks, Technological Collaboration, and Innovation Outcomes,” Organization Science 26 (2015), pp. 668–686.Schilling, M. A., Quirky: The Remarkable Story of the Traits, Foibles, and Genius of Breakthrough Innovators Who Changed the World (New York: Public Affairs, 2018).Sawyer, R. K., Explaining Creativity: The Science of Human Innovation (Oxford: Oxford University Press, 2011).Toole, A. A., “The Impact of Public Basic Research on Industrial Innovation: Evi-dence from the Pharmaceutical Industry,” Research Policy 41 (2012), pp. 1–12.Youtie, J., and Shapira, P., “Building an Innovation Hub: A Case Study of the Trans-formation of University Roles in Regional Technological Development,” Research Policy 37 (2008), pp. 1188–1204. 1. R. Rothwell, “Factors for Success in Industrial Innovations, Project SAPPHO—A Comparative Study of Success and Failure in Industrial Innovation,” SPRU, University of Sussex, Brighton, U.K., 1972; and L. Smith-Doerr, J. Owen-Smith, K. W. Koput, and W. W. Powell, “Networks and Knowledge Production: Collaboration and Patenting in Biotechnology,” in Corporate Social Capital, eds. R. Leenders and S. Gabbay (Norwell, MA: Kluwer Academic Publishers, 1999), pp. 331–50. 2. F. Barron, Creative Person and Creative Process (New York: Holt, Rinehart, and Winston, 1969); D. W. MacKinnon, “Personality and the Realization of Creative Potential,” American Psychologist 17 (1965), pp. 484–95; R. Oshse, Before the Gates of Excellence: The Determinants of Creative Genius (New York: Cambridge University Press, 1990); and T. I. Lubart, “Creativity,” in Thinking and Problem Solving, ed. R. J. Sternberg (New York: Academic Press, 1994), pp. 289–332. 3. M. Boden, The Creative Mind: Myths and Mechanisms (New York: Basic Books, 1992). 4. Lubart, “Creativity.” 5. Freud, S. The unconscious, standard edition, 14:159–214; Mednick, S. A. 1962. “The Associa-tive Basis of the Creative Process,” Psychological Review 69 (1962):220–32; Suler, J. “Primary Process Thinking and Creativity,” Psychological Bulletin 80 (1980):155–65; Simonton, D. K. Origins of Genius (Oxford: Oxford University Press, 1999). 6. Schilling, M. A. “A Small-World Network Model of Cognitive Insight,” Creativity Research Journal 17, nos. 2 and 3 (2005):131–154. 7. Benedek, M., and A. C. Neubauer, “Revisiting Mednick’s Model on Creativity-Related Dif-ferences in Associative Hierarchies. Evidence for a Common Path to Uncommon Thought,” Journal of Creative Behavior 47 (2013):273–289. 8. This argument is also invoked in a line of work on “defocused attention.” See Martindale, C. “Biological bases of creativity,” in Handbook of Creativity, ed. R. J. Sternberg Cambridge UK: (Cambridge University Press, 1999), 137–52. 9. Frensch, P. A., and Sternberg, R. J., “Expertise and Intelligent Thinking: When is it Worse to Know Better?” in Advances in the Psychology of Human Intelligence, ed. R. J. Sternberg ( Hillsdale, NJ: Erlbaum, 1989), 5:157–8. 10. Schilling, M. A., Quirky: The Remarkable Story of the Traits, Foibles, and Genius of Break-through Innovators Who Changed the World (New York: Public Affairs, 2018). 11. Schilling, M. A., Quirky: The Remarkable Story of the Traits, Foibles, and Genius of Break-through Innovators Who Changed the World (New York: Public Affairs, 2018).EndnotesFinal PDF to printer
sch87956_ch02_013-042.indd 40 11/05/18 01:32 PM40 Part One Industry Dynamics of Technological Innovation 12. McCrae, R. R., and P. T. Costa, Jr., “Conceptions and Correlates of Openness to Experience,” in Handbook of Personality Psychology, ed. R. Hogan, J. A. Johnson, S. R. Briggs (San Diego: Academic Press, 1997), 825–47. 13. T. M. Amabile, The Social Psychology of Creativity (New York: Springer-Verlag, 1983) and T. M. Amabile, Creativity in Context (Boulder CO: Westview, 1996). 14. Deci, E. L., R. Koestner, and R. M. Ryan. “A Meta-Analytic Review of Experiments Examining the Effects of Extrinsic Rewards on Intrinsic Motivation,” Psychological Bulletin 125 (1999):627–68. 15. Schilling, M. A., Quirky: The Remarkable Story of the Traits, Foibles, and Genius of Break-through Innovators Who Changed the World (New York: Public Affairs, 2018). 16. R. W. Woodman, J. E. Sawyer, and R. W. Griffin, “Toward a Theory of Organizational Creativ-ity,” Academy of Management Review 18 (1993), pp. 293–321. 17. C. Gorski and E. Heinekamp, “Capturing Employee Ideas for New Products,” in The PDMA Toolbook for New Product Development, eds. P. Belliveau, A. Griffin, and S. Somermeyer (New York: John Wiley & Sons, 2002). 18. Gorski and Heinekamp, “Capturing Employee Ideas for New Products”; and R. E. Mcdermott, R. J. Mikulak, and M. R. Beauregard, Employee Driven Quality: Releasing the Creative Spirit of Your Organization through Suggestion Systems (White Plains, NY: Quality Resource, 1993). 19. Gorski and Heinekamp, “Capturing Employee Ideas for New Products.” 20. Reiss, R. 2015. “Top CEOs share how to shepherd innovation.” Forbes, July 20. 21. Woodman, Sawyer, and Griffin, “Toward a Theory of Organizational Creativity”; and Amabile, The Social Psychology of Creativity. 22. Ibid. 23. Sir Frank Macfarlane Burnet, Changing Patterns, an Atypical Autobiography (Melbourne and London: Heinemann, 1968), p. 35. 24. P. Debye, interview in The Editors of International Science and Technology, The Way of the Scientist. Interviews from the World of Science and Technology (New York: Simon and Schuster, 1966), p. 80. 25. T. P. Hughes, “How Did the Heroic Inventors Do It?” American Heritage of Invention and Tech-nology, Fall 1985, p. 21. 26. B. Z. Khan and K. I. Sokoloff, “Schemes of Practical Utility: Entrepreneurship and Innovation among ‘Great Inventors’ in the United States, 1790–1865,” Journal of Economic History 53, no. 2 (1993), p. 289. 27. E. Von Hippel, “Innovation by User Communities: Learning from Open-Source Software,” Sloan Management Review 42, no. 4 (2001), pp. 82–86. 28. E. Von Hippel, The Sources of Innovation (New York: Oxford University Press, 1988); S. K. Shah, “Motivation, Governance, And The Viability of Hybrid Forms In Open Source Software Development,” Management Science 52 (2006), pp. 1000–14. 29. R. J. Thomas, New Product Success Stories: Lessons from Leading Innovators (New York: John Wiley & Sons, 1995). 30. From a presentation given by Bernie Bolger of Loctite to the Masters of Science Technology Group at University College Dublin, November 21, 2003. Thanks to Brian McGrath for provid-ing this example. 31. E. Roberts, “Benchmarking Global Strategic Management of Technology,” Research Technol-ogy Management, March–April 2001, pp. 25–36. 32. M. Dodgson, The Management of Technological Innovation (New York: Oxford University Press, 2000). 33. Ibid. 34. C. Freeman, “Networks of Innovators: A Synthesis of Research Issues,” Research Policy 20 (1991), pp. 499–514; Rothwell, “Factors for Success in Industrial Innovations, Project SAPPHO”; Final PDF to printer
sch87956_ch02_013-042.indd 41 11/05/18 01:32 PMChapter 2 Sources of Innovation 41and R. Rothwell, C. Freeman, A. Horseley, V. T. B. Jervis, A. B. Robertson, and J. Townsend, “SAPPHO Updated—Project SAPPHO Phase II,” Research Policy 3 (1974), pp. 258–91. 35. Roberts, “Benchmarking Global Strategic Management of Technology.” 36. “Supercharging Android: Google to Acquire Motorola Mobility,” Google Press Release, August 15, 2011; Efrati, A & Anti, SE. “Google’s $12.5 Billion Gamble: Web Giant Pays Big for Motorola’s Phone Business, Patents; Risks Alienating Allies.” Wall Street Journal (2011) August 16 ( 37. W. M. Cohen and D. A. Levinthal, “Absorptive Capacity: A New Perspective on Learning and Innovation,” Administrative Science Quarterly, March 1990, pp. 128–52. 38. M. Biese and H. Stahl, “Public Research and Industrial Innovations in Germany,” Research Policy 28 (1999), pp. 397–422; and E. Mansfield, “Academic Research and Industrial Innova-tion,” Research Policy 20 (1991), pp. 1–12. 39. A. Silverman, “Understanding University Patent Policies,” JOM 55, no. 1 (2003), p. 64. 40. D. Rahm and V. Hansen, “Technology Policy 2000: University to Industry Transfer,” Interna-tional Journal of Public Administration 22, no. 8 (1999), pp. 1189–1211. 41. Brady Huggett, “Reinventing Tech Transfer,” Nature Biotechnology 32 (2014) pp. 1184–119 42. Ibid. 43. G. Ahuja and C. M. Lampert, “Entrepreneurship in the Large Corporation: A Longitudinal Study of How Established Firms Create Breakthrough Inventions,” Strategic Management Journal 22 (2001), pp. 521–43; T. J. Allen, Managing the Flow of Technology: Technology Transfer and the Dissemination of Technological Information within the R&D Organization (Cambridge, MA: MIT Press, 1977); R. S. Burt, Structural Holes (Cambridge, MA: Harvard University Press, 1992); C. Freeman, “Networks of Innovators: A Synthesis of Research Issues,” Research Policy 20 (1991), pp. 499–514; S. C. Gilfillan, The Sociology of Invention (Chicago: Follett, 1935); and A. B. Hargadon and R. I. Sutton, “Technology Brokering and Innovation in a Product Development Firm,” Administrative Science Quarterly 42 (1997) pp. 716–49, M. A. Schilling, M. A. 2015. “Technology Shocks, Technological Collaboration, and Innovation Outcomes,” Organization Science, 26 (2015), pp. 668–686; M. A. Schilling, and C. Phelps, “Interfirm Collaboration Networks: The Impact of Large-Scale Network Structure on Firm Innovation,” Management Science, 53 (2007), pp. 1113–1126. 44. K. Imai and Y. Baba, 1989, “Systemic Innovation and Cross-Border Networks: Transcending Markets and Hierarchies to Create a New Techno-Economic System,” OECD, Conference on Science Technology and Economic Growth, Paris; and C. Freeman, “Networks of Innovators: A Synthesis of Research Issues,” Research Policy 20 (1991), pp. 499–514. 45. J. Hagedoorn, “Inter-Firm R&D Partnerships—an Overview of Major Trends and Patterns since 1960,” Research Policy 31 (2002), pp. 477–92; M. A. Schilling, “Technology Shocks, Technological Collaboration, and Innovation Outcomes,” Organization Science, 26 (2015), pp. 668–686. 46. Rosenkopf and Almeida, “Overcoming Local Search through Alliances and Mobility”; and Liebeskind, Oliver, Zucker, and Brewer, “Social Networks, Learning, and Flexibility”; M. A. Schilling, “Technology Shocks, Technological Collaboration, and Innovation Outcomes,” Organization Science, 26 (2015), pp. 668–686. 47. M. A. Schilling, “Technology Shocks, Technological Collaboration, and Innovation Outcomes,” Organization Science, 26 (2015), pp. 668–686. 48. This analysis is from M. A. Schilling, “Technology Shocks, Technological Collaboration, and Innovation Outcomes,” Organization Science, 26 (2015), pp. 668–686. In accordance with norms in network research, each snapshot shows the aggregate of alliances formed in the pre-vious three years (i.e., the 1995 snapshot aggregates alliances from 1993 to 1995; the 2000 Final PDF to printer
sch87956_ch02_013-042.indd 42 11/05/18 01:32 PM42 Part One Industry Dynamics of Technological Innovationsnapshot aggregates alliances from 1998 to 2000). Only large components (those greater than 15 organizations) are shown. 49. M. A. Schilling, “Technology Shocks,Technological Collaboration, and Innovation Outcomes,” Organization Science, 26 (2015), pp. 668–686. 50. M. E. Porter, “Location, Competition, and Economic Development: Local Clusters in a Global Economy,” Economic Development Quarterly 14, no. 1 (2000), pp. 15–34. 51. P. Almeida and B. Kogut, “Localization of Knowledge and the Mobility of Engineers in Regional Networks,” Management Science 45 (1999), pp. 905–17; P. Bourdieu, “The Forms of Capital,” in Handbook of Theory and Research for the Sociology of Education, ed. J. G. Richardson (Westport, CT: Greenwood Press, 1986), pp. 241–58; M. S. Granovetter, “Problems of Expla-nation in Economic Sociology,” in Networks and Organizations: Structure, Form, and Action, eds. N. Nohria and R. Eccles (Boston: Harvard Business School Press, 1992), pp. 25–56; and M. T. Hansen, “The Search-Transfer Problem: The Role of Weak Ties in Sharing Knowledge across Organization Subunits,” Administrative Science Quarterly 44 (1999), pp. 82–112; Arikan, A., and M. A. Schilling, “Structure and Governance in Industrial Districts: Implications for Competitive Advantage,” Journal of Management Studies 48 (2011): 772–803. 52. U. Zander and B. Kogut, “Knowledge and the Speed of the Transfer and Imitation of Orga-nizational Capabilities: An Empirical Test,” Organization Science 6 (1995), pp. 76–92; and G. Szulanski, “Exploring Internal Stickiness: Impediments to the Transfer of Best Practice within the Firm,” Strategic Management Journal 17 (winter special issue) (1996), pp. 27–43. 53. J. H. Dyer and K. Nobeoka, “Creating and Managing a High-Performance Knowledge- Sharing Network: The Toyota Case,” Strategic Management Journal 21 (2000), pp. 345–67; and E. Von Hippel, “Cooperation between Rivals: Informal Know-How Trading,” Research Policy 16 (1987), pp. 291–302. 54. T. Stuart and O. Sorenson, “The Geography of Opportunity: Spatial Heterogeneity in Founding Rates and the Performance of Biotechnology Firms,” Research Policy 32 (2003), p. 229. 55. Arikan, A., and M. A. Schilling, “Structure and Governance in Industrial Districts: Implications for Competitive Advantage,” Journal of Management Studies 48 (2011): 772–803. 56. Arikan, A., and M. A. Schilling, “Structure and Governance in Industrial Districts: Implications for Competitive Advantage,” Journal of Management Studies 48 (2011): 772–803. 57. A. Saxenian, Regional Advantage: Culture and Competition in Silicon Valley and Route 128 (Cambridge, MA/London: Harvard University Press, 1994). 58. P. Almeida and B. Kogut, “Localization of Knowledge and the Mobility of Engineers in Regional Networks,” Management Science 45 (1999), pp. 905–17. 59. S. Breschi, “The Geography of Innovation: A Cross-Sector Analysis,” Regional Studies 34, no. 3 (2000), pp. 213–29. 60. A. B. Jaffe, “Technological Opportunity and Spillovers of R&D: Evidence from Firms’ Patents, Profits and Market Value,” American Economic Review 76 (1986), pp. 984–1001; A. B. Jaffe, “Real Effects of Academic Research,” American Economic Review 79 (1989), pp. 957–70; and A. B. Jaffee, M. Trajtenberg, and R. Henderson, “Geographic Localization of Knowledge Spill-overs as Evidenced by Citations,” Quarterly Journal of Economics 63 (1993), pp. 577–98. 61. W. Cohen, A. Goto, A. Nagata, R. Nelson, and J. Walsh, “R&D Spillovers, Patents and the Incentives to Innovate in Japan and the United States,” Research Policy 31 (2002), pp. 1349–67. 62. Almeida and Kogut, “Localization of Knowledge and the Mobility of Engineers in Regional Networks.”Final PDF to printer
43sch87956_ch03_043-066.indd 43 11/12/18 10:19 AMChapter ThreeTypes and Patterns of InnovationInnovating in India: The chotuKool ProjectGodrej & Boyce, founded in India in 1897, sold a range of products to the Indian market including household appliances, office furniture, and industrial process equipment. In recent years, international competitors such as Haier and Samsung were cutting deep into Godrej’s market share for household appliances such as refrigerators, washing machines, and air conditioners, and management knew that to preserve the company would require innovative solutions.One such solution was the chotuKool, a small, portable refrigerator. Though around the world refrigeration was considered a mature technology, in rural India as many as 90 percent of families could not afford household appliances, did not have reliable access to electricity, and had no means of refrigeration. This signifi-cantly limited the kinds of foods they could eat and how they could be prepared. Finding a way to provide refrigeration to this segment of the population offered the promise of both a huge market and making a meaningful difference in peo-ple’s quality of life. As noted by Navroze Godrej, Directed of Special Projects at Godrej, “We imagined we would be making a shrunken down version of a refrig-erator. Make it smaller, make it cheaper. And we had preconceived notions of how to build a brand that resonated with these users through big promotions and fancy ad campaigns.”These assumptions would turn out to be wrong. First, as Godrej’s team looked at the options of how to reduce the cost of a conventional compressor-based refrigerator, they quickly realized that they could not reduce its cost by enough to make a meaningful difference.a Second, they discovered that having the refrigerator be lightweight was more important than they had previously thought because many rural Indians lived migratory lives, moving to follow the availability of work. Third, because of the lack of refrigeration, most people were in the habit of cooking just enough for the day, and thus had relatively low refrigeration capacity needs. Fourth, of those few rural Indians that did have refrigerators, many did not plug them in for most of the day for fear of Final PDF to printer
sch87956_ch03_043-066.indd 44 11/12/18 10:19 AM44 Part One Industry Dynamics of Technological Innovationthem being damaged by power surges. As Godrej notes, “We were surprised by many things, we were shocked by many things . . . we realized our original hypothesis was quite wrong.”bBased on these insights, the company designed a small and portable refrig-erator based on thermoelectric cooling (rather than compressor technology). Thermoelectric cooling was the cooling method used in laptops; it involved running a current between two semiconductors. It was far more expensive on a per-unit-of-cooling basis, but it had much lower power requirements and could be used on a much smaller scale than compressor cooling. This enabled Godrej to make a very small, lightweight refrigerator with a relatively low price (35–40 percent cheaper than traditional refrigerators). It also lowered the power costs of operating a refrigerator, and made the refrigerator able to operate for several hours on a 12-volt battery, making it much more adaptable to situations where power was unreliable.In Godrej’s initial plan for the chotuKool, the refrigerators would be cherry red and look like coolers. Soon, however, managers at chotuKool realized that if the refrigerators were just perceived as inexpensive alternatives to refrigera-tors, they had the potential to be stigmatizing for consumers who, in turn, would not talk about them to their friends. This was a serious problem because the company had counted on word of mouth to spread information about the refrig-erators deep into rural communities. To get people to talk about the coolers they needed to be aspirational—they needed to be cool.Godrej decided to revamp the design of the coolers, giving them a more sophisticated shape and making them customizable (buyers could choose from over 100 decorative skin colors for the chotuKool).c They also decided to market the refrigerators to the urban affluent market in addition to the rural market, as adoption by the urban affluent market would remove any stigma associated with buying them. To attract this market they positioned the refrigerators as perfect for picnics, parties, offices, dorm rooms, use in cars, and so on.To get the chotuKool to rural customers would require a dramatically differ-ent distribution system than Godrej had traditionally used. However, building out a distribution system into rural communities would prohibitively raise the cost of chotuKool, potentially rendering the product nonviable. The develop-ment team was initially stumped. Then one day G. Sunderraman, vice presi-dent of Godrej and leader of the chotuKool project, happened to inquire with a university official about obtaining college application forms for his youngest son and the official pointed out that Sunderraman could get the forms at any post office. At that moment, Sunderraman realized that the post office, which had offices in every rural area of India, could be an ideal distribution channel for the chotuKool.d It was a very novel proposition, but India Post agreed to the collaboration and soon chotuKools were available in all post offices in the central region of India.e As Sunderraman noted, “The India Post network is very well spread in India and is about three or four times larger than the best logistic suppliers.”fFinal PDF to printer
sch87956_ch03_043-066.indd 45 11/12/18 10:19 AMChapter 3 Types and Patterns of Innovation 45The chotuKool won several design awards in its first years, and after selling 100,000 units in its second year Fast Company gave Godrej its “Most Innovative Company” award. Godrej and Sunderraman were disappointed to discover that it was not as rapidly adopted by rural poor households as they had hoped; the roughly $50 price was still too expensive for most poor rural families in India. However, the chotuKool turned out to be much more popular than anticipated among hotels, food stalls, flower shops, and other small stores because it enabled these small stores to offer higher valued products (such as cold drinks) or to keep products fresh longer, thereby increasing their profits. The chotuKool also became a popular lifestyle product among the urban affluent population who began to widely use them in their cars.Godrej’s experience developing and launching the chotuKool had provided many lessons. They had learned that to radically reduce the cost of a prod-uct might require completely rethinking the technology—sometimes even in ways that initially seemed more expensive. They learned that customers who had adapted their way of life to the lack of a technology (like refrigeration) might not adopt that technology even if it was made markedly less expen-sive. Finally, they learned not to underestimate the value of making a product work for multiple market segments, including those that might not be initially obvious as customers. Though some people considered chotuKool a failure because it had not achieved its original objective of wide adoption by the rural poor, Godrej (and many others) considered it a success: the product expanded Godrej’s market share, penetrated new market segments in which Godrej had not formerly competed, and demonstrated Godrej’s innovative capabilities to the world.Discussion Questions 1. What were the pros and cons of attempting to develop a refrigerator for India’s rural poor? 2. What product and process innovations did the chotuKool entail? Would you consider these incremental or radical? Architectural or component? Competence enhancing or competence destroying? 3. Did the chotuKool pose a threat of disrupting the traditional refrigerator market? Why or why not? 4. Is there anything you think Godrej should have done differently to pen-etrate the market of rural poor families in India? 5. What other products might the lessons Godrej learned with chotuKool apply to? a McDonald, R., D. van Bever, and E. Ojomo, “chotuKool: ‘Little Cool,’ Big Opportunity,” Harvard Business School Case 616–020 (June 2016), revised September 2016. b Furr, N., and J. Dyer, “How Godrej Became an Innovation Star,” Forbes (May 13, 2015). c, accessed June 26, 2018. d Furr, N., and J. Dyer, “How Godrej Became an Innovation Star,” Forbes (May 13, 2015). e Nadu, T., “chotuKool Offer in Post Offices,” The Hindu (June 9, 2013). f “chotuKool: Keeping Things Cool with Frugal Innovation,” WIPO Magazine, (December 2013).Final PDF to printer
sch87956_ch03_043-066.indd 46 11/12/18 10:19 AM46 Part One Industry Dynamics of Technological InnovationOVERVIEWThe previous chapters pointed out that technological innovation can come from many sources and take many forms. Different types of technological innovations offer dif-ferent opportunities for organizations and society, and they pose different demands upon producers, users, and regulators. While there is no single agreed-upon taxonomy to describe different kinds of technological innovations, in this chapter we will review several dimensions that are often used to categorize technologies. These dimensions are useful for understanding some key ways that one innovation may differ from another.The path a technology follows through time is termed its technology trajectory. Technology trajectories are most often used to represent the technology’s rate of per-formance improvement or its rate of adoption in the marketplace. Though many factors can influence these technology trajectories (as discussed in both this chapter and the following chapters), some patterns have been consistently identified in technology tra-jectories across many industry contexts and over many periods. Understanding these patterns of technological innovation provides a useful foundation that we will build upon in the later chapters on formulating technology strategy.The chapter begins by reviewing the dimensions used to distinguish types of inno-vations. It then describes the s-curve patterns so often observed in both the rate of technology improvement and the rate of technology diffusion to the market. In the last section, the chapter describes research suggesting that technological innovation fol-lows a cyclical pattern composed of distinct and reliably occurring phases.TYPES OF INNOVATIONTechnological innovations are often described using dimensions such as radical versus incremental. Different types of innovation require different kinds of underlying knowl-edge and have different impacts on the industry’s competitors and customers. Four of the dimensions most commonly used to categorize innovations are described here: product versus process innovation, radical versus incremental, competence enhancing versus competence destroying, and architectural versus component.Product Innovation versus Process InnovationProduct innovations are embodied in the outputs of an organization—its goods or ser-vices, even if those products are services. For example, Snapchat’s filters and special effects that enable users to augment their photos are product innovations. Process inno-vations are innovations in the way an organization conducts its business, such as in the techniques of producing or marketing goods or services. For example, Elon Musk’s use of automation for most of the production process for the Model 3 with giant robots is a process innovation. Process innovations are often oriented toward improving the effectiveness or efficiency of production by, for example, reducing defect rates or increasing the quantity that may be produced in a given time. For example, a process innovation at a biotechnology firm might entail developing a genetic algorithm that can quickly search a set of disease-related genes to identify a target for therapeutic technology trajectoryThe path a technology takes through its lifetime. This path may refer to its rate of performance improvement, its rate of diffusion, or other change of interest.Final PDF to printer
sch87956_ch03_043-066.indd 47 11/12/18 10:19 AMChapter 3 Types and Patterns of Innovation 47intervention. In this instance, the process innovation (the genetic algorithm) can speed up the firm’s ability to develop a product innovation (a new therapeutic drug).New product innovations and process innovations often occur in tandem. First, new processes may enable the production of new products. For example, as discussed later in the chapter, the development of new metallurgical techniques enabled the develop-ment of the bicycle chain, which in turn enabled the development of multiple-gear bicycles. Second, new products may enable the development of new processes. For example, the development of advanced workstations has enabled firms to implement computer-aided manufacturing processes that increase the speed and efficiency of production. Finally, a product innovation for one firm may simultaneously be a pro-cess innovation for another. For example, when United Parcel Service (UPS) helps a customer develop a more efficient distribution system, the new distribution system is simultaneously a product innovation for UPS and a process innovation for its customer.Though product innovations are often more visible than process innovations, both are extremely important to an organization’s ability to compete. Throughout the remainder of the book, the term innovation will be used to refer to both product and process innovations.Radical Innovation versus Incremental InnovationOne of the primary dimensions used to distinguish types of innovation is the con-tinuum between radical versus incremental innovation. A number of definitions have been posed for radical innovation and incremental innovation, but most hinge on the degree to which an innovation represents a departure from existing practices.1 Thus, radicalness might be conceived as the combination of newness and the degree of differentness. A technology could be new to the world, new to an industry, new to a firm, or new merely to an adopting business unit. A technology could be signifi-cantly different from existing products and processes or only marginally different. The most radical innovations would be new to the world and exceptionally different from existing products and processes. The introduction of wireless telecommunica-tion products aptly illustrates this—it embodied significantly new technologies that required new manufacturing and service processes. Incremental innovation is at the other end of the spectrum. An incremental innovation might not be particularly new or exceptional; it might have been previously known to the firm or industry, and involve only a minor change from (or adjustment to) existing practices. For example, changing the screen of a cell phone to make it more crack resistant or offering a new service plan with better international texting rates would represent incremental innovation.The radicalness of innovation is also sometimes defined in terms of risk. Since radi-cal innovations often embody new knowledge, producers and customers will vary in their experience and familiarity with the innovation, and in their judgment of its useful-ness or reliability.2 The development of third generation (3G) telephony is illustrative. 3G wireless communication technology utilizes broadband channels. This increased bandwidth gave mobile phones far greater data transmission capabilities that enabled activities such as videoconferencing and accessing the most advanced Internet sites. For companies to develop and offer 3G wireless telecommunications service required a significant investment in new networking equipment and an infrastructure capable radical innovationAn innovation that is very new and different from prior solutions.incremental innovationAn innovation that makes a relatively minor change from (or adjustment to) existing practices.Final PDF to printer
sch87956_ch03_043-066.indd 48 11/12/18 10:19 AM48 Part One Industry Dynamics of Technological Innovationof carrying a much larger bandwidth of signals. It also required developing phones with greater display and memory capabilities, and either increasing the phone’s bat-tery power or increasing the efficiency of the phone’s power utilization. Any of these technologies could potentially pose serious obstacles. It was also unknown to what degree customers would ultimately value broadband capability in a wireless device. Thus, the move to 3G required managers to assess several different risks simultane-ously, including technical feasibility, reliability, costs, and demand.Finally, the radicalness of an innovation is relative, and may change over time or with respect to different observers. An innovation that was once considered radi-cal may eventually be considered incremental as the knowledge base underlying the innovation becomes more common. For example, while the first steam engine was a monumental innovation, today its construction seems relatively simple. Further-more, an innovation that is radical to one firm may seem incremental to another. Although both Kodak and Sony introduced digital cameras for the consumer mar-ket within a year of each other (Kodak’s DC40 was introduced in 1995, and Sony’s Cyber-Shot Digital Still Camera was introduced in 1996), the two companies’ paths to the introduction were quite different. Kodak’s historical competencies and reputa-tion were based on its expertise in chemical photography, and thus the transition to digital photography and video required a significant redirection for the firm. Sony, on the other hand, had been an electronics company since its inception, and had a substantial level of expertise in digital recording and graphics before producing a digital camera. Thus, for Sony, a digital camera was a straightforward extension of its existing competencies.Competence-Enhancing Innovation versus Competence-Destroying InnovationInnovations can also be classified as competence enhancing versus competence destroying. An innovation is considered to be competence enhancing from the per-spective of a particular firm if it builds on the firm’s existing knowledge base. For example, each generation of Intel’s microprocessors (e.g., 286, 386, 486, Pentium, Pentium II, Pentium III, Pentium 4) builds on the technology underlying the previous generation. Thus, while each generation embodies innovation, these innovations lever-age Intel’s existing competencies, making them more valuable.An innovation is considered to be competence destroying from the perspective of a particular firm if the technology does not build on the firm’s existing competen-cies or renders them obsolete. For example, from the 1600s to the early 1970s, no self- respecting mathematician or engineer would have been caught without a slide rule. Slide rules are lightweight devices, often constructed of wood, that use logarithm scales to solve complex mathematical functions. They were used to calculate every-thing from the structural properties of a bridge to the range and fuel use of an aircraft. Specially designed slide rules for businesses had, for example, scales for doing loan calculations or determining optimal purchase quantities. During the 1950s and 1960s, Keuffel & Esser was the preeminent slide-rule maker in the United States, producing 5000 slide rules a month. However, in the early 1970s, a new innovation relegated the slide rule to collectors and museum displays within just a few years: the inex-pensive handheld calculator. Keuffel & Esser had no background in the electronic competence-enhancing and competence destroying innovationA competence-enhancing innovation builds on existing knowledge and skills whereas a competence-destroying innovation renders existing knowledge and skills obsolete. Whether an inno-vation is compe-tence enhancing or competence destroying depends on whose perspec-tive is being taken. An innovation can be competence enhancing to one firm, while competence destroying for another.Final PDF to printer
sch87956_ch03_043-066.indd 49 11/12/18 10:19 AMChapter 3 Types and Patterns of Innovation 49components that made electronic calculators possible and was unable to transition to the new technology. By 1976, Keuffel & Esser withdrew from the market.3 Whereas the inexpensive handheld calculator built on the existing competencies of companies such as Hewlett-Packard and Texas Instruments (and thus for them would be compe-tence enhancing), for Keuffel & Esser, the calculator was a competence-destroying innovation.Architectural Innovation versus Component InnovationMost products and processes are hierarchically nested systems, meaning that at any unit of analysis, the entity is a system of components, and each of those components is, in turn, a system of finer components, until we reach some point at which the compo-nents are elementary particles.4 For example, a bicycle is a system of components such as a frame, wheels, tires, seat, brakes, and so on. Each of those components is also a system of components: The seat might be a system of components that includes a metal and plastic frame, padding, a nylon cover, and so on.An innovation may entail a change to individual components, to the overall archi-tecture within which those components operate, or both. An innovation is considered a component innovation (or modular innovation) if it entails changes to one or more components, but does not significantly affect the overall configuration of the system.5 In the example above, an innovation in bicycle seat technology (such as the incorporation of gel-filled material for additional cushioning) does not require any changes in the rest of the bicycle architecture.In contrast, an architectural innovation entails changing the overall design of the system or the way that components interact with each other. An innovation that is strictly architectural may reconfigure the way that components link together in the system, without changing the components themselves.6 Most architectural innova-tions, however, create changes in the system that reverberate throughout its design, requiring changes in the underlying components in addition to changes in the ways those components interact. Architectural innovations often have far-reaching and com-plex influences on industry competitors and technology users.For example, the transition from the high-wheel bicycle to the safety bicycle was an architectural innovation that required (and enabled) the change of many compo-nents of the bicycle and the way in which riders propelled themselves. In the 1800s, bicycles had extremely large front wheels. Because there were no gears, the size of the front wheel directly determined the speed of the bicycle since the circumference of the wheel was the distance that could be traveled in a single rotation of the ped-als. However, by the start of the twentieth century, improvements in metallurgy had enabled the production of a fine chain and a sprocket that was small enough and light enough for a human to power. This enabled bicycles to be built with two equally sized wheels, while using gears to accomplish the speeds that the large front wheel had enabled. Because smaller wheels meant shorter shock-absorbing spokes, the move to smaller wheels also prompted the development of suspension systems and pneumatic (air-filled) tires. The new bicycles were lighter, cheaper, and more flexible. This archi-tectural innovation led to the rise of companies such as Dunlop (which invented the pneumatic tire) and Raleigh (which pioneered the three-speed, all-steel bicycle), and transformed the bicycle from a curiosity into a practical transportation device.component (or modular) innovationAn innovation to one or more components that does not significantly affect the overall configuration of the system.architectural innovationAn innovation that changes the overall design of a system or the way its com-ponents interact with each other.Final PDF to printer
sch87956_ch03_043-066.indd 50 11/12/18 10:19 AM50 Part One Industry Dynamics of Technological InnovationFor a firm to initiate or adopt a component innovation may require that the firm have knowledge only about that component. However, for a firm to initiate or adopt an architectural innovation typically requires that the firm have architectural knowledge about the way components link and integrate to form the whole system. Firms must be able to understand how the attributes of components interact, and how changes in some system features might trigger the need for changes in many other design features of the overall system or the individual components. Modular-ity, and its role in the creation of platform ecosystems, is discussed in greater detail in Chapter Four.Using the DimensionsThough the dimensions described above are useful for exploring key ways that one innovation may differ from another, these dimensions are not independent, nor do they offer a straightforward system for categorizing innovations in a precise and con-sistent manner. Each of the above dimensions shares relationships with others—for example, architectural innovations are often considered more radical and more com-petence destroying than component innovations. Furthermore, how an innovation is described on a dimension often depends on who is doing the describing and with what it is being compared. An all-electric vehicle, for example, might seem like a radical and competence destroying innovation to a manufacturer of internal combus-tion engines, but to a customer who only has to change how they fuel/charge the vehicle, it might seem like an incremental and competence-enhancing innovation. Thus, while the dimensions above are valuable for understanding innovation, they should be considered relative dimensions whose meaning is dependent on the context in which they are used.We now will turn to exploring patterns in technological innovation. Numerous stud-ies of innovation have revealed recurring patterns in how new technologies emerge, evolve, are adopted, and are displaced by other technologies. We begin by examining technology s-curves.TECHNOLOGY S-CURVESBoth the rate of a technology’s performance improvement and the rate at which the technology is adopted in the marketplace repeatedly have been shown to conform to an s-shape curve. Though s-curves in technology performance and s-curves in technology diffusion are related (improvements in performance may foster faster adoption, and greater adoption may motivate further investment in improving performance), they are fundamentally different processes. S-curves in technology improvement are described first, followed by s-curves in technology diffusion. This section also explains that despite the allure of using s-curves to predict when new phases of a technology’s life cycle will begin, doing so can be misleading.S-Curves in Technological ImprovementMany technologies exhibit an s-curve in their performance improvement over their life-times.7 When a technology’s performance is plotted against the amount of effort and money invested in the technology, it typically shows slow initial improvement, then Final PDF to printer
sch87956_ch03_043-066.indd 51 11/12/18 10:19 AMChapter 3 Types and Patterns of Innovation 51accelerated improvement, then diminishing improvement (see Figure 3.1). Performance improvement in the early stages of a technology is slow because the fundamentals of the technology are poorly understood. Great effort may be spent exploring differ-ent paths of improvement or different drivers of the technology’s improvement. If the technology is very different from previous technologies, there may be no evaluation routines that enable researchers to assess its progress or its potential. Furthermore, until the technology has established a degree of legitimacy, it may be difficult to attract other researchers to participate in its development.8 However, as scientists or firms gain a deeper understanding of the technology, improvement begins to accelerate. The technology begins to gain legitimacy as a worthwhile endeavor, attracting other devel-opers. Furthermore, measures for assessing the technology are developed, permitting researchers to target their attention toward those activities that reap the greatest improvement per unit of effort, enabling performance to increase rapidly. However, at some point, diminishing returns to effort begin to set in. As the technology begins to reach its inherent limits, the cost of each marginal improvement increases, and the s-curve flattens.Often a technology’s s-curve is plotted with performance (e.g., speed, capacity, or power) against time, but this must be approached with care. If the effort invested is not constant over time, the resulting s-curve can obscure the true relationship. If effort is relatively constant over time, plotting performance against time will result in the same characteristic curve as plotting performance against effort. However, if the amount of effort invested in a technology decreases or increases over time, the resulting curve could appear to flatten much more quickly, or not flatten at all. For instance, one of the more well-known technology trajectories is described by an axiom that became known as Moore’s law. In 1965, Gordon Moore, cofounder of Intel, noted that the density of transistors on integrated circuits had doubled every year since the integrated circuit was invented. Figure 3.2 shows Intel’s microprocessor transistor density from 1971 to 2007 and reveals a sharply increasing performance curve.FIGURE 3.1S-Curve of Technology PerformancePerformanceEffortLimit of TechnologyFinal PDF to printer
sch87956_ch03_043-066.indd 52 11/12/18 10:19 AM52 Part One Industry Dynamics of Technological InnovationHowever, Intel’s rate of investment (research and development dollars per year) also increased rapidly over that time frame, as shown in Figure 3.3. Not all of Intel’s R&D expense goes directly to improving microprocessor power, but it is reasonable to assume that Intel’s investment specifically in microprocessors would exhibit a simi-lar pattern of increase. Figure 3.3 shows that the big gains in transistor density have come at a big cost in terms of effort invested. Though the curve does not yet resemble FIGURE 3.2Improvements in Intel’s Microprocessor Transistor Density over TimeYearTransistorsIntel CPU197122504004197225008008197450008080197829,00080861982120,0002861985275,000386™19891,180,000486™ DX19933,100,000Pentium®19977,500,000Pentium II199924,000,000Pentium III200042,000,000Pentium 4200255,000,000Pentium M2003220,000,000Itanium 22005291,000,000Pentium D2006582,000,000Core 2 Quad731,000,000Core i7 (Quad)2007800,000,000700,000,000600,000,000500,000,000400,000,000Transistor Density300,000,000200,000,000100,000,000-197019751980198519901995200020052010YearFIGURE 3.3Graph of Transistor Density versus Cumulative R&D Expense, 1972–2007800,000,000700,000,000600,000,000500,000,000400,000,000Transistor Density300,000,000200,000,000100,000,0000010,00020,00030,000Cumulative R&D Expense ($millions)40,00050,00060,000Final PDF to printer
sch87956_ch03_043-066.indd 53 11/12/18 10:19 AMChapter 3 Types and Patterns of Innovation 53the traditional s-curve, its rate of increase is not as sharp as when the curve is plotted against years.Technologies do not always get the opportunity to reach their limits; they may be rendered obsolete by new, discontinuous technologies. A new innovation is dis-continuous when it fulfills a similar market need, but does so by building on an entirely new knowledge base.9 For example, the switches from propeller-based planes to jets, from silver halide (chemical) photography to digital photography, from carbon copy-ing to photocopying, and from audio on compact discs to MP3 were all technological discontinuities.Initially, the technological discontinuity may have lower performance than the incumbent technology. For instance, one of the earliest automobiles, introduced in 1771 by Nicolas Joseph Cugnot, was never put into commercial production because it was much slower and harder to operate than a horse-drawn carriage. It was three-wheeled, steam-powered, and could travel at 2.3 miles per hour. A number of steam- and gas-powered vehicles were introduced in the 1800s, but it was not until the early 1900s that automobiles began to be produced in quantity.In early stages, effort invested in a new technology may reap lower returns than effort invested in the current technology, and firms are often reluctant to switch. How-ever, if the disruptive technology has a steeper s-curve (see Figure 3.4a) or an s-curve that increases to a higher performance limit (see Figure 3.4b), there may come a time when the returns to effort invested in the new technology are much higher than effort invested in the incumbent technology. New firms entering the industry are likely to choose the disruptive technology, and incumbent firms face the difficult choice of try-ing to extend the life of their current tech-nology or investing in switching to the new technology. If the disruptive tech-nology has much greater performance potential for a given amount of effort, in the long run it is likely to displace the incumbent technology, but the rate at which it does so can vary significantly.S-Curves in Technology DiffusionS-curves are also often used to describe the diffusion of a technology. Unlike s-curves in technology performance, s-curves in technology diffusion are obtained by plotting the cumulative number of adopt-ers of the technology against time. This yields an s-shape curve because adop-tion is initially slow when an unfa-miliar technology is introduced to the market; it accelerates as the technology becomes better understood and utilized by the mass market, and eventually the market is saturated so the rate of new discontinuous technologyA technology that fulfills a similar market need by building on an entirely new knowledge diffusionThe spread of a technology through a population.FIGURE 3.4Technology S-Curves—Introduction of Discontinuous TechnologyPerformanceEffortPerformanceEffortFirsttechnologyFirsttechnologySecondtechnologySecondtechnology(a)(b)Final PDF to printer
sch87956_ch03_043-066.indd 54 11/12/18 10:19 AM54 Part One Industry Dynamics of Technological Innovationadoptions declines. For instance, when electronic calculators were introduced to the market, they were first adopted by the relatively small pool of scientists and engineers. This group had previously used slide rules. Then the calculator began to penetrate the larger markets of accountants and commercial users, followed by the still larger market that included students and the general public. After these markets had become satu-rated, fewer opportunities remained for new adoptions.10One rather curious feature of technology diffusion is that it typically takes far more time than information diffusion.11 For example, Mansfield found that it took 12 years for half the population of potential users to adopt industrial robots, even though these potential users were aware of the significant efficiency advantages the robots offered.12 If a new technology is a significant improvement over existing solutions, why do some firms shift to it more slowly than others? The answer may lie in the complexity of the knowledge underlying new technologies, and in the development of complemen-tary resources that make those technologies useful. Although some of the knowledge necessary to utilize a new technology might be transmitted through manuals or other documentation, other aspects of knowledge necessary to fully realize the potential of a technology might be built up only through experience. Some of the knowledge about the technology might be tacit and require transmission from person to person through extensive contact. Many potential adopters of a new technology will not adopt it until such knowledge is available to them, despite their awareness of the technology and its potential advantages.13Furthermore, many technologies become valuable to a wide range of potential users only after a set of complementary resources are developed for them. For example, while the first electric light was invented in 1809 by Humphry Davy, an English chem-ist, it did not become practical until the development of bulbs within which the arc of light would be encased (first demonstrated by James Bowman Lindsay in 1835) and vacuum pumps to create a vacuum inside the bulb (the mercury vacuum pump was invented by Herman Sprengel in 1875). These early lightbulbs burned for only a few hours. Thomas Alva Edison built on the work of these earlier inventors when, in 1880, he invented filaments that would enable the light to burn for 1200 hours. The role of complementary resources and other factors influencing the diffusion of technological innovations are discussed further in Chapters four, five, and thirteen.Finally, it should be clear that the s-curves of diffusion are in part a function of the s-curves in technology improvement: As technologies are better developed, they become more certain and useful to users, facilitating their adoption. Further-more, as learning-curve and scale advantages accrue to the technology, the price of finished goods often drops, further accelerating adoption by users. For example, as shown in Figures 3.5 and 3.6, drops in average sales prices for video record-ers, compact disc players, and cell phones roughly correspond to their increases in household penetration.S-Curves as a Prescriptive ToolSeveral authors have argued that managers can use the s-curve model as a tool for pre-dicting when a technology will reach its limits and as a prescriptive guide for whether and when the firm should move to a new, more radical technology.14 Firms can use data on the investment and performance of their own technologies, or data on the Final PDF to printer
sch87956_ch03_043-066.indd 55 11/12/18 10:19 AMChapter 3 Types and Patterns of Innovation 55overall industry investment in a technology and the average performance achieved by multiple producers. Managers could then use these curves to assess whether a technol-ogy appears to be approaching its limits or to identify new technologies that might be emerging on s-curves that will intersect the firm’s technology s-curve. Managers could then switch s-curves by acquiring or developing the new technology. However, as a prescriptive tool, the s-curve model has several serious limitations.Limitations of S-Curve Model as a Prescriptive ToolFirst, it is rare that the true limits of a technology are known in advance, and there is often considerable disagreement among firms about what a technology’s limits will be. Second, the shape of a technology’s s-curve is not set in stone. Unexpected changes FIGURE 3.6Penetration of Consumer ElectronicsSource: Consumer Electronics Association.VCRCD PlayerCell Phone100%90%80%70%60%50%40%30%20%10%0%1988199019841986198019821992199419961998200020022004Percent of U.S. HouseholdsFIGURE 3.5Average Sales Prices of Consumer ElectronicsSource: Consumer Electronics Association.$0$800$600$400$200$10001988199019841986198019821992199419961998200020022004VCRCD PlayerCell PhoneFinal PDF to printer
sch87956_ch03_043-066.indd 56 11/12/18 10:19 AM56 Part One Industry Dynamics of Technological Innovationin the market, component technologies, or complementary technologies can shorten or extend the life cycle of a technology. Furthermore, firms can influence the shape of the s-curve through their development activities. For example, firms can sometimes stretch the s-curve through implementing new development approaches or revamping the architecture design of the technology.15Christensen provides an example of this from the disk-drive industry. A disk drive’s capacity is determined by its size multiplied by its areal recording density; thus, density has become the most pervasive measure of disk-drive performance. In 1979, IBM had reached what it perceived as a density limit of ferrite-oxide–based disk drives. It abandoned its ferrite-oxide–based disk drives and moved to developing thin-film technology, which had greater potential for increasing den-sity. Hitachi and Fujitsu continued to ride the ferrite-oxide s-curve, ultimately achieving densities that were eight times greater than the density that IBM had perceived to be a limit.Finally, whether switching to a new technology will benefit a firm depends on a number of factors, including (a) the advantages offered by the new technology, (b) the new technology’s fit with the firm’s current abilities (and thus the amount of effort that would be required to switch, and the time it would take to develop new competen-cies), (c) the new technology’s fit with the firm’s position in complementary resources (e.g., a firm may lack key complementary resources, or may earn a significant portion of its revenues from selling products compatible with the incumbent technology), and (d) the expected rate of diffusion of the new technology. Thus, a firm that follows an s-curve model too closely could end up switching technologies earlier or later than it should.TECHNOLOGY CYCLESThe s-curve model above suggests that technological change is cyclical: Each new s-curve ushers in an initial period of turbulence, followed by rapid improvement, then diminishing returns, and ultimately is displaced by a new technological discontinu-ity.16 The emergence of a new technological discontinuity can overturn the existing competitive structure of an industry, creating new leaders and new losers. Schumpeter called this process creative destruction, and argued that it was the key driver of prog-ress in a capitalist society.17Several studies have tried to identify and characterize the stages of the technol-ogy cycle in order to better understand why some technologies succeed and others fail, and whether established firms or new firms are more likely to be successful in introducing or adopting a new technology.18 One technology evolution model that rose to prominence was proposed by Utterback and Abernathy. They observed that a tech-nology passed through distinct phases. In the first phase (what they termed the fluid phase), there was considerable uncertainty about both the technology and its market. Products or services based on the technology might be crude, unreliable, or expensive, but might suit the needs of some market niches. In this phase, firms experiment with different form factors or product features to assess the market response. Eventually, however, producers and customers begin to arrive at some consensus about the desired Final PDF to printer
sch87956_ch03_043-066.indd 57 11/12/18 10:19 AMChapter 3 Types and Patterns of Innovation 57Research Brief The Diffusion of Innovation and Adopter CategoriesS-curves in technology diffusion are often explained as a process of different categories of people adopt-ing the technology at different times. One typology of adopter categories that gained prominence was proposed by Everett M. Rogers.a Figure 3.7 shows each of Rogers’s adopter categories on a technol-ogy diffusion s-curve. The figure also shows that if the non cumulative share of each of these adopter groups is plotted on the vertical axis with time on the horizontal axis, the resulting curve is typically bell shaped (though in practice it may be skewed right or left).INNOVATORSInnovators are the first individuals to adopt an inno-vation. Extremely adventurous in their purchasing behavior, they are comfortable with a high degree of complexity and uncertainty. Innovators typically have access to substantial financial resources (and thus can afford the losses incurred in unsuccessful adoption decisions). Though they are not always well integrated into a particular social system, innova-tors play an extremely important role in the diffusion of an innovation because they are the individuals who bring new ideas into the social system. Rogers estimated that the first 2.5 percent of individuals to adopt a new technology are in this category.EARLY ADOPTERSThe second category of adopters is the early adopt-ers. Early adopters are well integrated into their social system and have the greatest potential for opinion leadership. Early adopters are respected by their peers and know that to retain that respect they must make sound innovation adoption deci-sions. Other potential adopters look to early adopt-ers for information and advice; thus early adopters make excellent missionaries for new products or pro-cesses. Rogers estimated that the next 13.5 percent of individuals to adopt an innovation (after innova-tors) are in this category.EARLY MAJORITYRogers identifies the next 34 percent of individuals in a social system to adopt a new innovation as the early majority. The early majority adopts innovations slightly before the average member of a social sys-tem. They are typically not opinion leaders, but they interact frequently with their peers.LATE MAJORITYThe next 34 percent of the individuals in a social system to adopt an innovation are the late majority, according to Rogers. Like the early majority, the late majority constitutes one-third of the individuals in a social system. Those in the late majority approach innovation with a skeptical air and may not adopt the innovation until they feel pressure from their peers. The late majority may have scarce resources, thus making them reluctant to invest in adoption until most of the uncertainty about the innovation has been resolved.LAGGARDSThe last 16 percent of the individuals in a social sys-tem to adopt an innovation are termed laggards. They may base their decisions primarily upon past experience rather than influence from the social network, and they possess almost no opinion lead-ership. They are highly skeptical of innovations and innovators, and they must feel certain that a new innovation will not fail before adopting it.a E. M. Rogers, Diffusion of Innovations, 5th ed. (New York: Free Press, 2003).continuedFinal PDF to printer
sch87956_ch03_043-066.indd 58 11/12/18 10:19 AM58 Part One Industry Dynamics of Technological InnovationconcludedFIGURE 3.7Technology Diffusion S-Curve with Adopter CategoriesS-Curve of Cumulative Adopters Normal (Bell-Shaped) Curve of Market Share CumulativeAdoptersTimeInnovators100%84%16%50%2.5%Laggards Late MajorityEarly MajorityEarly Adopters ShareTime2.5%34%13.5%InnovatorsEarlyAdoptersEarlyMajority LateMajority Laggards (a)(b)Final PDF to printer
59sch87956_ch03_043-066.indd 59 11/12/18 10:19 AMFrom 1980 to 2012, Microsoft was entrenched as the dominant personal computer operating system, giving it enormous influence over many aspects of the computer hardware and software industries. Though competing operating systems had been introduced during that time (e.g., Unix, Geoworks, NeXTSTEP, Linux, and the Mac OS), Microsoft’s share of the personal computer operating sys-tem market held stable at roughly 85  percent throughout most of that period. In 2013, however, Microsoft’s domi-nance in computer operating systems was under greater threat than it had ever been. A high-stakes race for domi-nance over the next generation of computing was well underway, and Microsoft was not even in the front pack.“SEGMENT ZERO”As Andy Grove, former CEO of Intel, noted in 1998, in many industries—including microprocessors, soft-ware, motorcycles, and electric vehicles—technologies improve faster than customer demands of those tech-nologies increase. Firms often add features (speed, power, etc.) to products faster than customers’ capac-ity to absorb them. Why would firms provide higher performance than that required by the bulk of their customers? The answer appears to lie in the market segmentation and pricing objectives of a technol-ogy’s providers. As competition in an industry drives prices and margins lower, firms often try to shift sales into progressively higher tiers of the market. In these tiers, high performance and feature-rich products can command higher margins. Though customers may also expect to have better-performing products over time, their ability to fully utilize such performance improve-ments is slowed by the need to learn how to use new features and adapt their work and lifestyles. Thus, while both the trajectory of technology improvement and the trajectory of customer demands are upward sloping, the trajectory for technology improvement is steeper (for simplicity, the technology trajectories are drawn in Figure 3.8 as straight lines and plotted against time in order to compare them against cus-tomer requirements).In Figure 3.8, the technology trajectory begins at a point where it provides performance close to that demanded by the mass market, but over time it increases faster than the expectations of the mass mar-ket as the firm targets the high-end market. As the price of the technology rises, the mass market may feel it is overpaying for technological features it does not value. In Figure 3.9, the low-end market is not being served; it either pays far more for technology that it does not need or goes without. It is this market that Andy Grove, former CEO of Intel, refers to as segment zero.For Intel, segment zero was the market for low-end personal computers (those less than $1000). While seg-ment zero may seem unattractive in terms of margins, if it is neglected, it can become the breeding ground for companies that provide lower-end versions of the tech-nology. As Grove notes, “The overlooked, underserved, and seemingly unprofitable end of the market can provide fertile ground for massive competitive change.”aTheory in Action “Segment Zero”—A Serious Threat to Microsoft?FIGURE 3.9Low-End Technology’s Trajectory Intersects Mass Market TrajectoryHigh-end marketMass marketLow-end marketHigh-endtechnologyPerformanceTimeLow-endtechnologyFIGURE 3.8Trajectories of Technology Improvement and Customer RequirementsHigh-end marketMass marketLow-end marketTechnologytrajectoryPerformanceTimecontinuedFinal PDF to printer
60sch87956_ch03_043-066.indd 60 11/12/18 10:19 AMAs the firms serving low-end markets with simpler technologies ride up their own trajectories (which are also steeper than the slope of the trajectories of cus-tomer expectations), they can eventually reach a perfor-mance level that meets the demands of the mass market, while offering a much lower price than the premium tech-nology (see Figure 3.9). At this point, the firms offering the premium technology may suddenly find they are los-ing the bulk of their sales revenue to industry contenders that do not look so low end anymore. For example, by 1998, the combination of rising microprocessor power and decreasing prices enabled personal computers priced under $1000 to capture 20 percent of the market.THE THREAT TO MICROSOFTSo where was the “segment zero” that could threaten Microsoft? Look in your pocket. In 2018, Apple’s iPhone operating system (iOS) and Google’s Android collectively controlled almost 100 percent of the worldwide mar-ket for smartphones (with Android at 86.1 percent and iOS at 13.7 percent), followed by Research in Motion’s Blackberry.b Gartner estimates put Microsoft’s share at 3 percent. The iOS and Android interfaces offered a double whammy of beautiful aesthetics and remarkable ease of use. The applications business model used for the phones was also extremely attractive to both devel-opers and customers, and quickly resulted in enormous libraries of applications that ranged from the ridiculous to the indispensible.From a traditional economics perspective, the phone operating system market should not be that attractive to Microsoft—people do not spend as much on the applications, and the carriers have too much bargaining power, among other reasons. However, those smart-phone operating systems soon became tablet operat-ing systems, and tablets were rapidly becoming fully functional computers. Suddenly, all of that mindshare that Apple and Google had achieved in smartphone operating systems was transforming into mindshare in personal computer operating systems. Despite years of masterminding the computing industry, Microsoft’s dom-inant position was at risk of evaporating.a A. S. Grove, “Managing Segment Zero,” Leader to Leader, 1999, p. 11.b, 2018.concludedproduct attributes, and a dominant design emerges.19 The dominant design estab-lishes a stable architecture for the technology and enables firms to focus their efforts on process innovations that make production of the design more effective and effi-cient or on incremental innovations to improve components within the architecture. Utterback and Abernathy termed this phase the specific phase because innovations in products, materials, and manufacturing processes are all specific to the dominant design. For example, in the United States, the vast majority of energy production is based on the use of fossil fuels (e.g., oil, coal), and the methods of producing energy based on these fuels are well established. On the other hand, technologies that produce energy based on renewable resources (e.g., solar, wind, hydrogen) are still in the fluid phase. Organizations such as Royal Dutch/Shell, General Electric, and Ballard Power are experimenting with various forms of solar photocell technologies, wind-turbine technologies, and hydrogen fuel cells in efforts to find methods of using renewable resources that meet the capacity and cost requirements of serving large populations.Building on the Utterback and Abernathy model, Anderson and Tushman stud-ied the history of the U.S. minicomputer, cement, and glass industries through sev-eral cycles of technological change. Like Utterback and Abernathy, Anderson and Tushman found that each technological discontinuity inaugurated a period of turbu-lence and uncertainty (which they termed the era of ferment) (see Figure 3.10). The new technology might offer breakthrough capabilities, but there is little agreement about what the major subsystems of the technology should be or how they should be dominant designA product design that is adopted by the majority of producers, typically creating a stable archi-tecture on which the industry can focus its efforts.Final PDF to printer
sch87956_ch03_043-066.indd 61 11/12/18 10:19 AMChapter 3 Types and Patterns of Innovation 61configured together. Furthermore, as later researchers noted, during the era of ferment different stakeholders might have different concepts of what purpose the technology should serve, or how a business model might be built around it.20 Thus, while the new technology displaces the old (Anderson and Tushman refer to this as substitution), there is considerable design competition as firms experiment with different forms of the technology. Just as in the Utterback and Abernathy model, Anderson and Tushman found that a dominant design always arose to command the majority of the market share unless the next discontinuity arrived too soon and disrupted the cycle, or sev-eral producers patented their own proprietary technologies and refused to license to each other. Anderson and Tushman also found that the dominant design was never in the same form as the original discontinuity, but it was also never on the leading edge of the technology. Instead of maximizing performance on any individual dimen-sion of the technology, the dominant design tended to bundle together a combination of features that best fulfilled the demands of the majority of the market.In the words of Anderson and Tushman, the rise of a dominant design signals the transition from the era of ferment to the era of incremental change.21 In this era, firms focus on efficiency and market penetration. Firms may attempt to achieve greater mar-ket segmentation by offering different models and price points. They may also attempt to lower production costs by simplifying the design or improving the production pro-cess. This period of accumulating small improvements may account for the bulk of the technological progress in an industry, and it continues until the next technological discontinuity.Understanding the knowledge that firms develop during different eras lends insight into why successful firms often resist the transition to a new technology, even if it provides significant advantages. During the era of incremental change, many firms cease to invest in learning about alternative design architectures and instead invest in refining their competencies related to the dominant architecture. Most competition revolves around improving components rather than altering the architecture; thus, companies focus their efforts on developing component knowledge and knowledge FIGURE 3.10The Technol-ogy CycleEra of Incremental ChangeElaboration of Dominant Design Era of FermentDesign CompetitionSubstitutionDominant DesignSelectedTechnologicalDiscontinuityFinal PDF to printer
sch87956_ch03_043-066.indd 62 11/12/18 10:19 AM62 Part One Industry Dynamics of Technological Innovationrelated to the dominant architecture. As firms’ routines and capabilities become more and more wedded to the dominant architecture, the firms become less able to identify and respond to a major architectural innovation. For example, the firm might establish divisions based on the primary components of the architecture and structure the com-munication channels between divisions on the basis of how those components interact. In the firm’s effort to absorb and process the vast amount of information available to it, it is likely to establish filters that enable it to identify the information most crucial to its understanding of the existing technology design.22 As the firm’s expertise, struc-ture, communication channels, and filters all become oriented around maximizing its ability to compete in the existing dominant design, they become barriers to the firm’s recognizing and reacting to a new technology architecture.While many industries appear to conform to this model in which a dominant design emerges, there are exceptions. In some industries, heterogeneity of products and pro-duction processes are a primary determinant of value, and thus a dominant design is undesirable.23 For example, art and cuisine may be examples of industries in which there is more pressure to do things differently than to settle upon a standard. 1. Different dimensions have been used to distinguish types of innovation. Some of the most widely used dimensions include product versus process innovation, radi-cal versus incremental innovation, competence-enhancing versus competence-destroying innovation, and architectural versus component innovation. 2. A graph of technology performance over cumulative effort invested often exhibits an s-shape curve. This suggests that performance improvement in a new technology is initially difficult and costly, but, as the fundamental principles of the technol-ogy are worked out, it then begins to accelerate as the technology becomes better understood, and finally diminishing returns set in as the technology approaches its inherent limits. 3. A graph of a technology’s market adoption over time also typically exhibits an s-shape curve. Initially the technology may seem uncertain and there may be great costs or risks for potential adopters. Gradually, the technology becomes more cer-tain (and its costs may be driven down), enabling the technology to be adopted by larger market segments. Eventually the technology’s diffusion slows as it reaches market saturation or is displaced by a newer technology. 4. The rate at which a technology improves over time is often faster than the rate at which customer requirements increase over time. This means technologies that initially met the demands of the mass market may eventually exceed the needs of the market. Furthermore, technologies that initially served only low-end custom-ers (segment zero) may eventually meet the needs of the mass market and capture the market share that originally went to the higher-performing technology. 5. Technological change often follows a cyclical pattern. First, a technological discontinuity causes a period of turbulence and uncertainty, and producers and consumers explore the different possibilities enabled by the new technology. As producers and customers begin to converge on a consensus of the desired techno-logical configuration, a dominant design emerges. The dominant design provides Summary of ChapterFinal PDF to printer
sch87956_ch03_043-066.indd 63 11/12/18 10:19 AMChapter 3 Types and Patterns of Innovation 63a stable benchmark for the industry, enabling producers to turn their attention to increasing production efficiency and incremental product improvements. This cycle begins again with the next technological discontinuity. 6. The first design based on the initial technological discontinuity rarely becomes the dominant design. There is usually a period in which firms produce a variety of competing designs of the technology before one design emerges as dominant. 7. The dominant design rarely embodies the most advanced technological features available at the time of its emergence. It is instead the bundle of features that best meets the requirements of the majority of producers and customers. 1. What are some reasons that established firms might resist adopting a new technology? 2. Are well-established firms or new entrants more likely to (a) develop and/or (b) adopt new technologies? Why? 3. Think of an example of an innovation you have studied at work or school. How would you characterize it on the dimensions described at the beginning of the chapter? 4. What are some reasons that both technology improvement and technology diffu-sion exhibit s-shape curves? 5. Why do technologies often improve faster than customer requirements? What are the advantages and disadvantages to a firm of developing a technology beyond the current state of market needs? 6. In what industries would you expect to see particularly short technology cycles? In what industries would you expect to see particularly long technology cycles? What factors might influence the length of technology cycles in an industry?Discussion QuestionsClassicsAnderson, P., and M. L. Tushman, “Technological discontinuities and dominant designs,” Administrative Science Quarterly 35 (1990), pp. 604–33.Bijker, W. E., T. P. Hughes, and T. J. Pinch, The Social Construction of Technological Systems (Cambridge, MA: MIT Press, 1987).Christensen, C. M., The Innovator’s Dilemma: When New Technologies Cause Great Firms to Fail (Boston: Harvard Business School Publishing, 1997).Dosi, G., “Technological paradigms and technological trajectories,” Research Policy 11 (1982), pp. 147–60.Rogers, E., Diffusion of Innovations, 5th ed. (New York: Simon & Schuster Publish-ing, 2003).Schilling, M. A., and M. Esmundo, “Technology S-Curves in Renewable Energy Alternatives: Analysis and Implications for Industry and Government,” Energy Policy, 37 (2009), pp. 1767–81.Suggested Further ReadingFinal PDF to printer
sch87956_ch03_043-066.indd 64 11/12/18 10:19 AM64 Part One Industry Dynamics of Technological InnovationRecent WorkAnder, R., and R. Kapoor, “Innovation Ecosystems and the Pace of Substitution: Re-examining Technology S-curves,” Strategic Management Journal (2015), 37:625–648.Ethiraj, S., D. Levinthal, and R. R. Roy, “The dual role of modularity: Innovation and imitation,” Management Science, 54 (2008), pp. 93–955.Park, W., Y. K. Ro, and N. Kim, 2018. “Architectural Innovation and the Emergence of a Dominant Design: The Effects of Strategic Sourcing on Performance,” 47 (2018), pp. 326–341.Schilling, M. A., “Technology Shocks, Technological Collaboration, and Innovation Outcomes,” Organization Science, 26 (2015), pp. 668–686.Slater, S. F., J. J. Mohr, and S. Sengupta, “Radical Product Innovation Capability: Lit-erature Review, Synthesis, and Illustrative Research Propositions,” Journal of Product Innovation Management, 31 (2014), pp. 552–566.Young, H. P., “Innovation diffusion in heterogeneous populations: Contagion, social influence, and social learning,” American Economic Review 99 (2009), pp. 1899–1924. 1. R. L. Daft and S. W. Becker, Innovation in Organizations (New York: Elsevier, 1978); T. D. Duchesneau, S. Cohn, and J. Dutton, A Study of Innovation in Manufacturing: Determina-tion, Processes and Methodological Issues, vol. 1 (Social Science Research Institute, University of Maine, 1979); and J. Hage, Theories of Organization (New York: Wiley Interscience, 1980). 2. R. D. Dewar and J. E. Dutton, “The Adoption of Radical and Incremental Innovations: An Empirical Analysis,” Management Science 32 (1986), pp. 1422–33; and J. Dutton and A. Thomas, “Relating Technological Change and Learning by Doing,” in Research on Tech-nological Innovation, Management and Policy, ed. R. Rosenbloom (Greenwich, CT: JAI Press, 1985), pp. 187–224. 3. C. Scuria-Fontana, “The Slide Rule Today: Respect for the Past; History of the Slide Rule,” Mechanical Engineering-CIME, July 1990, pp. 122–24. 4. H. Simon, “The Architecture of Complexity,” Proceedings of the American Philosophical Soci-ety 106 (1962), pp. 467–82. 5. L. Fleming and O. Sorenson, “Navigating the Technology Landscape of Innovation,” Sloan Management Review 44, no. 2 (2003), p. 15; and M. A. Schilling, “Towards a General Modular Systems Theory and Its Application to Interfirm Product Modularity,” Academy of Manage-ment Review 25 (2000), pp. 312–34. 6. R. Henderson and K. Clark, “Architectural Innovation: The Reconfiguration of Existing Prod-uct Technologies and the Failure of Established Firms,” Administrative Science Quarterly 35 (1990), pp. 9–30. 7. R. Foster, Innovation: The Attacker’s Advantage (New York: Summit Books, 1986). 8. R. Garud and M. A. Rappa, “A Socio-Cognitive Model of Technology Evolution: The Case of Cochlear Implants,” Organization Science 5 (1994), pp. 344–62; and W. E. Bijker, T. P. Hughes, and T. J. Pinch, The Social Construction of Technological Systems ( Cambridge, MA: MIT Press, 1987). 9. Foster, Innovation. 10. R. Brown, “Managing the ‘s’ Curves of Innovation,” Journal of Consumer Marketing 9 (1992), pp. 61–72.EndnotesFinal PDF to printer
sch87956_ch03_043-066.indd 65 11/12/18 10:19 AMChapter 3 Types and Patterns of Innovation 65 11. E. Rogers, Diffusion of Innovations, 4th ed. (New York: Free Press, 1995). 12. E. Mansfield, “Industrial Robots in Japan and the USA,” Research Policy 18 (1989), pp. 183–92. 13. P. A. Geroski, “Models of Technology Diffusion,” Research Policy 29 (2000), pp. 603–25. 14. Foster, Innovation; and E. H. Becker and L. M. Speltz, “Putting the S-curve Concept to Work,” Research Management 26 (1983), pp. 31–33. 15. C. Christensen, Innovation and the General Manager (New York: Irwin/McGraw-Hill, 1999). 16. P. Anderson and M. Tushman, “Technological Discontinuities and Dominant Designs: A Cycli-cal Model of Technological Change,” Administrative Science Quarterly 35 (1990), pp. 604–34. 17. J. Schumpeter, Capitalism, Socialism and Democracy (New York: Harper Brothers, 1942). 18. See, for example, J. M. Utterback and W. J. Abernathy, “A Dynamic Model of Process and Product Innovation,” Omega, the International Journal of Management Science 3 (1975), pp. 639–56; and D. Sahal, Patterns of Technological Innovation (Reading, MA: Addison- Wesley Publishing Co., 1981). 19. Utterback and Abernathy, “A Dynamic Model of Process and Product Innovation”; F. F. Suarez and J. M. Utterback, “Dominant Designs and the Survival of Firms,” Strategic Management Journal 16 (1995), pp. 415–30; and J. M. Utterback and F. F. Suarez, “Innovation, Competition and Industry Structure,” Research Policy 22 (1993), pp. 1–21. 20. Kaplan, S. and Tripsas, M. “Thinking about Technology: Applying a Cognitive Lens to Techni-cal Change,” Research Policy, 37 (2008):790–805. 21. P. Anderson and M. Tushman, “Technological Discontinuities and Dominant Designs: A Cycli-cal Model of Technological Change,” Administrative Science Quarterly 35 (1990), pp. 604–34. 22. R. Henderson and K. Clark, “Architectural Innovation: The Reconfiguration of Existing Product Technologies and the Failure of Established Firms,” Administrative Science Quarterly 35 (1990), pp. 9–30. 23. M. E. Porter, “The Technological Dimension of Competitive Strategy,” in Research on Techno-logical Innovation, Management and Policy, ed. R. S. Rosenbloom (Greenwich, CT: JAI Press, 1983); and S. Klepper, “Entry, Exit, Growth, and Innovation over the Product Life Cycle,” American Economic Review 86 (1996), pp. 562–83.Final PDF to printer
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67sch87956_ch04_067-094.indd 67 11/09/18 10:47 AMChapter FourStandards Battles, Modularity, and Platform CompetitionA Battle for Dominance in Mobile PaymentsBy 2018, there were roughly five billion mobile broadband subscribers in the world.a As smartphones spread worldwide, so do mobile payment systems. The fastest growth is in developing economies in Asia, Africa, and Latin America, where many people did not have credit cards or bank cards and are transitioning directly from cash payments to mobile payments (see Figure 1).b It is difficult to get a precise picture of worldwide mobile payment system use and esti-mates vary widely, but they are all large: from hundreds of billions to trillions of U.S.  dollars. However, in 2018, there was no dominant mobile payment system standard, and a battle among competing mobile payment mechanisms and stan-dards was unfolding.Many of the large mobile payment systems such as Apple Pay, Samsung Pay, or Android Pay, use Near Field Communication (NFC) chips in smartphones. NFC chips enable communication between a mobile device and a point-of-sale system just by having the devices in close proximity.c These systems transfer the customer’s information wirelessly, and then merchant banks and credit card systems such as Visa or Mastercard complete the transaction. These systems are thus very much like existing ways of using credit cards, but enable comple-tion of the purchase without contact. In emerging markets such as Asia-Pacific and Latin America, where NFC-enabled smartphones are less common, mobile payment systems are more likely to use QR codes (machine-readable bar codes), contactless stickers, and magnetic secure transmission (MST). MST sends a mag-netic signal from a mobile device to a payment terminal.The largest mobile payment system in the world, Alipay (owned by Alibaba group in China) uses a system based on QR codes. With Alipay, a merchant generates a barcode at the point of sale, and the consumer scans with their phone. An application then shows the details of the transaction and the Final PDF to printer
sch87956_ch04_067-094.indd 68 11/09/18 10:47 AM68 Part One Industry Dynamics of Technological Innovationconsumer enters a pin to confirm payment. Alipay reports that by the end of 2017 it had 520  million active users.Other competitors, such as Square (with Square Wallet) and PayPal, use a downloadable application and the Web to transmit a customer’s information. Square had gained early fame by offering small, free, credit card readers that could be plugged into the audio jack of a smartphone. These readers enabled vendors that would normally take only cash (street vendors, babysitters, etc.) to accept major credit cards.d Square processed $30 billion in payments in 2014, making the company one of the fastest growing tech start-ups in Silicon Valley.e Square takes about 2.75 to 3 percent from each transaction it processes, but must split that with credit card companies and other financial institutions. In terms of installed base, however, PayPal had the clear advantage, with more than 227 million active registered accounts by year end 2017. With PayPal, custom-ers could complete purchases simply by entering their phone numbers and a pin number, or use a PayPal-issued magnetic stripe cards linked to their PayPal FIGURE 1Proximity Mobile Payment Users Worldwide, by Region, 2016–2021Source: eMarketer Report, 2018201620172018201920202021Proximity mobile payment users (millions)Asia-Pacific413.4569.9650.7722.6793.8855.6North America42.053.060.768.074.279.3Western Europe33.442.249.756.662.968.6Central & Eastern Europe17.323.338.833.237.441.7Latin America17.423.228.734.239.945.1Middle East & Africa7.09.612.816.520.724.8Worldwide530.6721.2831.4931.31028.91115.2Proximity mobile payment user growth (% change)Middle East & Africa61.5%37.5%32.4%29.8%24.8%20.0%Latin America60.2%33.4%23.8%19.6%16.1%13.2%Central & Eastern Europe49.5%34.6%23.7%15.3%12.8%11.5%Western Europe38.4%26.3%17.6%13.9%11.1%9.1%North America49.3%26.0%14.6%12.1%9.1%6.9%Asia-Pacific90.3%37.8%14.2%11.1%9.8%7.8%Worldwide79.1%35.9%15.3%12.0%10.5%8.4%Note: ages 14+; mobile phone users who have made at least one proximity mobile payment transaction in the past 6 months; includes point-of-sale transactions made by using mobile devices as a payment method; excludes transactions made via tablet.Final PDF to printer
sch87956_ch04_067-094.indd 69 11/23/18 08:12 AMChapter 4 Standards Battles, Modularity, and Platform Competition 69accounts. Users could opt to link their PayPal accounts to their credit cards, or directly to their bank accounts. PayPal also owned a service called Venmo that enabled peer-to-peer exchanges with a Facebook-like interface that was grow-ing in popularity as a way to exchange money without carrying cash. Venmo charged a 3 percent fee if the transaction used a major credit card, but was free if the consumer used it with a major bank card or debit card.In other parts of the world, intriguing alternatives for mobile banking are gain-ing traction quickly. In India and Africa, for example, there are enormous popula-tions of “unbanked” or “underbanked” people (individuals who do not have bank accounts or make limited use of banking services). In these regions, the propor-tion of people with mobile phones vastly exceeds the proportion of people with credit cards. According to a GSMA report, for example, in sub-Saharan Africa, the number of mobile money accounts surpassed the number of bank accounts in 2015, and in 2016 more than 40 percent of the adult population of Kenya, Tanzania, Ghana, and Paraguay actively used mobile payment systems.fThe World Bank estimates that roughly two billion people worldwide do not have access to financial services, and 31 percent of adults have no bank account (Figure 2). This is a serious obstacle to overcoming poverty—access to banking is a very important resource for people to save money and utilize credit. Fortunately, the rise of mobile payment systems could have enormously beneficial social and economic consequences by helping the unbanked become banked.FIGURE 2Percent of Adults with a Bank AccountSource: Global Findex database.No data0–1990–10020–3965–8940–64Today, 69 percent of adults around the world have an accountAdults with an account (%), 2017Final PDF to printer
sch87956_ch04_067-094.indd 70 11/09/18 10:47 AM70 Part One Industry Dynamics of Technological InnovationIn parts of Africa, where the proportion of people who are unbanked is very large, a system called M-Pesa (“M” for mobile and “pesa,” which is kiswahili for money) enables any individual with a passport or national ID card to deposit money into his or her phone account, and transfer money to other users using Short Message Service (SMS).g By 2017, there were roughly 30 million M-Pesa users in 10 countries. The system had grown to offer a range of services includ-ing international transfers, loans, and health provision. It processed about six  billion transactions in 2016, hitting a peak rate of 529 per second.hAs noted above, some of the mobile systems did not require involvement of the major credit card companies. PayPal, and its peer-to-peer system Venmo, for instance, did not require credit cards, nor does Alipay. A mobile payment sys-tem that cuts out the credit card companies could potentially save (or capture) billions of dollars in transaction fees. Credit card companies and merchants thus both had high incentives to influence the outcome of this battle.For consumers, the key dimensions that influenced adoption were conve-nience (e.g., would the customer have to type in a code at the point of pur-chase? Was it easily accessible on a device the individual already owned?), risk of fraud (e.g., was the individual’s identity and financial information at risk?), and ubiquity (e.g., could the system be used everywhere? Did it enable peer-to-peer transactions?). For merchants, the primary concerns were fraud and cost (e.g., what were the fixed costs and transaction fees of using the system?). Apple Pay had a significant convenience advantage in that a customer could pay with their fingerprint.i QR code–based systems, by contrast, required the customer to open the application on their phone and get a QR code that would need to be scanned at the checkout or to type in a pin.By early 2018, it was clear that mobile payments represented a game- changing opportunity that could accelerate e-commerce, smartphone adoption, and the global reach of financial services. However, lack of compatibility between many of the mobile payment systems and uncertainty over what type of mobile payment system would become dominant still posed significant obstacles to consumer and merchant adoption, particularly in countries where most consumers already had credit cards.Discussion Questions 1. What are some of the advantages and disadvantages of mobile payment systems in (a) developed countries and (b) developing countries? 2. What are the key factors that differentiate the different mobile payment systems? Which factors do consumers care most about? Which factors do merchants care most about? 3. Are there forces that are likely to encourage one of the mobile payment systems to emerge as dominant? If so, what do you think will determine which becomes dominant? 4. Is there anything the mobile payment systems could do to increase the likelihood of them becoming dominant? 5. How do these different mobile systems increase or decrease the power of (a) banks and (b) credit cards?Final PDF to printer
sch87956_ch04_067-094.indd 71 11/09/18 10:47 AMChapter 4 Standards Battles, Modularity, and Platform Competition 71 a International Telecommunications Union ICT Facts and Figures 2017. b World Payments Report 2017, Capgemini and BNP Paribas, c Kent, J., “Dominant Mobile Payment Approaches and Leading Mobile Payment Solution Providers: A Review,” Journal of Payments Strategy & Systems 6, no. 4 (2012):315–24. d Helft, M., “The Death of Cash,” Fortune 166, no. 2 (2012):118–28. e Isaac, M., “Square Expands Its Reach into Small-Business Services.” New York Times (March 8, 2015). f State of the Industry Report on Mobile Money, GSMA, wp-content/uploads/2017/03/GSMA_State-of-the-Industry-Report-on-Mobile-Money_2016.pdf. g Govindarajan, V., and M. Balakrishnan, “Developing Countries Are Revolutionizing Mobile Banking,” Harvard Business Review,” Blog Network, (April 30, 2012). h Monks, K., M-Pesa: Kenya’s Mobile Money Success Story Turns 10. CNN (February 24, 2017). i Pogue, D., “How Mobile Payments Are Failing and Credit Cards Are Getting Better,” in Scientific American (January 20, 2015).OVERVIEWThe previous chapter described recurrent patterns in technological innovation, and one of those patterns was the emergence of a dominant design. As Anderson and Tushman pointed out, the technology cycle almost invariably exhibits a stage in which the industry selects a dominant design. Once this design is selected, producers and customers focus their efforts on improving their efficiency in manufacturing, deliver-ing, marketing, or deploying this dominant design, rather than continue to develop and consider alternative designs. In this chapter, we first will examine why indus-tries experience strong pressure to select a single technology design as dominant and the multiple dimensions of value that will shape which technology designs rise to dominance. We will then look at why and how modularity and platform competition emerges in some industries.WHY DOMINANT DESIGNS ARE SELECTEDWhy do many markets coalesce around a single dominant design rather than sup-port a variety of technological options? One primary reason is that many indus-tries exhibit increasing returns to adoption, meaning that the more a technology is adopted, the more valuable it becomes.1 Complex technologies often exhibit increasing returns to adoption in that the more they are used, the more they are improved. A technology that is adopted usually generates revenue that can be used to further develop and refine the technology. Furthermore, as the technology is used, greater knowledge and understanding of the technology accrue, which may then enable improvements both in the technology itself and in its applications. Finally, as a technology becomes more widely adopted, complementary assets are often developed that are specialized to operate with the technology. These effects can result in a self-reinforcing mechanism that increases the dominance of a technology regardless of its superiority or inferiority to competing technolo-gies. Two of the primary sources of increasing returns are (1) learning effects and (2) network externalities.dominant designA single product or process archi-tecture that dom-inates a product category— usually 50 percent or more of the mar-ket. A dominant design is a de facto standard, meaning that while it may not be officially enforced or acknowledged, it has become a standard for the industry.Final PDF to printer
sch87956_ch04_067-094.indd 72 11/09/18 10:47 AM72 Part One Industry Dynamics of Technological InnovationLearning EffectsAmple empirical evidence shows that the more a technology is used, the more it is developed and the more effective and efficient it becomes.2 As a technology is adopted, it generates sales revenues that can be reinvested in further developing and refining the technology. Furthermore, as firms accumulate experience with the technology, they find ways to use the technology more productively, including developing an organiza-tional context that improves the implementation of the technology. Thus, the more a technology is adopted, the better it should become.One example of learning effects is manifest in the impact of cumulative produc-tion on cost and productivity—otherwise known as the learning curve. As individuals and producers repeat a process, they learn to make it more efficient, often producing new technological solutions that may enable them to reduce input costs or waste rates. Organizational learning scholars typically model the learning curve as a function of cumulative output: performance increases, or cost decreases, with the number of units of production, usually at a decreasing rate (see Figure 4.1). For example, in studies of industries as diverse as aircraft production and pizza franchises, researchers have con-sistently found that the cost of producing a unit (e.g., a pizza or an airplane) falls as the number of units produced increases.The standard form of the learning curve is formulated as y= ax−b, where y is the number of direct labor hours required to produce the xth unit, a is the number of direct labor hours required to produce the first unit, x is the cumulative number of units produced, and b is the learning rate. This pattern has been found to be consistent with production data on a wide range of products and services, including the production of automobiles, ships, semiconductors, pharmaceuticals, and even heart surgery tech-niques.3 Learning curves have also been identified by using a variety of performance measures, including productivity, total costs per unit, accidents per unit, and waste per unit.4Though learning curves are found in a wide range of organizational processes, there are substantial differences in the rates at which organizations learn.5 Both managers FIGURE 4.1Standard Learning-Curve FormsCosts perunitCost DecreasingCumulative output(a)Performanceon each unitPerformance IncreasingCumulative output(b)increasing returnsWhen the rate of return (not just gross returns) from a product or process increases with the size of its installed base.Final PDF to printer
sch87956_ch04_067-094.indd 73 11/09/18 10:47 AMChapter 4 Standards Battles, Modularity, and Platform Competition 73and scholars are very interested in understanding why one firm reaps great improve-ment in a process while another exhibits almost no learning. Many studies have exam-ined reasons for this variability, including looking at how the firm’s learning rate is affected by process-improvement projects, intentional innovation, or contact with cus-tomers and suppliers.6 The results suggest the learning rate can be influenced by fac-tors such as the nature of the task, firm strategy, and the firm’s prior experience.Prior Learning and Absorptive CapacityA firm’s investment in prior learning can accelerate its rate of future learning by building the firm’s absorptive capacity.7 Absorptive capacity refers to the phenom-enon whereby as firms accumulate knowledge, they also increase their future ability to assimilate information. A firm’s prior related experience shapes its ability to recognize the value of new information, and to utilize that information effectively. For example, in developing a new technology, a firm will often try a number of unsuccessful config-urations or techniques before finding a solution that works well. This experimentation builds a base of knowledge in the firm about how key components behave, what alter-natives are more likely to be successful than others, what types of projects the firm is most successful at, and so on. This knowledge base enables the firm to more rapidly assess the value of related new materials, technologies, and methods. The effects of absorptive capacity suggest that firms that develop new technologies ahead of others may have an advantage in staying ahead. Firms that forgo investment in technology development may find it very difficult or expensive to develop technology in a subse-quent period. This explains, in part, why firms that fall behind the technology frontier find it so difficult to catch up.At the aggregate level, the more firms that are using a given technology and refin-ing it, the more absorptive capacity that is being generated related to that technology, making development of that technology (and related technologies) more effective and efficient. Furthermore, as firms develop complementary technologies to improve the productivity or ease of utilization of the core technology, the technology becomes more attractive to other firms. In sum, learning effects suggest that early technology offerings often have an advantage because they have more time to develop and become enhanced than subsequent offerings. (However, as we shall discuss in Chapter Five, it is also possible to be too early to a market!)Network ExternalitiesMany markets are characterized by network externalities, or positive consumption externalities.8 In a market characterized by network externalities, the benefit from using a good increases with the number of other users of the same good. The classic examples of markets demonstrating network externality effects are those involving physical networks, such as railroads or telecommunications. Railroads are more valu-able as the size of the railroad network (and therefore the number of available desti-nations) increases. Similarly, a telephone is not much use if only a few people can be called with it—the amount of utility the phone provides is directly related to the size of the network.Network externalities can also arise in markets that do not have physical networks. For example, a user’s benefit from using a good may increase with the number of users absorptive capacityThe ability of an organization to recognize, assimilate, and utilize new externalitiesAlso termed pos-itive consumption externalities, this is when the value of a good to a user increases with the number of other users of the same or similar good.Final PDF to printer
sch87956_ch04_067-094.indd 74 11/09/18 10:47 AM74 Part One Industry Dynamics of Technological Innovationof the same good when compatibility is important. The number of users of a particular technology is often referred to as its installed base. A user may choose a computer platform based on the number of other users of that platform, rather than on the tech-nological benefits of a particular platform, because it increases the ease of exchanging files. For example, many people choose a computer that uses the Windows operating system and an Intel microprocessor because the “Wintel” (Windows and Intel) plat-form has the largest installed base, thus maximizing the number of people with which the user’s files will be compatible. Furthermore, the user’s training in a particular plat-form becomes more valuable as the size of the installed base of the platform increases. If the user must invest considerable effort in learning to use a computer platform, the user will probably choose to invest this effort in learning the format he or she believes will be most widely used.Network externalities also arise when complementary goods are important. Many products are functional or desirable only when there is a set of complementary goods available for them (videotapes for VCRs, film for cameras, etc.). Some firms make both a good and its complements (e.g., Kodak produced both cameras and film), whereas others rely on other companies to provide complementary goods or services for their products (e.g., computer manufacturers often rely on other vendors to sup-ply service and software to customers). Products that have a large installed base are likely to attract more developers of complementary goods. This is demonstrated in the Theory in Action about Microsoft: Once the Windows operating system had the largest installed base, most producers of complementary software applications chose to design their products to be optimized to work with Windows. Since the availability of complementary goods will influence users’ choice among competing platforms, the availability of complementary goods influences the size of the installed base. A self-reinforcing cycle ensues (see Figure 4.2).The effect of this cycle is vividly demonstrated by Microsoft’s dominance of the operating system market, and later the graphical user interface market, as discussed in the Theory in Action on the rise of Microsoft. Microsoft’s early advantage in installed base led to an advantage in the availability of complementary goods. These network externality advantages enabled Windows to lock several would-be contenders such as Geoworks and NeXT (and, some would argue, Apple) out of the market.installed baseThe number of users of a particular good. For instance, the installed base of a particular video game console refers to the number of those consoles that are installed in homes worldwide.complemen-tary goodsAdditional goods and services that enable or enhance the value of another good. For example, the value of a video game console is directly related to the availability of complementary goods such as video games, peripheral devices, and services such as online gaming.FIGURE 4.2The Self- Reinforcing Cycle of Installed Base and Availabil-ity of Comple-mentary GoodsSize of Installed BaseAvailability ofComplementary GoodsA large installedbase attractsproducers ofcomplementarygoods.The availability ofcomplementarygoods attractsusers, increasingthe installed base.Final PDF to printer
75sch87956_ch04_067-094.indd 75 11/09/18 10:47 AMFrom the early 1980s to the decade beginning in 2010, Microsoft’s Windows controlled an overwhelming share of the personal computer operating system market. An operating system is the main program on a computer, which enables it to run other programs. Operating sys-tems are responsible for recognizing the input from a keyboard, sending output to the display, tracking files and directories on the disk drives, and controlling periph-eral devices. Because the operating system determines how other software applications must be designed, Microsoft’s dominance in the operating system market made it extraordinarily powerful in the software industry. However, Microsoft’s emergence as a software super-power was due largely to the unfolding of a unique set of circumstances. Had these events played out differ-ently, Microsoft’s dominance might have never been.In 1980, the dominant operating system for personal computers was CP/M. CP/M was invented by Gary Kildall and marketed by Kildall’s company, Digital Research. Kildall had been retained by Intel in 1972 to write soft-ware for Intel’s 4004, the first true microprocessor in that it could be programmed to do custom calculations. Later that year, Intel began to sell the 8008 to designers who would use it as a computer, and Kildall was hired to write a programming language for the chip, called PL/M (Programming Language/Microcomputers).aThen Memorex and Shugart began offering floppy disks (which IBM had invented) as a replacement for punch cards, and Kildall acquired one of these drives. However, no existing program would make the disk drive communicate with Intel’s microprocessor, so he wrote a disk operating system that he called Control Program/Microprocessor (CP/M).b CP/M could be adapted to any computer based on Intel microprocessors.Before 1980, IBM, the world’s largest computer pro-ducer, had not been interested in developing a personal computer. IBM managers could not imagine the personal computer market ever amounting to more than a small niche of hobbyists. However, when businesses began adopting Apple computers to do basic accounting or word processing, IBM began to get nervous. IBM sud-denly realized that the personal computer market might become a significant industry, and if it wanted to be a major player in that market it needed to act fast. IBM’s managers did not believe they had time to develop their own microprocessor and operating system, so they based their personal computer on Intel microproces-sors and planned to use Kildall’s CP/M operating sys-tem. There are many stories of why Kildall did not sign with IBM. One story is that Kildall was out flying his plane when IBM came around, and though the IBM manag-ers left their names with Kildall’s wife, Dorothy McEwen, they did not state the nature of their business, and Kildall did not get back to them for some time. Another version of the story posits that Kildall was reluctant to become tied into any long-term contracts with the massive com-pany, preferring to retain his independence. Yet a third version claims that Kildall was simply more interested in developing advanced technologies than in the strategic management of the resulting products. Whatever the reason, Kildall did not sign with IBM.Pressed for time, IBM turned to Bill Gates, who was already supplying other software for the system, and asked if he could provide an operating system as well. Though Gates did not have an operating system at that time, he replied that he could supply one. Gates bought a 16-bit operating system (basically a clone of CP/M) from Seattle Computer Company, and reworked the soft-ware to match IBM’s machines. The product was called Microsoft DOS. With DOS bundled on every IBM PC (which sold more than 250,000 units the first year), the product had an immediate and immense installed base. Furthermore, the companies that emerged to fulfill the unmet demand for IBM PCs with clones also adopted Microsoft DOS to ensure that their products were IBM PC compatible. Because it replicated CP/M, Microsoft DOS was compatible with the range of software that had been developed for the CP/M operating system. Fur-thermore, after it was bundled with the IBM PC, more software was developed for the operating system, creat-ing an even wider availability of complementary goods. Microsoft DOS was soon entrenched as the industry standard, and Microsoft was the world’s fastest-growing software company.“We were able to get the technology out into the market early to develop a standard. We were effective in soliciting software vendors to write to that platform to solidify the standard,” said B. J. Whalen, Microsoft product manager. “Once you get it going, it’s a snowball effect. The more applications you have available for a Theory in Action The Rise of MicrosoftcontinuedFinal PDF to printer
76sch87956_ch04_067-094.indd 76 11/09/18 10:47 AMplatform, the more people will want to use that platform. And of course, the more people that want to use that platform, the more software vendors will want to write to that platform.”Later Microsoft would develop a graphical interface named Windows that closely replicated the user-friendly functionality of Apple computers. By bundling Windows with DOS, Microsoft was able to transition its base of DOS customers over to the Windows system. Microsoft also worked vigorously to ensure that compatible applications were developed for DOS and Windows, making applica-tions itself and also encouraging third-party developers to support the platform. Microsoft was able to leverage its dominance with Windows into a major market share in many other software markets (e.g., word processing, spreadsheet programs, presentation programs) and influ-ence over many aspects of the computer software and hardware industries. However, had Kildall signed with IBM, or had Compaq and other computer companies been unable to clone the IBM personal computer, the software industry might look very different today.a P. Korzeniowski, “DOS: Still Thriving after All These Years,” Software Magazine 10, no. 6 (1990), pp. 83–112.b S. Veit, “What Ever Happened to . . . Gary Kildall?” Computer Shopper 14, no. 11 (1994), pp. 608–14.concludedFirms can also attempt to influence the selection of a dominant design by building coalitions around a preferred technology.9 This is aptly illustrated in the opening case. While the preceding has emphasized the emergence of dominant designs through market forces, occasionally a dominant design is put in place through government regulation.Government RegulationIn some industries, the consumer welfare benefits of having compatibility among tech-nologies have prompted government regulation, and thus a legally induced adherence to a dominant design. This has often been the case for the utilities, telecommunications, and television industries, to name a few.10 For example, in 1953, the U.S. Federal Com-munications Commission (FCC) approved the National Television Systems Committee (NTSC) color standard in television broadcasting to ensure that individuals with mono-chrome television sets would be able to receive the color television programs broadcast by networks (though they would see them in black and white). That standard was still in place in 2003. Similarly, in 1998, while a battle was being fought in the United States over wireless technology formats, the European Union (EU) adopted a single wire-less telephone standard (the general standard for mobile communications, or GSM). By choosing a uniform standard, the EU could avoid the proliferation of incompatible standards and facilitate exchange both within and across national borders. Where gov-ernment regulation imposes a single standard on an industry, the technology design embodied in that standard necessarily dominates the other technology options available to the industry. The consumer welfare impact of dominant designs is explored further in the Theory in Action section on Are Winner-Take-All Markets Good for Consumers?The Result: Winner-Take-All MarketsAll these forces can encourage the market toward natural monopolies. While some alternative platforms may survive by focusing on niche markets, the majority of the market may be dominated by a single (or few) design(s). A firm that is able to lock in Final PDF to printer
sch87956_ch04_067-094.indd 77 11/09/18 10:47 AMChapter 4 Standards Battles, Modularity, and Platform Competition 77its technology as the dominant design of a market usually earns huge rewards and may dominate the product category through several product generations. When a firm’s technology is chosen as a dominant design, not only does the firm have the potential to earn near-monopoly rents in the short run, but the firm also is in a good position to shape the evolution of the industry, greatly influencing what future generations of products will look like. However, if the firm supports a technology that is not chosen as the dominant design, it may be forced to adopt the dominant technology, effectively forfeiting the capital, learning, and brand equity invested in its original technology. Even worse, a firm may find itself locked out of the market if it is unable to adopt the dominant technology. Such standards battles are high-stakes games—resulting in big winners and big losers.Increasing returns to adoption also imply that technology trajectories are charac-terized by path dependency, meaning that relatively small historical events may have a great impact on the final outcome. Though the technology’s quality and tech-nical advantage undoubtedly influence its fate, other factors, unrelated to the techni-cal superiority or inferiority, may also play important roles.11 For instance, timing may be crucial; early technology offerings may become so entrenched that subse-quent technologies, even if considered to be technically superior, may be unable to gain a foothold in the market. How and by whom the technology is sponsored may also impact adoption. If, for example, a large and powerful firm aggressively spon-sors a technology (perhaps even pressuring suppliers or distributors to support the technology), that technology may gain a controlling share of the market, locking out alternative technologies.The influence of a dominant design can also extend beyond its own technology cycle. As the dominant design is adopted and refined, it influences the knowledge that is accumulated by producers and customers, and it shapes the problem-solving techniques used in the industry. Firms will tend to use and build on their existing knowledge base rather than enter unfamiliar areas.12 This can result in a very “sticky” technological paradigm that directs future technological inquiry in the area.13 Thus, a dominant design is likely to influence the nature of the technological discontinuity that will eventually replace it.Such winner-take-all markets demonstrate very different competitive dynamics than markets in which many competitors can coexist relatively peacefully. These markets also require very different firm strategies to achieve success. Techno-logically superior products do not always win—the firms that win are usually the ones that know how to manage the multiple dimensions of value that shape design selection.MULTIPLE DIMENSIONS OF VALUEThe value a new technology offers a customer is a composite of many different things. We first consider the value of the stand-alone technology, and then show how the stand-alone value of the technology combines with the value created by the size of the installed base and availability of complementary goods.14 In industries characterized by increasing returns, this combination will influence which technology design rises to dominance.path dependencyWhen end results depend greatly on the events that took place leading up to the outcome. It is often impossible to reproduce the results that occur in such a situation.Final PDF to printer
sch87956_ch04_067-094.indd 78 11/09/18 10:47 AM78 Part One Industry Dynamics of Technological InnovationA Technology’s Stand-Alone ValueThe value a new technology offers to customers can be driven by many different things, such as the functions it enables the customer to perform, its aesthetic qualities, and its ease of use. To help managers identify the different aspects of utility a new technology offers customers, W. Chan Kim and Renee Mauborgne developed a “Buyer Utility Map.”15 They argue that it is important to consider six different utility levers, as well as six stages of the buyer experience cycle, to understand a new technology’s utility to a buyer.The stages they identify are purchase, delivery, use, supplements, maintenance, and disposal. The six utility levers they consider are customer productivity, simplicity, convenience, risk, fun and image, and environmental friendliness. Creating a grid with stages and levers yields a 36-cell utility map (see Figure 4.3). Each cell provides an opportunity to offer a new value proposition to a customer.A new technology might offer a change in value in a single cell or in a combination of cells. For example, when retailers establish an online ordering system, the primary new value proposition they are offering is greater simplicity in the purchase stage. On the other hand, as shown in Figure 4.3, the introduction of the Toyota Prius hybrid-electric vehicle offered customers greater productivity (in the form of gas savings), image benefits, and environmental friendliness in the customer’s use, supplements, and maintenance stages, while providing the same simplicity and convenience of regular gasoline-only–powered vehicles.Kim and Mauborgne’s model is designed with an emphasis on consumer products, but their mapping principle can be easily adapted to emphasize industrial products or different aspects of buyer utility. For example, instead of having a single entry for customer productivity, the map could have rows for several dimensions of productiv-ity such as speed, efficiency, scalability, and reliability. The map provides a guide for managers to consider multiple dimensions of technological value and multiple stages of the customer experience. Finally, the new benefits have to be considered with respect to the cost to the customer of obtaining or using the technology—it is the ratio of benefits to cost that determines value.Network Externality ValueIn industries characterized by network externalities, the value of a technological innovation to users will be a function not only of its stand-alone benefits and cost, but also of the value created by the size of its installed base and the availability of complementary goods (see Figure 4.4(a)).16 Thus, the value to consumers of using the Windows operating system is due in part to the technology’s stand-alone value (e.g., the ability of the operating system to make it easy for consumers to use the computer), the installed base of the operating system (and thus the num-ber of computers with which the user can easily interact), and the availability of compatible software. Visualizing the value of technological innovations in this way makes it clear why even innovations that offer significant improvements in tech-nological functionality often fail to displace existing technologies that are already widely adopted: Even if a new innovation has a significant advantage in function-ality, its overall value may be significantly less than the incumbent standard. This situation is poignantly illustrated in the case of NeXT computers. In 1985, Steve Final PDF to printer
sch87956_ch04_067-094.indd 79 11/09/18 10:47 AMChapter 4 Standards Battles, Modularity, and Platform Competition 79FIGURE 4.3The Buyer Utility Map with Toyota Prius ExampleSource: Adapted from Harvard Business Review. Exhibit from “Knowing a Winning Business Idea When You See One,” by W. C. Kim and R. Mauborgne, September–October 2000.PurchaseDeliveryUseSupplementsMaintenanceDisposalCustomer productivityPrice of Prius slightly higher than comparable nonhybrid modelsOffers speed and power compara-ble to nonhybrid modelsCan stop less often for gas, saving money and timeSimplicityBuyer may feel less able to assess value of vehicleOperates like a regular combus-tion engine vehicleRefuels like a regular com-bustion engine vehicleHybrids have larger batter-ies that would have to be recycled and disposed of at end of lifeConvenienceWill be sold through tradi-tional dealer channelsDoes not have to be plugged into electrical outletCan purchase fuel at regular gas stationsMaintenance is similar to regular combustion engine vehicleRiskBuyer might face a higher risk of product failure because it embodies a new technologyBuyer might have dif-ficulty finding replacement parts because of new technologyPrius might be more difficult to resell or have lower resell valueFun and imageConnotes image of environmental responsibilityEnvironmental friendlinessBuyers feel they are helping sup-port the develop-ment of more environmentally friendly carsEmits lower lev-els of pollutantsRequires less use of fossil fuelsJobs and five senior managers of Apple Computer founded NeXT Incorporated. They unveiled their first computer in 1988. With a 25-MHz Motorola 68030 and 8 MB of RAM, the machine was significantly more powerful than most other per-sonal computers available. It offered advanced graphics capability and even ran an object-oriented operating system (called NextStep) that was considered extremely advanced. However, the machine was not compatible with the IBM-compatible Final PDF to printer
sch87956_ch04_067-094.indd 80 11/09/18 10:47 AM80 Part One Industry Dynamics of Technological Innovationpersonal computers (based on Intel’s microprocessors and Microsoft’s operat-ing system) that had become the dominant standard. The machine thus would not run the vast majority of software applications on the market. A small contingent of early adopters bought the NeXT personal computers, but the general market rejected them because of a dire lack of software and uncertainty about the com-pany’s viability. The company discontinued its hardware line in 1993 and ceased development of NextStep in 1996.A similar battle was playing out in 2015 between smartphone operating systems, though in this case there were two contenders who were more evenly matched: Apple’s iOS and Google’s Android. Both companies offered smartphone operating systems with intuitive, powerful, and aesthetically pleasing interfaces (technological utility). Both were aggressively building communities of applications providers that provided large ranges of interesting and/or useful applications (complementary goods). Both were also trying to build installed base through aggressive marketing and distribution. Market share estimates of the two systems varied widely based on the timing of the data announcements, the geographical scope considered, and the product scope con-sidered, but in early 2015 it was clear that Apple and Google were in a head-to-head battle for dominance, whereas Rim’s Blackberry and Microsoft’s mobile operating systems were barely in the race (for more on this, see the section on the “Segment Zero” threat to Microsoft in Chapter Three).As shown in Figure 4.4(b), it is not enough for a new technology’s stand-alone utility to exceed that of the incumbent standard. The new technology must be able to offer greater overall value. For the new technology to compete on its stand-alone utility alone, that utility must be so great that it eclipses the combined value of an existing technology’s stand-alone utility, its installed base, and its comple-mentary goods.In some cases, the new technology may be made compatible with the existing tech-nology’s installed base and complementary goods as in Figure 4.4(c). In this case, a FIGURE 4.4Components of ValueComplementary goodsavailabilityInstalled baseTechnological utilityTechnological utilityInstalled baseTechnological utilityCombined value ofstand-alone technologicalutility, installed base,and complementarygoods offered byexisting technology.New technology competesonly on the value of itsstand-alone utility.New technology that iscompatible with existingtechnology’s installedbase and complementarygoods.Marginal value ofnew technologyValueComplementary goodsavailability(a)(b)(c)Final PDF to printer
sch87956_ch04_067-094.indd 81 11/09/18 10:47 AMChapter 4 Standards Battles, Modularity, and Platform Competition 81new technology with only a moderate functionality advantage may offer greater over-all value to users. Sony and Philips employed this strategy with their high-definition audio format, Super Audio CD (SACD), a high-density multichannel audio format based on a revolutionary “scalable” bit-stream technology known as Direct Stream Digital (DSD). Anticipating that users would be reluctant to replace their existing compact disk players and compact disk music collections, Sony and Philips made the new Super Audio CD technology compatible with existing compact disk technol-ogy. The Super Audio CD players included a feature that enables them to play standard CDs, and the recorded Super Audio CDs included a CD audio layer in addition to the high-density layer, enabling them to be played on standard CD systems. Customers can thus take advantage of the new technology without giving up the value of their existing CD players and music libraries.When users are comparing the value of a new technology to an existing technology, they are weighing a combination of objective information (e.g., actual technological benefits, actual information on installed base or complementary goods), subjective information (e.g., perceived technological benefits, perceived installed base or com-plementary goods), and expectations for the future (e.g., anticipated technological benefits, anticipated installed base and complementary goods). Thus, each of the primary value components described above also has corresponding perceived or anticipated value components (see Figure 4.5). In Figure 4.5(a), the perceived and anticipated value components map proportionately to their corresponding actual com-ponents. However, as depicted in Figure 4.5(b), this need not be the case. For instance, perceived installed base may greatly exceed actual installed base, or customers may expect that a technology will eventually have a much larger installed base than com-petitors and thus the value accrued from the technology’s installed base is expected to grow much larger than it is currently.Firms can take advantage of the fact that users rely on both objective and subjective information in assessing the combined value offered by a new technology. For example, even a technology with a small installed base can achieve a relatively large mind share through heavy advertising by its backers. Producers can also shape users’ expectations of the future installed base and availability of complements through announcements of preorders, licensing agreements, and distribution arrangements. For example, when Sega and Nintendo were battling for dominance in the 16-bit video game console mar-ket, they went to great lengths to manage impressions of their installed base and market share, often to the point of deception. At the end of 1991, Nintendo claimed it had sold 2 million units of the Super Nintendo Entertainment System in the U.S.  market. Sega disagreed, arguing that Nintendo had sold 1 million units at most. By May 1992, Nintendo was claiming a 60 percent share of the 16-bit market, and Sega was claiming a 63 percent share!17 Since perceived or expected installed base may drive subse-quent adoptions, a large perceived or expected installed base can lead to a large actual installed base.Such a tactic also underlies the use of “vaporware”—products that are not actu-ally on the market and may not even exist but are advertised—by many software vendors. By building the impression among customers that a product is ubiqui-tous, firms can prompt rapid adoption of the product when it actually is available. Final PDF to printer
sch87956_ch04_067-094.indd 82 11/09/18 10:47 AM82 Part One Industry Dynamics of Technological InnovationVaporware may also buy a firm valuable time in bringing its product to market. If other vendors beat the firm to market and the firm fears that customers may select a dominant design before its offering is introduced, it can use vaporware to attempt to persuade customers to delay purchase until the firm’s product is available. The video game console industry also provides an excellent example here. When Sega and Sony introduced their 32-bit video game consoles (the Saturn and PlayStation, respectively), Nintendo was still a long way from introducing its next-generation console. In an effort to forestall consumer purchases of 32-bit systems, Nintendo began aggressively promoting its development of a 64-bit system (originally named Project Reality) in 1994, though the product would not actually reach the market until September 1996. The project underwent so many delays that some industry observers dubbed it “Project Unreality.”18 Nintendo was successful in persuading many customers to wait for its Nintendo 64, and the system was ultimately rela-tively successful.Nintendo, however, was never able to reclaim dominance over the video game industry. By the time the Nintendo 64 had gained significant momentum, Sony FIGURE 4.5Actual, Perceived, and Expected Components of ValueTechnologicalutilityInstalled baseComplementsavailabilityAnticipatedTechnological utilityInstalled baseComplements availabilityPerceivedTechnologicalutilityInstalled baseComplementsavailabilityActualProportional(a)TechnologicalutilityInstalled baseComplementsavailabilityAnticipatedTechnologicalutilityInstalled baseComplementsavailabilityPerceivedTechnologicalutilityInstalled baseComplementsavailabilityActualDisproportional(b)Final PDF to printer
sch87956_ch04_067-094.indd 83 11/09/18 10:47 AMChapter 4 Standards Battles, Modularity, and Platform Competition 83was developing its even more advanced PlayStation 2. Sony’s experience in VCRs and compact disks had taught it to manage the multiple dimensions of value very well: Sony’s PlayStation 2 offered more than double the processing power of the Nintendo 64, it was backward compatible (helping the PlayStation 2 tap the value of customers’ existing PlayStation game libraries), and Sony sold it for a price that many speculated was less than the cost of manufacturing the console ($299). Sony also invested heavily to ensure  that many game titles would be available at launch, and it used its distribution leverage and advertising budget to ensure the product would seem ubiquitous at its launch.Competing for Design Dominance in Markets with Network ExternalitiesGraphs illustrate how differing technological utilities and network externality returns to installed base or market share impact the competition for design domi-nance. The following figures examine whether network externalities create pres-sure for a single dominant design versus a few dominant designs by considering the rate at which value increases with the size of the installed base, and how large of an installed base is necessary before most of the network externality benefits are achieved. As explained earlier, when an industry has network externalities, the value of a good to a user increases with the number of other users of the same or similar good. However, it is rare that the value goes up linearly—instead, the value is likely to increase in an s-shape as shown in Figure 4.6(a). Initially, the benefits may increase slowly. For example, whether a cell phone can reach 1  percent of the population or 5 percent is fairly insignificant—the reach of the phone service has to become much wider before the phone has much value. However, beyond some threshold level, the network externality returns begin to increase rapidly, until at some point, most of the benefits have been obtained and the rate of return decreases. Consider the example of operating systems at the beginning of the FIGURE 4.6Network Externality Returns to Market ShareValue accrued fromnetwork externalitiesInstalled BaseValueto UsersTech.ValueValue accrued from networkexternalities + Technology utilityInstalled BaseValueto Users(a)(b)Final PDF to printer
sch87956_ch04_067-094.indd 84 11/09/18 10:47 AM84 Part One Industry Dynamics of Technological Innovationchapter: If an operating system has too small of an installed base, few software developers will write applications for it and thus it will be of little value to consum-ers. An increase from a 1 percent market share to a 2 percent market share makes little difference—developers are still unlikely to be attracted to the platform. Once the operating system exceeds some threshold level of adoption, however, it becomes worthwhile to develop software applications for it, and the value of the operating system begins to increase rapidly. Once the operating system achieves a large share of the market, the user has probably obtained most of the network externality value. There is likely to be a large range of quality software available for the operating system, and incremental increases in available software have less marginal impact on the value reaped by the customer.Next we consider the stand-alone functionality of the technology. In Figure 4.6(b), a base level of technological utility has been added to the graph, which shifts the entire graph up. For example, an operating system that has an exceptionally easy-to-use inter-face makes the technology more valuable at any level of installed base. This becomes relevant later when two technologies that have different base levels of technological utility are considered.When two technologies compete for dominance, customers will compare the overall value yielded (or expected) from each technology, as discussed in the pre-vious section. In Figure 4.7, two technologies, A and B, each offer similar tech-nological utility, and have similarly shaped network externality returns curves. To illustrate the competitive effects of two technologies competing for market share, the graphs in Figure 4.7 are drawn with market share on the horizontal axis instead of installed base. Furthermore, the curve for B is drawn with the market share dimension reversed so that we can compare the value offered by the two different technologies at different market share splits, that is, when A has a 20 percent mar-ket share, B has an 80 percent market share, and so on. This graph shows that at every point where A has less than 50 percent market share (and thus B has greater than 50 percent market share), B will yield greater overall value, making B more FIGURE 4.7Network Exter-nality Returns and Techno-logical Utility: Competing DesignsTech.ValueBAMarket Share(reversed for B)Indifferent at50/50Tech.Valueof BBAValuetoUsersMarket Share(reversed for B)Indifferent at60/40Tech.Valueof AFinal PDF to printer
sch87956_ch04_067-094.indd 85 11/09/18 10:47 AMChapter 4 Standards Battles, Modularity, and Platform Competition 85attractive to customers. On the other hand, when A has greater than 50 percent market share (and B thus has less than 50  percent market share), A yields more overall value. When each technology has exactly 50  percent market share, they yield the same overall value and customers will be indifferent between them. How-ever, if both technologies earn similar network externality returns to market share, but one technology offers greater stand-alone utility, the indifference point will be shifted in its favor. In the right-hand graph in Figure 4.7, technology B offers a greater level of stand-alone technological utility, shifting its overall value curve up. In this graph, technology A must have greater than 60 percent market share (and B must have less than 40 percent market share) for A to offer more overall value than B.Another interesting scenario arises when customers attain their desired level of network externality benefits at lower levels of market share, depicted graphically in Figure 4.8. In this graph, the curves flatten out sooner, implying that the maximum amount of network externality value is obtained by customers at lower levels of market share. In this case, customers may face a relatively large indifference region within which neither technology clearly dominates. This may be the case with the video game console industry: While customers may experience some network exter-nality benefits to a console having significant share (more game titles, more people to play against), those benefits might be achieved by a console without attaining a majority of the market. For example, even with Sony, Microsoft, and Nintendo split-ting the game console market, there is still an abundance of game titles for all three consoles and a significant pool of people to play games against. Such markets may not experience great pressure to select a single dominant design; two or more plat-forms may successfully coexist.FIGURE 4.8Network Externality Value Is Fully Tapped at Minority Market Share LevelsA dominatesBAValueto UsersMarket Share(reversed for B)IndifferenceRegionB dominatesTech.ValueFinal PDF to printer
86sch87956_ch04_067-094.indd 86 11/09/18 10:47 AMTheory in Action Are Winner-Take-All Markets Good for Consumers?Traditionally, economics has emphasized the consumer welfare benefits of competitive markets; however, increasing returns make this a complicated issue. This is exemplified by the antitrust suits brought against Microsoft. While some analysts argued that Microsoft had clearly engaged in anticompetitive behavior and had damaged consumers in its quest to dominate the personal computer operating system market, others argued that Microsoft had behaved appropriately, and that its overwhelming share of the personal computer operating system market was good for consumers since it created greater compatibility among computers and more software applications. So how does a regulatory body decide when a firm has become too dominant? One way to think about this is to compare the value customers reap from network externalities at different levels of market share with the corresponding monop-oly costs. Network externality returns refers to the value customers reap as a larger portion of the market adopts the same good (e.g., there is likely to be greater availability of complementary goods, more compatibil-ity among users, and more revenues can be channeled into further developing the technology). Monopoly costs refer to the costs users bear as a larger portion of the market adopts the same good (e.g., a monopolist may charge higher prices, there may be less product variety, and innovation in alternative technologies may be stifled). Network externality returns to market share often exhibit the s-shape described in the previous section. Monopoly costs to market share, however, are often considered to be exponentially increasing. Plot-ting them on the same graph (as in Figure 4.9) reveals how network externality benefits and monopoly costs trade-off against each other.In Figure 4.9, so long as technology A’s market share remains less than X, the combination of techno-logical utility and network externality benefits exceeds the monopoly costs, even if X represents a very large share of the market. However, as technology A’s mar-ket share climbs beyond X, the monopoly costs now exceed the value of the technology utility and net-work externality benefits. A number of factors can shift where these two curves cross. If the technology utility for A were higher, the curves would cross at a point greater than X. If the network externality returns curve began to flatten at a lower market share (as was dem-onstrated earlier with the video game console indus-try), then the curves would cross at a market share less than X.The steepness of the monopoly cost curve is largely a function of the firm’s discretionary behavior. A firm can choose not to exploit its monopoly power, thus flattening FIGURE 4.9Network Externality Benefits and Monopoly CostsMarket shareMonopoly costs toconsumers as technologyA gains market shareTech.valueValue accrued by consumersfrom network externalities fortechnology A XcontinuedFinal PDF to printer
87sch87956_ch04_067-094.indd 87 11/23/18 07:35 AMMODULARITY AND PLATFORM COMPETITIONAs noted earlier in the chapter, in many industries the value of a product system is strongly related to the number and quality of complements available for it. A smartphone operating system, for example, is only as good as the applications available, and a music streaming service is only as valuable as the number and quality and music titles it offers. In markets like these, rather than having a single firm produce both the platform (e.g., the smartphone operating system) and all of the complements (e.g., applications for the smartphone), industry players will instead often use modularity to create a platform eco-system where many different firms contribute to the product system.19ModularityTo understand modularity, consider a product like a computer: A computer is a bundle of components that includes a microprocessor, a monitor, a keyboard, and more. Some of these components can be bought separately and assembled by the user, and some are typically bought preassembled. Each of those components can also be thought of as a bundle. The monitor, for example, includes circuitry, plastic housing, power input, and so on. Most of these are not sold separately to the end user, but they might be mixed and matched by a manufacturer to achieve different end products.Products may be made increasingly modular both by expanding the range of com-patible components (increasing the range of possible product configurations), and by uncoupling integrated functions within components (making the product modular at a finer level) (see Figure 4.10). For example, a smartphone manufacturer might originally offer only proprietary phones where they have produced both the hardware and software, and integrate them tightly into a single product configuration (Figure 4.10, panel A). However, greater market demand for flexibility might induce manufacturers to begin offering phones with a few different product configurations, each composed of the firm’s own components. Should customers prefer to be able to combine phones with peripheral devices or applications developed by other producers, smartphone makers may eventu-ally “open” their systems up, creating a standard by which other developers can create products that are compatible with the phones (Figure 4.10, panel B). Smartphone makers may even decide to uncouple their operating systems from the hardware so that consum-ers can use the operating system on devices made by other manufacturers (Figure 4.10, panel C). In each of these stages, the product has become increasingly modular.modularityThe degree to which a system’s components can be separated and recombined.the monopoly costs curve. For instance, one of the most obvious assertions of monopoly power is typically exhibited in the price charged for a good. However, a firm can choose not to charge the maximum price that customers would be willing to pay for a good. For exam-ple, many people would argue that Microsoft does not charge the maximum price for its Windows operating system that the market would bear. However, a firm can also assert its monopoly power in more subtle ways, by controlling the evolution of the industry through selec-tively aiding some suppliers or complementors more than others, and many people would argue that in this respect, Microsoft has taken full advantage of its near-monopoly power.concludedFinal PDF to printer
sch87956_ch04_067-094.indd 88 11/09/18 10:47 AM88 Part One Industry Dynamics of Technological InnovationFIGURE 4.10Modularity and Platform EcosystemsSoftwareSoftwareMicro-processorRAMGame 1Game 2Game 3GraphicschipGame 4Game 5Game 6Game 4Game 5RAM BGraphicschip BGame 6Integrated product bundle Product bundle compatible with third-party complementsModular product with third-partycomponents and complements A. Traditional integratedproduct bundle:Example: Nokia E90Communicator Provider tries to meetbuyers needs itselfNo customization, noexternal compatibilityC.Product bundle withthird-party componentsand complements:Example: Android device Customer has evengreater range ofconfiguration choicesB.Product bundle withthird-party complements:Compatibility with third-party choices expandsoptions for customersExample: Apple iPhone SoftwareMicro-processorRAMGame 1Game 2Game 3GraphicschipGame 3Game 2Game 1RAMMicro-processorGraphicschipThe majority of products are modular at some level. For example, many stereos, shelving systems, and bicycles allow the customer to mix and match components from different vendors. There are a great many more products that are modular in that the customer can choose components but not assemble the end product themselves. For example, when you buy a car, you can often choose an engine size, upholstery options, automatic steering or transmission, stereo system, tires, roof racks, security systems, Final PDF to printer
sch87956_ch04_067-094.indd 89 11/23/18 07:36 AMChapter 4 Standards Battles, Modularity, and Platform Competition 89and so on, but the automaker assembles the configuration for you. Even aircraft are offered this way: though Boeing and Airbus manufacture airframes, they do not manu-facture engines. Engines are produced by companies such as GE, Pratt Whitney, or Rolls Royce. The engines are generally designed to be used in a few different air-craft models. Similarly, the aircraft is not committed to a single engine, though they may designate a “launch engine” as a preferred choice. The aircraft customer typically makes the final decision on which engine will be used in the aircraft.Tightly integrated (i.e., nonmodular) product systems and modular systems have different kinds of advantages. A tightly integrated product system might have compo-nents that are customized to work together, which may enable a level of performance that more standardized components cannot achieve. The producer of a tightly inte-grated system also has more control over the end product, which can enable them to better monitor quality and reliability. For years this was the reason Steve Jobs gave for not making Apple computers as modular as Windows-based computers—he believed that by controlling all of the components and most of the software, Apple computers could achieve greater functionality and be more reliable. An integrated product may also be more attractive to a customer that does not want to choose or assemble compo-nents themselves.Modular products, on the other hand, often offer more choices over function, design, scale, and other features, enabling the customer to choose a product system that more closely suits their needs and preferences. Second, because components are reused in different combinations, this can achieve product variety while still allowing scale economies in manufacturing the individual components. This is known as economies of substitution.20Modularity becomes increasingly valuable in a product system when there are (a) diverse technological options available to be recombined, and (b) heterogeneous customer preferences.21 For example, there is a very wide range of applications available for smartphones, and customers are very heterogeneous in the applications they want on their smartphones. This increases the value of being able to pick and choose your own customized mix of applications that go on your smartphone. This example also reveals how pressure for modularity can lead to platform ecosystems, as discussed below.Platform EcosystemsThe word ecosystem comes from biology and is a contraction of ecological sys-tem.This means that when we use the term ecosystem, we are usually referring to entities that have some degree of mutual dependence. In a platform ecosystem, some core part of a product (such as a video game console or music streaming service) mediates the relationship between a wide range of other components or complements (such as video games or music titles) and prospective end users.22A platform’s boundaries can be well-defined with a stable set of members dedi-cated wholly to that platform, or they can be amorphous and changing, with members entering and exiting freely, and participating in multiple platforms simultaneously. For example, consider the difference between the television/movie streaming ser-vices HBO on Demand and Amazon Prime. HBO on Demand exists to serve only HBO content up to consumers. The shows available are tightly controlled, and there platform ecosystemsEcosystem is a contraction of ecological and system, and refers to a system where elements share some form of mutual dependence. A platform in this context is a stable core that mediates the relationship between a range of components, complements, and end users. Thus platform ecosystem refers to a system of mutually depen-dent entities mediated by a stable core.Final PDF to printer
sch87956_ch04_067-094.indd 90 11/09/18 10:47 AM90 Part One Industry Dynamics of Technological Innovationis limited entry and exit of show producers. The Amazon Prime ecosystem is much more open. In fact, just about any content producer—including individual independent filmmakers—can make their content available on Amazon Prime.Because it is the overall appeal of the ecosystem that attracts end users to the plat-form, the success of individual members depends, at least in part, upon the success of other members of the ecosystem—even those with which they may be simultaneously competing. Furthermore, in many platforms there are switching costs that make it dif-ficult or costly to change ecosystems. Platforms and their complements often make investments in co-specialization or sign exclusivity agreements that bind them into stickier, longer-term relationships than the market contracts used in typical reseller arrangements. A video game that has been made for the Microsoft Xbox, for example, cannot be played on a PlayStation console unless a new version of it is made (and the game producer may have signed a contract with Microsoft that prohibits this).A platform ecosystem is thus characterized by relationships that are neither as independent as arms-length market contracts nor as dependent as those within a hierarchical organization. It is, in essence, a hybrid organizational form.23 It strikes a compromise between the loose coupling of a purely modular system and the tight coupling of a traditional integrated product. It enables customers to mix and match some components and complements, while still enabling some co-specialization and curation of the complements and components available for the system (see Figure 4.11).Once we understand that platforms are like a compromise between pure modularity and pure integration, it becomes easier to understand when platforms will be desirable in a market. First, platforms will be more valuable than a tightly integrated product when (a) customers are diverse and want more choices than a single firm can provide, (b) when third-party options are diverse and high quality, (c) when compatibility with third-party products can be made seamless without integration, and/or (d) when the platform sponsor is powerful enough that it can retain control over quality and the overall product architecture without producing the complements itself. Looking at it from the other direction, platforms will be more valuable than a purely modular system when (a) complements are nonroutine purchases with uncertainty (and thus the FIGURE 4.11Platforms as a Compromise between Pure Modular-ity and Pure IntegrationPure IntegrationPure modularityPlatformsCombinations determinedby producerHigh co-specializationProducer controls qualityand compatibilityMore choice andconfigurationsNo co-specializationQuality and compatibilitymay be uncertainThird-party components andcomplements curated by platformsponsorChoice and reconfigurability butshepherded by platform sponsorSome co-specializationFinal PDF to printer
sch87956_ch04_067-094.indd 91 11/09/18 10:47 AMChapter 4 Standards Battles, Modularity, and Platform Competition 91customer prefers to have some shepherding by the platform sponsor), (b) when some integration between the platform and its complements provides performance advan-tages, and/or (c) when important components of the ecosystem require subsidization (e.g., the market is unlikely to provide all the complements the end customer needs at adequate quality or value).Video game systems are an iconic example of platform ecosystems. Consoles need to launch with high-quality games. Since it is difficult to induce game developers to make games for a console that has not yet been widely adopted, most game console producers must produce games themselves (or subsidize their production) to ensure that high-quality games are available when the console launches. On the other hand, end users want more games than just those produced by the console producer, so con-sole producers like Microsoft, Sony, and Nintendo also license third-party developers to produce games for their consoles. They carefully screen the licensed games for quality and compatibility, and they may require the game developers to sign exclusiv-ity agreements or to customize the games for the console. The console maker may also manage the end users’ awareness and perception of the games in the ecosystem by giving “Best” of awards to particular games, by bundling particular games with the console at point of purchase, or by featuring particular games in its marketing. These strategies enable the console producer to actively manage the overall value created by its ecosystem.24 1. Many technologies demonstrate increasing returns to adoption, meaning that the more they are adopted, the more valuable they become. 2. One primary source of increasing returns is learning-curve effects. The more a technology is produced and used, the better understood and developed it becomes, leading to improved performance and reduced costs. 3. Another key factor creating increasing returns is network externality effects. Net-work externality effects arise when the value of a good to a user increases with the size of the installed base. This can be due to a number of reasons, such as need for compatibility or the availability of complementary goods. 4. In some industries, the consumer welfare benefits of having a single standard have prompted government regulation, such as the European Union’s mandate to use the GSM cellular phone standard. 5. Increasing returns can lead to winner-take-all markets where one or a few compa-nies capture nearly all the market share. 6. The value of a technology to buyers is multidimensional. The stand-alone value of a technology can include many factors (productivity, simplicity, etc.) and the technology’s cost. In increasing returns industries, the value will also be signifi-cantly affected by the technology’s installed base and availability of complemen-tary goods. 7. Customers weigh a combination of objective and subjective information. Thus, a customer’s perceptions and expectations of a technology can be as important as (or more important than) the actual value offered by the technology.Summary of ChapterFinal PDF to printer
sch87956_ch04_067-094.indd 92 11/09/18 10:47 AM92 Part One Industry Dynamics of Technological Innovation 8. Firms can try to manage customers’ perceptions and expectations through adver-tising and public announcements of preorders, distribution agreements, and so on. 9. The combination of network externality returns to market share and technological utility will influence at what level of market share one technology will dominate another. For some industries, the full network externality benefits are attained at a minority market share level; in these industries, multiple designs are likely to coexist. 10. In markets where customers have heterogeneous preferences and there are many potential technological options available, firms might use modularity to enable customers to mix and match components, producing a wider array of end products. 11. Platform ecosystems are an example of modularity in action. A stable core plat-form (e.g., a smartphone operating system) may mediate the relationship between many complements producers (e.g., applications developers) and end users. 1. What are some of the sources of increasing returns to adoption? 2. What are some examples of industries not mentioned in the chapter that demon-strate increasing returns to adoption? 3. What are some of the ways a firm can try to increase the overall value of its tech-nology and its likelihood of becoming the dominant design? 4. What determines whether an industry is likely to have one or a few dominant designs? 5. Are dominant designs good for consumers, competitors, complementors, and suppliers?Discussion QuestionsClassicsArthur, W. B., Increasing Returns and Path Dependency in the Economy (Ann Arbor, MI: University of Michigan Press, 1994).Gawer, A., and M. A. Cusumano, Platform Leadership (Boston: Harvard Business School Publishing, 2002).Katz, M., and C. Shapiro, “Technology Adoption in the Presence of Network Exter-nalities,” Journal of Political Economy 94 (1986):822–41.Schilling, M. A., “Technological Leapfrogging: Lessons from the U.S. Video Game Console Industry,” California Management Review 45, no. 3 (2003):6–32.Shapiro, C., and Varian, H. Information Rules: A Strategic Guide to the Network Economy (Boston: Harvard Business Review Press, 1999).Schilling, M. A., “Towards a General Modular Systems Theory and Its Applica-tion to Inter-Firm Product Modularity,” Academy of Management Review 25 (2000):312–34.Recent WorkAdner, R., and R. Kapoor, “Value Creation in Innovation Ecosystems: How the Struc-ture of Technological Interdependence Affects Firm Performance in New Technology Generations,” Strategic Management Journal 31 (2010):306–33.Suggested Further ReadingFinal PDF to printer
sch87956_ch04_067-094.indd 93 11/09/18 10:47 AMChapter 4 Standards Battles, Modularity, and Platform Competition 93Boudreau, K. J., “Open Platform Strategies and Innovation: Granting Access vs. Devolving Control,” Management Science 56 (2010):1849–72.Boudreau, K. J., and L. B. Jeppesen, “Unpaid Crowd Complementors: The Platform Network Effect Mirage,” Strategic Management Journal 36, no. 12 (2015):1761–77.Jacobides, M., C. Cennamo, and A. Gawer, “Towards a Theory of Ecosystems,” Strategic Management Journal 39 (May 2018):2255–76.Sterman, J. D., R. Henderson, E. D. Beinhocker, and L. I. Newman, “Getting Big Too Fast: Strategic Dynamics with Increasing Returns and Bounded Rationality,” Manage-ment Science 53 (2007):683–96.Seamans, R., and F. Zhu, “Responses to Entry in Multi-Sided Markets: The Impact of Craigslist on Local Newspapers,” Management Science 60 (2013):476–93. 1. W. B. Arthur, Increasing Returns and Path Dependency in the Economy (Ann Arbor, MI: Uni-versity of Michigan Press, 1994). 2. For examples of this, see M. Lapre, A. S. Mukherjee, and L. N. Van Wassenhove, “Behind the Learning Curve: Linking Learning Activities to Waste Reduction,” Management Science 46 (2000), pp. 597–611; F. K. Levy, “Adaptation in the Production Process,” Management Science 11 (1965), pp. B136–54; and L. E. Yelle, “The Learning Curve: Historical Review and Compre-hensive Survey,” Decision Sciences 10 (1979), pp. 302–28. 3. L. Argote, Organizational Learning: Creating, Retaining and Transferring Knowledge (Boston: Kluwer Academic Publishers, 1999); N. W. Hatch and D. C. Mowery, “Process Innovation and Learning by Doing in Semiconductor Manufacturing,” Management Science 44, no. 11 (1998), pp. 1461–77; and M. A. Schilling, P. Vidal, R. Ployhart, and A. Marangoni, “Learning by Doing Something Else: Variation, Relatedness, and the Learning Curve,” Management Science 49 (2003), pp. 39–56. 4. For examples, see L. Argote, “Group and Organizational Learning Curves: Individual, System and Environmental Components,” British Journal of Social Psychology 32 (1993), pp. 31–52; Argote, Organizational Learning; N. Baloff, “Extensions of the Learning Curve—Some Empirical Results,” Operations Research Quarterly 22, no. 4 (1971), pp. 329–40; E. D. Darr, L. Argote, and D. Epple, “The Acquisition, Transfer and Depreciation of Knowledge in Service Organizations: Productivity in Franchises,” Management Science 41 (1995), pp. 1750–62; L. Greenberg, “Why the Mine Injury Picture Is Out of Focus,” Mining Engineer-ing 23 (1971), pp. 51–53; Hatch and Mowery, “Process Innovation and Learning by Doing in Semiconductor Manufacturing”; A. Mukherjee, M. Lapre, and L. Wassenhove, “Knowledge Driven Quality Improvement,” Management Science 44 (1998), pp. S35–S49; and Yelle, “The Learning Curve.” 5. Argote, Organizational Learning. 6. J. Dutton and A. Thomas, “Treating Progress Functions as a Managerial Opportunity,” Acad-emy of Management Review 9 (1984), pp. 235–47; Levy, “Adaptation in the Production Pro-cess”; and Mukherjee, Lapre, and Wassenhove, “Knowledge Driven Quality Improvement.” 7. W. M. Cohen and D. A. Levinthal, “Absorptive Capacity: A New Perspective on Learning and Innovation,” Administrative Science Quarterly, March 1990, pp. 128–52. 8. M. Katz and C. Shapiro, “Technology Adoption in the Presence of Network Externalities,” Journal of Political Economy 94 (1986), pp. 822–41; M. Schilling, “Technological Lock Out: An Integrative Model of the Economic and Strategic Factors Driving Technology Success and Failure,” Academy of Management Review 23 (1998), pp. 267–84; and M. Thum, “Network EndnotesFinal PDF to printer
sch87956_ch04_067-094.indd 94 11/09/18 10:47 AM94 Part One Industry Dynamics of Technological InnovationExternalities, Technological Progress, and the Competition of Market Contracts,” International Journal of Industrial Organization 12 (1994), pp. 269–89. 9. J. Wade, “Dynamics of Organizational Communities and Technological Bandwagons: An Empirical Investigation of Community Evolution in the Microprocessor Market,” Strategic Management Journal 16 (1995), pp. 111–34. 10. Schilling, “Technological Lock Out”; and F. F. Suarez, “Battles for Technological Dominance: An Integrative Framework,” Research Policy 33, pp. 271–86. 11. W. B. Arthur, “Competing Technologies, Increasing Returns, and Lock-In by Historical Events,” The Economic Journal, March 1989, pp. 116–31; R. W. England, “Three Reasons for Investing Now in Fossil Fuel Conservation: Technological Lock-In, Institutional Inertia, and Oil Wars,” Journal of Economic Issues, September 1994, pp. 755–76; and Katz and Shapiro, “Technology Adoption in the Presence of Network Externalities.” 12. G. Dosi, “Sources, Procedures, and Microeconomic Effects of Innovation,” Journal of Economic Literature 26 (1988), p. 1130. 13. Ibid., pp. 1120–71. 14. M. A. Schilling, “Technological Leapfrogging: Lessons from the U.S. Video Game Console Industry,” California Management Review 45, no. 3 (2003), pp. 6–32; and Suarez, “Battles for Technological Dominance.” 15. W. C. Kim and R. Mauborgne, “Knowing a Winning Business Idea When You See One,” Harvard Business Review, September–October 2000, pp. 129–38. 16. Schilling, “Technological Leapfrogging.” 17. A. Brandenberger, 1995b. “Power Play (B): Sega in 16-Bit Video Games,” Harvard Business School case no. 9-795-103. 18. A. Brandenberger, 1995c. “Power Play (C): 3DO in 32-Bit Video Games,” Harvard Business School case no. 9-795-104; and Schilling, “Technological Leapfrogging.” 19. Ceccagnoli, M., C. Forman, P. Huang, D. J. Wu, “Cocreation of Values in a Platform Eco-system: The Case of Enterprise Software.” MIS Quart 36, no. 1 (2012):263–90; Gawer, A., “Bridging Differing Perspectives on Technological Platforms: Toward an Integrative Frame-work.” Research Policy, 43, no. 7 (2014):1239–49; Jacobides, M. G., Knudsen, T., Augier, M., “Benefiting from Innovation: Value Creation, Value Appropriation and the Role of Industry Architectures.” Research Policy, 35, no. 8(2006):1200–21; Rietveld, J., M. A. Schilling, and C. Bellavitis, “Platform Strategy: Managing Ecosystem Value Through Selective Promotion of Complements.” (working paper, New York University, 2018); Schilling, M. A., “Towards a General Modular Systems Theory and Its Application to Inter-Firm Product Modularity.” Acad-emy of Management Review, 25 (2000):312–34. 20. Garud, R., and A. Kumaraswamy, “Technological and Organizational Designs for Realizing Economies of Substitution.” Strategic Management Journal 16 (1995):93–109. 21. Schilling, M. A., “Towards a General Modular Systems Theory and Its Application to Inter-Firm Product Modularity.” Academy of Management Review 25 (2000):312–34. 22. Rietveld, J., M. A. Schilling, and C. Bellavitis, “Platform Strategy: Managing Ecosystem Value Through Selective Promotion of Complements.” (working paper, New York University, 2018). 23. Ibid. 24. Ibid.Final PDF to printer
95sch87956_ch05_095-112.indd 95 11/14/18 04:56 PMChapter FiveTiming of EntryUberAIRIn April 2017, Jeff Holden, the chief product officer at Uber Technologies Inc. announced a radically new product called UberAir, an on-demand air transporta-tion service:On-demand aviation, has the potential to radically improve urban mobility, giving people back time lost in their daily commutes. . . . Just as skyscrapers allowed cities to use limited land more efficiently, urban air transportation will use three-dimensional airspace to alleviate transportation congestion on the ground. A network of small, electric aircraft that take off and land vertically (called Vertical Take-off and Landing, or VTOL, and pronounced vee-tol), will enable rapid, reliable transportation between suburbs and cit-ies and, ultimately, within cities.aUber’s on-demand ride-sharing service had seriously disrupted traditional taxi and livery, and induced many people to eschew car ownership altogether. How-ever, that service was based on an innovative business model and a software application—it did not require technological advances in either automobiles or driving infrastructure. UberAIR was almost the opposite: it would leverage Uber’s existing business model and software programs, but would require major technological development in air transportation technology, infrastructure for air traffic control, and a network of landing pads. It was an ambitious project, to put it mildly.Uber’s RiseUber was founded in 2009 as a taxi-like ride-sharing service. Customers could request a ride using a smartphone application, and the software would notify Uber drivers in the area of the request. When one accepted, it would show the customer the car’s approach on a map in real-time. The driver would take the user to their destination, and payment would occur automatically using the cus-tomer’s credit card information that was stored online.Perhaps the most unique part of the business model was that Uber drivers did not technically work for Uber. Drivers were independent contractors; they Final PDF to printer
sch87956_ch05_095-112.indd 96 11/14/18 04:56 PM96 Part One Industry Dynamics of Technological Innovationneeded only a smartphone, a driver’s license, a car, insurance, and a clean driv-ing record to qualify to become an Uber driver.b A dynamic pricing model raised prices when demand was high and drivers were few, and the higher prices, in turn, lured more Uber drivers to start accepting ride requests.Over time the company added different classes of services (such as UberPool, Uber X, Uber XL, Uber Select), and different services such as food delivery (Uber Eats), freight service (Uber Freight), and pet transport (Uber Pets). By 2016, Uber was also testing autonomous vehicles in San Francisco.Though the firm had endured numerous early conflicts with taxi unions and some highly public scandals involving one of the company’s founders, Travis Kalanick, the service was a huge success. By 2015, it had completed its one billionth ride, making it the second largest ride-sharing service worldwide, after Didi Chuxing in China. By 2018, it was operating in more than 674 cities in 82  countries worldwide. Its net revenue (after paying drivers) in 2017 was $7.4 billion, and though the company was not publicly held, its market valuation was estimated to be $72 billion.Opportunities and Challenges for UberAIRIn 2018, there were more than seventy companies developing electric VTOLs (eVTOLS), including Karem Aircraft, Embraer, Aurora Flight Sciences, and Bell Helicopter. However, there were a number of obstacles that had to be overcome to make UberAIR a reality. First, an eVTOL used an enormous amount of energy and would be heavily reliant on advances on battery development and charging infrastructure. Second, there would be numerous legal and safety issues to be worked out pertaining to air traffic control, pilot training and licensing, compat-ibility with city infrastructures, noise, dealing with adverse weather, and more.Last, but not least, was cost. The technology to vertically take off and land already existed in the form of helicopters, but most people have never ridden in one because it is an extremely expensive mode of transportation, estimated to be at least $8.93 per passenger per mile. How would UberAIR be different? First, electric propulsion was expected to be much more fuel efficient and require less maintenance. Second, the much smaller eVTOLs could land at flexible “skyports” rather than the large helipads or airports that helicopters used. Uber estimated that its initial operating costs would be $5.73 per passenger per mile, and with efficient pooling it believed it could get the operating costs down to $1.84 per passenger per mile. As people began to use eVTOLs in large numbers, scale economies would also drive down the cost of producing the eVTOLs them-selves. The final major cost-cutting measure would be to eliminate pilots with fully autonomous eVTOLs, saving training costs, salaries, and making room for an additional passenger. Uber estimated that with fully autonomous operation at scale, the long-run operating costs of UberAIR could be as low as 44 cents per passenger mile—less than the operating cost of many cars.cElon Musk, who is known for larger-than-life ambitions such as moving the world’s auto fleet to renewable energies and colonizing Mars, was skeptical, not-ing “it’s difficult to imagine the flying car becoming a scalable solution.”d Musk also thought that aerial transportation would be too disruptive to people on the Final PDF to printer
sch87956_ch05_095-112.indd 97 11/14/18 04:56 PMChapter 5 Timing of Entry 97ground, tweeting sarcastically, “If you love drones above your house, you’ll really love vast numbers of ‘cars’ flying over your head that are 1000 times bigger and noisier and blow away anything that isn’t nailed down when they land.”e Musk was betting that a better solution could be achieved underground, with electric pods that zipped through tunnels. Even Uber’s CEO, Dara Khosrowshahi was ini-tially doubtful about the project. However, after several rounds of discussion on the economics of it, he began to be persuaded. “For me the ‘aha’ moment came when I started understanding that Uber isn’t just about cars,” Khosrowshahi said. “Ultimately where we want to go is about urban mobility and urban transport, and being a solution for the cities in which we operate.”fAs of June, 2018, the company had plans for testing the service in Dallas and Los Angeles by 2020, and was seeking an international launch city.g It planned to have commercial deployment of the service by 2023.Battle for the SkiesUber was not the only company with dreams of revolutionizing personal air travel. Makers of eVTOLs such as eVolo (based in Germany) and EHang (based in China) were also in the process of launching air taxi services, and Terrafugia (based in the United States) was building a vehicle that it believed would be a mass market flying car for personal use. If eVTOLs became widely avail-able and economical, other ride-sharing companies such as Lyft might also be well positioned to target the market. Would Uber’s scale in ride sharing enable it to achieve dominance in air ride sharing, and would such a position be sustainable?Discussion Questions 1. Will there be increasing returns to adoption for an early mover in air taxi service? If so, what will they be? 2. What are the disadvantages of entering the air taxi market early? 3. What are the important complementary goods and enabling technologies for the air taxi market? Are they available in sufficient quality and economy? 4. Is Uber well positioned to be a dominant player in this market? What resources will it need to be successful? 5. Overall, would you say Uber’s entry into the air taxi market is too early, too late, or about right? a Holden, J., and N. Goel, “Fast-Forwarding to a Future of On-Demand Urban Air Transportation” (San Francisco: Uber Elevate, October 27, 2016). b Pancer, E., K. Gulliver, and M. MacLeod, “Uber Elevate: The Case for Flying Cars,” Ivey Publishing (2018), case W18135. c Goodwin, A., “Will You Be Able to Afford UberAir’s Flying Car Service?” CNET (May 8, 2018). d Muoio, D., “Elon Musk Says Flying Cars Aren’t a Good Fix for Traffic—Here’s Why,” Business Insider (February 16, 2017). e Source: Elon Musk, February 22, 2018. f Dickey, M. R., “Uber’s Aerial Taxi Play,” TechCrunch, (May 9, 2018). g PDF to printer
sch87956_ch05_095-112.indd 98 11/14/18 04:56 PM98 Part One Industry Dynamics of Technological InnovationOVERVIEWThe previous chapter pointed out that some industries are characterized by increasing returns to adoption, meaning that the more a technology is adopted, the more valuable it becomes. In such industries, timing can be crucial—a technology that is adopted earlier than others may reap self-reinforcing advantages such as greater funds to invest in improving the technology, greater availability of complementary goods, and less customer uncertainty. On the other hand, the same factors that cause increasing returns to adoption may make very early technologies unattractive: If there are few users of the technology or availability of complementary goods is poor, the technology may fail to attract customers. A number of other first-mover advantages, and disadvantages, can shape how timing of entry is related to likelihood of success.Entrants are often divided into three categories: first movers (or pioneers), which are the first to sell in a new product or service category; early followers (also called early leaders), which are early to the market but not first; and late entrants, which enter the market when or after the product begins to penetrate the mass market. The research on whether it is better to be a first mover, early follower, or late entrant yields conflicting conclusions. Some studies that contrast early entrants (lumping first movers and early followers together) with late entrants find that early entrants have higher returns and survival rates, consistent with the notion of first-mover (or at least early-mover) advantage.1 However, other research has suggested the first firm to market is often the first to fail, causing early followers to outperform first movers.2 Still other research contends the higher returns of being a first mover typically offset the survival risk.3 A number of factors influence how timing of entry affects firm survival and profits. In this chapter, we will first examine first-mover advantages and disadvantages. We will then look more closely at what factors determine the optimal timing of entry, and its implications for a firm’s entry strategy.FIRST-MOVER ADVANTAGESBeing a first mover may confer the advantages of brand loyalty and technological leadership, preemption of scarce assets, and exploitation of buyer switching costs.4 Furthermore, in industries characterized by increasing returns, early entrants may accrue learning and network externality advantages that are self-reinforcing over time.5Brand Loyalty and Technological LeadershipThe company that introduces a new technology may earn a long-lasting reputation as a leader in that technology domain. Such a reputation can help sustain the company’s image, brand loyalty, and market share even after competitors have introduced compa-rable products. The organization’s position as technology leader also enables it to shape customer expectations about the technology’s form, features, pricing, and other charac-teristics. By the time later entrants come to market, customer requirements may be well established. If aspects that customers have come to expect in a technology are difficult for competitors to imitate (e.g., if they are protected by patent or copyright, or arise from the first mover’s unique capabilities), being the technology leader can yield sustained late entrantsEntrants that do not enter the market until the time the product begins to pen-etrate the mass market or later.early followersEntrants that are early to market, but not first.first moversThe first entrants to sell in a new product or ser-vice category.Final PDF to printer
sch87956_ch05_095-112.indd 99 11/14/18 04:56 PMChapter 5 Timing of Entry 99monopoly rents. Even if the technology characteristics are imitable, the first mover has an opportunity to build brand loyalty before the entry of other competitors.Preemption of Scarce AssetsFirms that enter the market early can preemptively capture scarce resources such as key locations, government permits, patents, access to distribution channels, and rela-tionships with suppliers.For example, companies that wish to provide any wireless communication service must license the rights to broadcast over particular radio frequencies from the govern-ment. In the United States, the Federal Communications Commission (FCC) is primar-ily responsible for allotting rights to use bands of radio frequencies (known as the spectrum) for any wireless broadcasting. The FCC first allocates different portions of the spectrum for different purposes (digital television broadcasting, third-generation wireless telecommunication, etc.) and different geographic areas. It then auctions off rights to use these segments to the highest bidders. This means that early movers in wireless services can preemptively capture the rights to use portions of the wireless spectrum for their own purposes, while effectively blocking other providers. By 2003, the proliferation of wireless services had caused the spectrum to become a scarce com-modity, and the FCC was under pressure to allow the holders of wireless spectrum rights to sublet unused portions of their spectrum to other organizations.Exploiting Buyer Switching CostsOnce buyers have adopted a good, they often face costs to switch to another good. For example, the initial cost of the good is itself a switching cost, as is the cost of complements purchased for the good. Additionally, if a product is complex, buyers must spend time becoming familiar with its operation; this time investment becomes a switching cost that deters the buyer from switching to a different product. If buyers face switching costs, the firm that captures customers early may be able to keep those customers even if technologies with a superior value proposition are introduced later. This is often the reason given for the dominance of the QWERTY typewriter keyboard. In 1867, Christopher Sholes began experimenting with building a typewriter. At that time, letters were struck on paper by mechanical keys. If two keys were struck in rapid succession, they often would jam. Key jamming was a particularly significant problem in the 1800s because typewriters then were designed so that keys struck the back side of the paper, making it impossible for users to see what they were typing. The typist thus might not realize he or she had been typing with jammed keys until after remov-ing the page. Scholes designed his keyboard so that commonly used letter combina-tions were scattered as widely as possible over the keyboard. The QWERTY keyboard also puts a disproportionate burden on the left hand (3000 English words can be typed with the left hand alone, while only 300 can be typed with the right hand alone). This positioning of keys would slow the typing of letter combinations, and thus reduce the likelihood of jamming the keys.6Over time, many competing typewriter keyboards were introduced that boasted faster typing speeds or less-tiring typing. For example, the Hammand and Blickensderfer “Ideal” keyboard put the most commonly used letters in the bottom row for easy access, and used only three rows total. Another example, the Dvorak keyboard, placed monopoly rentsThe additional returns (either higher revenues or lower costs) a firm can make from being a monopolist, such as the ability to set high prices, or the ability to lower costs through greater bargaining power over suppliers.Final PDF to printer
sch87956_ch05_095-112.indd 100 11/14/18 04:56 PM100 Part One Industry Dynamics of Technological Innovationall five vowels and the three most commonly used consonants in the home row, and common letter combinations required alternating hands frequently, reducing fatigue. However, QWERTY’s early dominance meant typists were trained only on QWERTY keyboards. By the time Dvorak keyboards were introduced in 1932, tens of millions of typists were committed to QWERTY keyboards—the switching costs of learning how to type all over again were more than people were willing to bear.7 Even after daisy-wheel keys (and later, electronic typewriters) removed all possibility of jamming keys, the QWERTY keyboard remained firmly entrenched. August Dvorak is said to have died a bitter man, claiming, “I’m tired of trying to do something worthwhile for the human race. They simply don’t want to change!”8Reaping Increasing Returns AdvantagesIn an industry with pressures encouraging adoption of a dominant design, the timing of a firm’s investment in new technology development may be particularly critical to its likelihood of success. For example, in an industry characterized by increasing returns to adoption, there can be powerful advantages to being an early provider; a technology that is adopted early may rise in market power through self-reinforcing positive feedback mechanisms, culminating in its entrenchment as a dominant design. Intel is an apt example of this.Intel’s Ted Hoff invented the first microprocessor in 1971, and in 1975, Bill Gates and Paul Allen showed that it could run a version of BASIC that Gates had written. Gates’s BASIC became widely circulated among computer enthusiasts, and as BASIC was adopted and applications developed for it, the applications were simultaneously optimized for Intel’s architecture. IBM’s adoption of Intel’s 8088 microprocessor in its PC introduction secured Intel’s dominant position, and each of Intel’s subsequent generations of products has set the market standard.9FIRST-MOVER DISADVANTAGESDespite the great attention that first-mover advantages receive, there are also argu-ments for not entering a market too early. In a historical study of 50 product categories, Gerard Tellis and Peter Golder found that market pioneers have a high failure rate—roughly 47 percent—and that the mean market share of market pioneers is 10 percent.10 By contrast, early leaders (firms that enter after market pioneers but assume market leadership during the early growth phase of the product life cycle) averaged almost three times the market share of market pioneers.11 Tellis and Golder point out that the market may often perceive first movers to have advantages because it has misperceived who the first mover really was. For example, while today few people would dispute Procter & Gamble’s claim that it “created the disposable diaper market,”12 in actuality, Procter & Gamble entered the disposable market almost 30 years after Chux, a brand owned by a subsidiary of Johnson & Johnson. In the mid-1960s, Consumer Reports ranked both products as best buys. However, over time Pampers became very success-ful and Chux disappeared, and eventually people began to reinterpret history.Other studies have found that first movers earn greater revenues than other entrants, but that they also face higher costs, causing them to earn significantly lower profits in the long run.13 First movers typically bear the bulk of the research and development Final PDF to printer
sch87956_ch05_095-112.indd 101 11/14/18 04:56 PMChapter 5 Timing of Entry 101expenses for their product or service technologies, and they must also often pay to develop suppliers and distribution channels, plus consumer awareness. A later entrant often can capitalize on the research and development investment of the first mover, fine-tune the product to customer needs as the market becomes more certain, avoid any mistakes made by the earlier entrant, and exploit incumbent inertia.14 Later entrants can also adopt newer and more efficient production processes while early movers are either stuck with earlier technologies or must pay to rebuild their produc-tion systems.15Research and Development ExpensesDeveloping a new technology often entails significant research and development expenses, and the first to develop and introduce a technology typically bears the brunt of this expense. By the time a firm has successfully developed a new technology, it may have borne not only the expense of that technology but also the expense of exploring technological paths that did not yield a commercially viable product. This firm also typically bears the cost of developing necessary production processes and complementary goods that are not available on the market. Since the new product development failure rate can be as high as 95 percent, being the first to develop and introduce an unproven new technology is expensive and risky.By contrast, later entrants often do not have to invest in exploratory research. Once a product has been introduced to the market, competitors can often ascertain how the product was created. The later entrant can also observe the market’s response to par-ticular features of the technology and decide how to focus its development efforts. Thus, the later entrant can both save development expense and produce a product that achieves a closer fit with market preferences.Undeveloped Supply and Distribution ChannelsWhen a firm introduces a new-to-the-world technology, often no appropriate suppliers or distributors exist. The firm may face the daunting task of developing and producing its own supplies and distribution service, or assisting in the development of supplier and developer markets. For example, when DEKA Research began developing its self-balancing IBOT wheelchair, it needed a type of ball bearing for which there were no suppliers. DEKA was forced to develop a machine to mold the bearings. According to Dean Kamen, the company’s founder, “Nobody here planned to invent new ball bear-ings, but in order to make this engine practical we have to develop a bearing technol-ogy that doesn’t exist.”16Immature Enabling Technologies and ComplementsWhen firms develop technologies, they often rely on other producers of enabling technologies. For instance, for Uber to launch its UberAIR transportation service required the development of economical aircraft capable of taking off and landing vertically, advances in battery technology that would increase the range of the aircraft while keeping costs low, a charging infrastructure to charge the aircraft, a network of “skyports” for landing and takeoff, and pilots for the aircraft (until they could be made fully autonomous). Uber was thus heavily reliant on numerous third parties to make its project feasible.incumbent inertiaThe tendency for incumbents to be slow to respond to changes in the industry environ-ment due to their large size, estab-lished routines, or prior strategic commitments to existing suppliers and customers.enabling technologiesComponent tech-nologies that are necessary for the performance or desirability of a given innovation.Final PDF to printer
102sch87956_ch05_095-112.indd 102 11/14/18 04:56 PMTheory in Action Obstacles to the Hydrogen EconomyFuel cells create electricity from a reaction between hydrogen and oxygen, and are much more efficient than internal combustion gasoline engines. Whereas a typical internal combustion engine converts less than 20  percent of the energy potential of gasoline into power for the automobile, fuel cells capture 40  percent to 60 percent of the energy potential of their fuel source, which can be any hydrogen-rich liquid or gas.a Hydro-gen is one of the most abundant elements on the Earth and can be obtained in a number of ways, including electrolysis of water or steam conversion of methanol. Furthermore, the only waste products of hydrogen fuel cells are water vapor and carbon dioxide. Hydrogen thus offers an inexhaustible and environmentally friendly fuel source.b Utilizing hydrogen to power vehicles (among other things) offers the promise of reducing reliance on dwindling fossil fuel reserves while dramatically decreas-ing the environmental impact of automobiles. Many of the key players in fuel cell development envision a “hydro-gen economy” whereby automobiles with hydrogen fuel cells are used to supply power to homes and offices, eventually replacing the existing electrical power grids.Fuel cells were developed more than 150 years ago, but were initially too bulky and expensive to be used in automobiles. In the 1970s, however, the energy crisis sparked a resurgence in fuel cell development, and a number of prototypes emerged through the late 1970s and 1980s. By the 1990s, several auto manu-facturers, including Toyota and Daimler had developed automobiles powered by fuel cells and were planning commercial production. A number of serious obstacles, however, stood in the way of fuel cell adoption by the mass market. The most serious of these was the lack of a complementary refueling infrastructure. Before fuel cell vehicles could be promoted to the mass market, refueling options had to be developed that would be convenient and easy for consumers to use. This was no small feat—the existing fuel stations that were ubiq-uitous in almost every corner of the globe could not handle a gaseous fuel such as hydrogen. While liquid gasoline can be stored in almost any type of container, hydrogen gas is liquid only under very high pressure and has very small molecules. It would rapidly leak out of existing gasoline storage containers. Both fuel-ing stations and automobiles would need to be able to keep compressed hydrogen in a pressurized tank. Fur-thermore, many of the existing gasoline stations were owned or otherwise connected to oil companies. Since it was not yet clear what role oil companies would play in the hydrogen economy, many suspected that oil companies would use their resources and lobbying power to resist the adoption of hydrogen fuel cells. To unleash the power of the “hydrogen economy” vision would not only require heavy investment in new infra-structure, but also require resolving or overcoming the conflicting interests of numerous stakeholders, includ-ing government, utilities, auto manufacturers, oil pro-ducers, and consumers.a J. Rifkin, “The Hydrogen Economy,” E Magazine, January–February 2003, pp. 26–37.As discussed in Chapter Four, many products also require complementary goods to be useful or valuable. Computers need software, cameras need film, automobiles need service, gasoline, and roads. When new technologies are introduced to a market, important complements may not yet be fully developed, thus hindering adoption of the innovation. The development of vehicles powered by hydrogen fuel cells (see the above Theory in Action) provides an excellent example of how a lack of complemen-tary technologies and infrastructure can pose serious obstacles for early movers.Uncertainty of Customer RequirementsA first mover to the market may face considerable uncertainty about what product features customers will ultimately desire and how much they will be willing to pay for them. For a very new product technology, market research may be of little help. Final PDF to printer
sch87956_ch05_095-112.indd 103 11/14/18 04:56 PMChapter 5 Timing of Entry 103 Customers may have little idea of the value of the technology or the role it would play in their lives. As a consequence, first movers may find that their early product offer-ings must be revised as the market begins to reveal customer preferences.For instance, when Kodak introduced the 8-mm video camera in the late 1980s, it expected that customers would flock to the design’s smaller size and superior record-ing ability. Instead, consumers rejected the product. The 8-mm video cameras were more expensive, and consumers had not yet recognized a need for this product and were unsure of what value it could provide. Kodak decided to withdraw from the market. However, by the early 1990s, consumers had become more comfortable with the concept of 8-mm video camera technology, and several competitors (most notably Sony) successfully entered this market.First movers have an opportunity to shape customer preferences by establishing the precedent for product design in the newly emerging market and by investing in customer education. Customer education efforts are expensive, however. If the product is slow to begin to reap revenues for the sponsoring firm, it may collapse under the weight of its R&D and marketing expenses. Figure 5.1 provides a number of product categories with their first movers, prominent followers, and which of these were ulti-mately more successful.FIGURE 5.1First Movers and Followers—Who Wins?Source: R. M. Grant, Contemporary Strategy Analysis (Malden, MA: Blackwell Publishers, 1998); D. Teece, The Competitive Challenge: Strategies for Indus-trial Innovation and Renewal (Cambridge, MA: Ballinger, 1987); and M. A. Schilling, “Technology Success and Failure in Winner-Take-All Markets: Testing a Model of Technological Lock Out,” Academy of Man-agement Journal 45 (2002), pp. 387–98.ProductFirst MoverNotable Follower(s)The Winner8-mm video cameraKodakSonyFollowerDisposable diaperChuxPampersFollowersKimberly ClarkFloat glassPilkingtonCorningFirst moverGroupwareLotusAT&TFirst moverInstant cameraPolaroidKodakFirst moverMicroprocessorsIntelAMDFirst moverCyrixMicrowaveRaytheonSamsungFollowerPersonal computerMITS (Altair)AppleFollowersIBMPersonal computer operating systemDigital ResearchMicrosoft (MS-DOS)FollowerSmartphonesIBM (Simon)AppleFollowersNokiaSocial networking sitesSixDegrees.comMySpaceFollowersFacebookSpreadsheet softwareVisiCalcMicrosoft (Excel)FollowersLotusVideo game consoleMagnavoxAtariFollowersNintendoWeb browserNCSA MosaicNetscapeFollowersMicrosoft (Internet Explorer)Word processing softwareMicroPro (WordStar)Microsoft (MS Word)FollowersWordPerfectWorkstationXerox AltoSun MicrosystemsFollowersHewlett-PackardFinal PDF to printer
sch87956_ch05_095-112.indd 104 11/14/18 04:56 PM104 Part One Industry Dynamics of Technological InnovationFACTORS INFLUENCING OPTIMAL TIMING OF ENTRYIn very early market stages, a technology may be underdeveloped and its fit with cus-tomer needs unknown. In late market stages, a technology may be well understood, but competitors may have already captured controlling shares of the market. How does a firm decide whether to attempt to pioneer a technology category or to wait while oth-ers do so? The answer will depend on several factors, including customer certainty, the margin of improvement offered by the new technology, the state of enabling technolo-gies and complementary goods, the threat of competitive entry, the degree to which the industry exhibits increasing returns, and the firm’s resources. 1. How certain are customer preferences?When new-to-the-world technologies are first developed, customers may have diffi-culty understanding the technology and its role in their life. Both producers and cus-tomers may face considerable ambiguity about the importance of various features of the technology. As producers and customers gain experience with the technology, fea-tures that initially seemed compelling may turn out to be unnecessary, and features that had seemed unimportant may turn out to be crucial. For example, many of the companies that raced to establish an online presence in the e-commerce frenzy of the late 1990s believed that their Web sites needed exciting graphics and sounds to be competitive. Graphics and sound, however, turned out to be the downfall of many early Web sites. Many customers did not have high-speed Internet access or computers with enough processing power to quickly download the Web sites, making multimedia Web sites an annoyance rather than an attraction.The reverse scenario is demonstrated in Sony’s introduction of the PlayStation 2. When Sony introduced its multifeatured PlayStation 2, many industry analysts believed that Sony had overestimated consumer interest in having a game console that would play music CDs or DVD movies. It turned out, however, that Sony may have under-estimated the desirability of these features. Video game consoles are typically sold at cost (or at a loss) in order to rapidly build an installed base. Profits are then made on game royalties. However, when consumers realized that the PlayStation 2 was a very affordable combination of game console and high-quality DVD player, many consum-ers bought the system for its DVD capabilities first and game capabilities second. Many of these consumers bought very few games, causing Sony’s strategy of subsidiz-ing the console with the intention of making money on the games to backfire. Observ-ing this, Microsoft disabled DVD playback on its Xbox unless consumers purchased an add-on DVD playback kit.Not all pioneers face customer uncertainty—some innovations are developed in response to well-understood customer needs. Customer requirements may have been long known even if the method of meeting them was not. For example, the developers of Tagamet (a medication for patients with chronic heartburn or ulcers) faced very lit-tle customer uncertainty. Customers wanted an affordable, easy-to-use solution to their stomach discomfort. Once a method of achieving this objective had been developed, tested, and approved, its developers raced the product to market in hopes of patenting it and securing market share ahead of competing products. Other things being equal, less customer uncertainty favors earlier timing of entry.17Final PDF to printer
sch87956_ch05_095-112.indd 105 11/14/18 04:56 PMChapter 5 Timing of Entry 105 2. How much improvement does the innovation provide over previous solutions?The degree to which the technology represents an improvement over previous technol-ogies increases a firm’s likelihood of successful early entry. That is, when a technology makes a dramatic improvement over previous generations or different technologies that serve similar functions, it will more rapidly gain customer acceptance. There will be less ambiguity about the value of the technology and more early adoptions (as well as more support by complementary goods providers); as a consequence, customer expectations should become known sooner, and adoptions should be more rapid.18 3. Does the innovation require enabling technologies, and are these technologies sufficiently mature?As mentioned earlier, many innovations rely on crucial enabling technologies to ensure their performance. A high-definition television set is of little value if networks are incapable of broadcasting in high definition; cellular phones or portable stereos would have little value if small and long-lasting batteries were unavailable. A devel-oper must identify which enabling technologies will affect the performance of the new innovation and assess the degree to which those technologies are mature enough (or will be mature enough) to deliver the desired performance. More mature enabling technologies allow earlier entry; less mature enabling technologies may favor waiting for enabling technologies to be further developed. 4. Do complementary goods influence the value of the innovation, and are they sufficiently available?If the value of an innovation hinges critically on the availability and quality of comple-mentary goods, then the state of complementary goods determines the likelihood of successful entry. Not all innovations require complementary goods, and many more innovations can utilize existing complementary goods. For example, though numerous innovations in 35-mm cameras have been introduced in the last few decades, almost all have remained compatible with standard rolls of 35-mm film; thus availability of that complementary good was ensured. If, on the other hand, the innovation requires the development of new complementary goods, then a pioneer must find a way to ensure their availability. Some firms have the resources and capabilities to develop both a good and its complements, while others do not. If the firm’s innovation requires complementary goods that are not available on the market, and the firm is unable to develop those complements, successful early entry is unlikely. 5. How high is the threat of competitive entry?If there are significant entry barriers or few potential competitors with the resources and capabilities to enter the market, the firm may be able to wait while customer requirements and the technology evolve. Over time, one would expect customer expec-tations to become more certain, enabling technologies to improve, and support goods and services to be developed, thus increasing the likelihood that sponsored technol-ogies will possess a set of attributes that meet consumer demands. However, if the technology proves to be valuable, other firms are also likely to be attracted to the mar-ket. Thus, if entry barriers are low, the market could quickly become quite competi-tive, and entering a market that has already become highly competitive can be much more challenging than entering an emerging market.19 Margins may already have been Final PDF to printer
sch87956_ch05_095-112.indd 106 11/14/18 04:56 PM106 Part One Industry Dynamics of Technological Innovationdriven down to levels that require competitors to be highly efficient, and access to distribution channels may be limited. If the threat of competitive entry is high, the firm may need to enter earlier to establish brand image, capture market share, and secure relationships with suppliers and distributors. This is discussed further in the Research Brief “Whether and When to Enter?” 6. Is the industry likely to experience increasing returns to adoption?In industries that have increasing returns to adoption due to strong learning curve effects or network externalities, allowing competitors to get a head start in building an installed base can be very risky. If a competitor’s offering builds a significant installed base, the cycle of self-reinforcing advantages could make it difficult for the firm to ever catch up. Furthermore, if there are forces encouraging adoption of a single dom-inant design, a competitor’s technology may be selected. If protection mechanisms such as patents prevent the firm from offering a compatible technology, the firm may be locked out.20Research Brief Whether and When to Enter?In a study of 30 years of data on entry into the medi-cal diagnostic imaging industry, Will Mitchell exam-ined the factors that drive whether and when a firm that is an incumbent in one subfield of an industry chooses to enter a newly emerging subfield of the industry.a For instance, what determines whether and when a manufacturer of conventional X-ray machines decides to go into magnetic resonance imaging (MRI) equipment? While new goods offer opportunities for growth, they can cannibalize exist-ing products, and they also require an investment in new skills. Incumbents often are slow to enter new technical subfields.b They may be intentionally wait-ing for industry turbulence to subside, or they may be unintentionally slowed by factors that create iner-tia, such as the difficulty in altering well-established routines and strategic commitments to the firm’s existing supplier and customer base.Mitchell pointed out that entry barriers and imi-tability of a new product (e.g., whether it can be effectively protected by patents) interact to create dif-ferent incentives for timing. First, if only one firm can produce an inimitable good, it can enter if and when it wants. However, if several firms could produce a good that will subsequently be inimitable, they may race to do so to capture the market. In such a circum-stance, being early confers a significant advantage. Finally, if the good is expected to be highly imitable (e.g., if it would be difficult to effectively protect with patents because competitors could easily invent around the patent), then firms will prefer to wait while others bear the expense of developing and introduc-ing the good. There are disincentives to being early to market.cMitchell found that firms that had more special-ized assets that would be useful in the new subfield (e.g., a well-established distribution system that could be used for the new imaging equipment) were more likely to enter the new subfield. A firm was also more likely to enter if the products it currently pro-duced were threatened by the new products (i.e., if the new technology was likely to displace the firm’s current technology as the dominant choice in the market). Furthermore, the incumbent was likely to enter earlier if its core products were threatened and there were several potential rivals.a W. Mitchell, “Whether and When? Probability of Incum-bent’s Entry into Emerging Technical Subfields,” Adminis-trative Science Quarterly 38 (1989), pp. 208–30.b F. M. Scherer, Industrial Market Structure and Economic Performance, 2nd ed. (Chicago: Rand McNally, 1980).c M. Katz and C. Shapiro, “Technology Adoption in the Pres-ence of Network Externalities,” Journal of Political Econ-omy 94 (1986), pp. 822–41.Final PDF to printer
sch87956_ch05_095-112.indd 107 11/14/18 04:56 PMChapter 5 Timing of Entry 107 7. Can the firm withstand early losses?As was discussed earlier, a first mover often bears the bulk of the expense and risk of developing and introducing a new innovation. First movers thus often need significant amounts of capital that either is available internally (in the case of large firms) or can be accessed externally (e.g., through the debt or equity markets). Furthermore, the first mover must be able to withstand a significant period with little sales revenue from the product. Even in the case of successful new technologies, often a considerable period elapses between the point at which a first mover introduces a new innovation and the point at which the innovation begins to be adopted by the mass market. The s-curve shape of technology diffusion (discussed in Chapters Three and Thirteen) illustrates this aptly. New innovations tend to be adopted very slowly at first, while innovators and early adopters try the technology and communicate their experience to others. This slow initial takeoff of new innovations has caused the demise of many start-up firms. For example, in the personal digital assistant (PDA) industry—the precursor to smartphones—start-ups such as GO Corporation and Momenta had received acco-lades for their technology designs, but were unable to withstand the long period of market confusion about PDAs and ultimately ran out of capital. Companies such as IBM and Compaq survived because they were large and diversified, and thus not reli-ant on PDA revenues. Palm was a relatively late mover in the PDA industry so it did not have to withstand as long of a takeoff period, but even Palm was forced to seek external capital and was acquired by U.S. Robotics, which was later bought by 3COM.On the other hand, firms with significant resources also may be able to more easily catch up to earlier entrants.21 By spending aggressively on development and adver-tising, and leveraging relationships with distributors, a late entrant may be able to rapidly build brand image and take market share away from earlier movers. For exam-ple, though Nestlé was very late to enter the freeze-dried coffee market with Taster’s Choice, the company was able to use its substantial resources to both develop a supe-rior product and rapidly build market awareness. It was thus able to quickly overtake the lead from General Foods’ Maxim.22 8. Does the firm have resources to accelerate market acceptance?A firm with significant capital resources not only has the capability to withstand a slow market takeoff, but also can invest such resources in accelerating market take-off. The firm can invest aggressively in market education, supplier and distributor development, and development of complementary goods and services. Each of these strategies can accelerate the early adoption of the innovation, giving the firm much greater discretion over entering early.23 These strategies are discussed in more detail in Chapter Thirteen. Thus, a firm’s capital resources can give it some influence on the shape of the adoption curve. 9. Is the firm’s reputation likely to reduce the uncertainty of customers, suppliers, and distributors?In addition to capital resources, a firm’s reputation and credibility can also influence its optimal timing of entry.24 A firm’s reputation can send a strong signal about its like-lihood of success with a new technology. Customers, suppliers, and distributors will use the firm’s track record to assess its technological expertise and market prowess. Customers may use the firm’s reputation as a signal of the innovation’s quality, and Final PDF to printer
sch87956_ch05_095-112.indd 108 11/14/18 04:56 PM108 Part One Industry Dynamics of Technological Innovationthus face less ambiguity about adopting the innovation. A firm with a well-respected reputation for successful technological leadership is also more likely to attract sup-pliers and distributors.25 This was aptly demonstrated in Microsoft’s entry into the video game console industry: Despite having little experience in producing hardware, suppliers and distributors eagerly agreed to work with Microsoft because of its track record in personal computing. Other things being equal, an entrant with a strong repu-tation can attract adoptions earlier than entrants without strong reputations.STRATEGIES TO IMPROVE TIMING OPTIONSAs should now be clear, managing the timing of entry into the market is a complex mat-ter. If the technology has a clear advantage to consumers, entering the market early may give the entrant a path-dependent advantage that is nearly impossible for competitors to overcome. If, on the other hand, a firm enters a market very early and the advantages of the technology are not very clear to consumers, there is a strong possibility that the technology will receive a tepid welcome. Confounding this risk is the fact that watchful competitors may be able to use the firm’s failure to their advantage, refining the tech-nology the firm has introduced to the market and making any corrections necessary to improve the technology’s market acceptance. The later entrant may be able to enter at a lower cost because it can capitalize on the research and development of the early firm, and use knowledge of the market gained from observing the early entrant’s experience.In the above, it is assumed that timing of entry is a matter of choice for the firm. However, implicit in this assumption is a corollary assumption that the firm is capable of producing the technology at any point in the time horizon under consideration. For this to be true, the firm must possess the core capabilities required to produce the tech-nology to consumer expectations, or be able to develop them quickly. Furthermore, if the firm intends to refine an earlier entrant’s technology and beat the earlier entrant to market with a new version of this technology, it must have fast-cycle development processes. If a firm has very fast development processes, the firm not only has a better chance at being an early entrant, but it can also use experience gained through custom-ers’ reactions to its technology to quickly introduce a refined version of its technol-ogy that achieves a closer fit with customer requirements. In essence, a firm with very fast development deployment processes should be able to take advantage of both first- and second-mover advantages. The research on new product development cycle time indicates that development time can be greatly shortened by using strategic alli-ances, cross-functional new product development teams, and parallel development processes. Chapter Eleven will deal specifically with how firms can ensure that their innovations are deployed rapidly to the market.parallel development processWhen multiple stages of the new product development process occur simultaneously. 1. A first mover may be able to build brand loyalty and a reputation for technological leadership, preemptively capture scarce resources, and exploit buyer switching costs. 2. First movers may also benefit from increasing returns to adoption due to learning curve effects and network externalities.Summary of ChapterFinal PDF to printer
sch87956_ch05_095-112.indd 109 11/14/18 04:56 PMChapter 5 Timing of Entry 109 3. Some studies, however, argue that first movers may have higher failure rates. First movers have to bear the brunt of R&D expenses and may face considerable con-sumer ambiguity. Second movers can capitalize on the R&D and marketing efforts of the first mover, producing a technology that costs less to develop and that cor-rects for any of the first mover’s mistakes. 4. First movers may also face poorly developed supplier markets, distribution chan-nels, and availability of complementary goods, all of which can increase the challenge of successfully launching their new product or service. Enabling tech-nologies may also be immature, hindering the new technology’s performance. 5. The biggest disadvantage many first movers face is uncertainty over customer requirements. Customers themselves may be uncertain about what features or form they desire in a new innovation. A firm may have to withstand significant losses before customer preferences become more certain. 6. The optimal timing of entry is thus a function of several factors, including the margin of advantage offered by the new innovation, the state of enabling technolo-gies and complements, the state of customer expectations, the threat of competi-tive entry, whether the industry faces increasing returns, and a firm’s resources. 7. Firms that have fast-cycle development processes have more options when it comes to timing. Not only does a fast-cycle developer have an advantage in intro-ducing innovations earlier, but it also can be its own fast follower by quickly intro-ducing refined versions of its own technology. 1. What are some advantages of entering a market early? Are there any advantages to entering a market late? 2. Name a successful (a) first mover, (b) early follower, and (c) late entrant. Identify unsuccessful examples of each. 3. What factors might make some industries harder to pioneer than others? Are there industries in which there is no penalty for late entry?Discussion QuestionsClassicsDavid, P. A., “Clio and the economics of QWERTY,” American Economic Review 75 (1985), pp. 332–38.Lieberman, M. B., and D. B. Montgomery, “First-mover (dis)advantages: Retro-spective and link with the resource-based view,” Strategic Management Journal 19 (1998):1111–25.Katila, R., and E. L. Chen, “Effects of Search Timing on Innovation: The Value of Not Being in Sync with Rivals,” Administrative Science Quarterly 53 (2008):593–625.Tellis, G. J., and P. N. Golder, “First to Market, First to Fail? Real Causes of Enduring Market Leadership,” Sloan Management Review 37, no. 2 (1996), pp. 65–75.Recent WorkArgyres, N., L. Bigelow, and J. A. Nickerson, “Dominant Designs, Innovation Shocks and the Follower’s Dilemma,” Strategic Management Journal 36 (2015), pp. 216–234.Suggested Further ReadingFinal PDF to printer
sch87956_ch05_095-112.indd 110 11/14/18 04:56 PM110 Part One Industry Dynamics of Technological InnovationDiMasi, J. A., and L. B. Faden, “Competitiveness in follow-on drug R&D: A race or imitation?” Nature Reviews Drug Discovery 10 (2011), pp. 23–27.Kim, B., E. Kim, D. J. Miller, and J. T. Mahoney, “The Impact of the Timing of Patents on Innovation Performance,” Research Policy 45 (2016):914–28.Klingebiel, R., and J. Joseph, “Entry Timing and Innovation Strategy in Feature Phones,” Strategic Management Journal 37 (2015):1002–20.Suarez, F. F., S. Grodal, S., and A. Gotsopoulos, “Perfect timing? Dominant category, dominant design, and the window of opportunity for firm entry,” Strategic Manage-ment Journal 36 (2015), pp. 437–448. 1. R. Agarwal, “Technological Activity and Survival of Firms,” Economics Letters 52 (July 1996), pp. 101–8; R. Agarwal, “Survival of Firms over the Product Life Cycle,” Southern Eco-nomic Journal 63, no. 3 (1997), pp. 571–84; and R. Agarwal and G. Michael, “The Evolution of Markets and Entry, Exit, and Survival of Firms,” Review of Economics and Statistics 78 (November 1996), pp. 489–98. 2. P. Golder and G. Tellis, “Pioneer Advantage: Marketing Logic or Marketing Legend?” Journal of Marketing Research 30 (May 1993), pp. 158–70. 3. W. Robinson and M. Sungwook, “Is the First to Market the First to Fail? Empirical Evidence for Industrial Goods Businesses,” Journal of Marketing Research 39 (2002), pp. 120–28. 4. M. Lieberman and D. Montgomery, “First Mover Advantages: A Survey,” Strategic Manage-ment Journal 9 (1988), pp. 41–58. 5. Ibid.; and M. Spence, “The Learning Curve and Competition,” Bell Journal of Economics 12 (1981), pp. 49–70. 6. Diamond, “The Curse of QWERTY,” Discover 18, no. 4 (1997), pp. 34–42. 7. P. A. David, “Clio and the Economics of QWERTY,” American Economic Review 75 (1985), pp. 332–38. 8. Diamond, “The Curse of QWERTY.” 9. C. Ferguson and C. Morris, Computer Wars (New York: Random House, 1993). 10. P. N. Golder and G. Tellis, “Pioneer Advantage: Marketing Logic or Marketing Legend,” Jour-nal of Marketing Research 20 (1993), pp. 158–70. 11. G. Tellis and P. Golder, “First to Market, First to Fail? Real Causes of Enduring Market Leader-ship,” Sloan Management Review, Winter 1996, pp. 65–75. 12. Procter & Gamble Annual Report, 1977. 13. W. Boulding and M. Christen, “First-Mover Disadvantage,” Harvard Business Review, October 2001. 14. M. Lieberman and D. Montgomery, “First Mover Advantages: A Survey,” Strategic Manage-ment Journal 9 (1988), pp. 41–58. 15. Boulding and Christen, “First-Mover Disadvantage.” 16. E. I. Schwartz, “The Inventor’s Play-Ground,” Technology Review 105, no. 8 (2002), p. 69. 17. B. Kim, E. Kim, D. J. Miller, and J. T. Mahoney, “The Impact of the Timing of Patents on Inno-vation Performance,” Research Policy, 45 (2016), pp. 914–928. 18. A counterargument to this is made in S. Min, M. U. Kalwani, and W. T. Ronson, “Market Pio-neer and Early Follower Survival Risks: A Contingency Analysis of Really New versus Incre-mentally New Product Markets,” Journal of Marketing 70, no. 1 (2006), pp. 15–33.EndnotesFinal PDF to printer
sch87956_ch05_095-112.indd 111 11/14/18 04:56 PMChapter 5 Timing of Entry 111 19. G. L. Lilien and E. Yoon, “The Timing of Competitive Market Entry: An Exploratory Study of New Industrial Products,” Management Science 36 (1990), pp. 568–85; R. Makadok, “Can First-Mover and Early-Mover Advantages Be Sustained in an Industry with Low Barriers to Entry/Imitation?” Strategic Management Journal 19 (1998), pp. 683–96; and R. W. Shaw and S. A. Shaw, “Late Entry, Market Shares and Competitive Survival: The Case of Synthetic Fibers,” Managerial and Decision Economics 5 (1984), pp. 72–79. 20. W. B. Arthur, “Competing Technologies, Increasing Returns, and Lock-In by Historical Events,” The Economic Journal, March 1989, pp. 116–31; and M. Schilling, “Technological Lock Out: An Integrative Model of the Economic and Strategic Factors Driving Technology Success and Failure,” Academy of Management Review 23 (1998), pp. 267–84. 21. J. Shamsie, C. Phelps, and J. Kuperman, “Better Late than Never: A Study of Late Entrants in Household Electrical Equipment,” Strategic Management Journal 25 (2003), pp. 69–84. 22. D. A. Aaker and G. S. Day, “The Perils of High-Growth Markets,” Strategic Management Journal 7 (1986), pp. 409–21; Shamsie, Phelps, and Kuperman, “Better Late than Never;” V.  Shankar, G. S. Carpenter, and L. Krishnamurthi, “Late Mover Advantage: How Innovative Late Entrants Outsell Pioneers,” Journal of Marketing Research 35, no. 1 (1998), pp. 54–70; and G. L. Urban, T. Carter, S. Gaskin, and Z. Mucha, “Market Share Rewards to Pioneering Brands: An Empirical Analysis and Strategic Implications,” Management Science 32 (1986), pp. 645–59. 23. M. A. Schilling, “Technological Leapfrogging: Lessons from the U.S. Video Game Console Industry,” California Management Review 45, no. 3 (2003), pp. 6–32. 24. D. A. Shepherd and M. Shanley, New Venture Strategy: Timing, Environmental Uncertainty and Performance (London: Sage, 1998). 25. Schilling, “Technological Leapfrogging.”Final PDF to printer
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sch87956_ch06_113-140.indd 113 11/10/18 07:50 AMPart TwoFormulating Technological Innovation StrategyIn this section, we will cover the key aspects of formulating a technological inno-vation strategy, including: ∙ Assessing the firm’s position and defining its strategic direction. ∙ Choosing innovation projects in which to invest, including both quantitative and qualitative valuation techniques. ∙ Deciding whether and how the firm will collaborate on development activities, choosing a collaboration mode, and choosing and monitoring partners. ∙ Crafting a strategy for protecting—or diffusing—a technological innovation through such methods as patents, trademarks, copyrights, and trade secrets.Final PDF to printer
sch87956_ch06_113-140.indd 114 11/10/18 07:50 AMPart 1: Industry Dynamics ofTechnological InnovationPart 2: Formulating TechnologicalInnovation StrategyPart 3: Implementing TechnologicalInnovation StrategyChapter 2Sources ofInnovationChapter 3Types and Patternsof InnovationChapter 4Standards Battles,Modularity, andPlatform CompetitionChapter 5Timing of EntryChapter 7Choosing InnovationProjectsChapter 10Organizing forInnovationChapter 11Managing the NewProduct DevelopmentProcessChapter 12Managing NewProduct Development TeamsChapter 13Crafting aDeploymentStrategyChapter 8CollaborationStrategiesChapter 6Defining the Organization’sStrategic DirectionChapter 9Protecting InnovationFeedbackFormulating Technological Innovation StrategyFinal PDF to printer
115sch87956_ch06_113-140.indd 115 11/10/18 07:50 AMChapter SixDefining the Organization’s Strategic DirectionTesla, Inc. in 2018In 2018, Tesla was one of the most talked about companies in the world. What started as an unlikely and risky venture to produce an all-electric luxury sports car had grown into a company with almost $12 billion in annual revenues that produced multiple car models, owned Solar City (a solar panel leasing company), and produced energy storage systems (e.g., Powerwall) and solar roofs (see Figure 1 below). Though it was not yet posting profits, it had a market capitaliza-tion of more than $47 billion.In 2017, Tesla delivered 103,020 cars (see Figure 2 below), a 35 percent rise over its 2016 figures. In the first quarter of 2018, Tesla delivered 29,980 cars, of which almost one-third were its newest model, the Model 3. The company also had a growing waiting list for all three cars, highlighting both a strength and a weak-ness of the company: people were enthusiastic about the cars and demand was high, but Tesla was having trouble ramping up production to meet that demand.Some of the production capacity for Model S and Model X had been reallo-cated to production of the new Model 3 and getting the new model’s production up and running had been rougher than expected. The company’s CEO, Elon Musk, had forecasted producing 5000 Model 3 cars a week by the end of the first quarter of 2018, but instead production was closer to 1000 cars a week by the end of the first quarter, triggering an onslaught of criticism by analysts.To make matters worse, the company’s rapid expansion of production capacity meant that it would likely require additional capital within the year, causing stock-holders to worry about dilution of their shares. Tesla had made bold moves and impressive progress, but there were lingering concerns over its viability. Would it be able to turn a sustainable profit on its auto-making operations? In the niche market of luxury automobiles for the “eco-wealthy,” it had a privileged position with customers that were relatively price-insensitive and were seeking a stylish, high performance car that made an environmental statement. To compete for the Final PDF to printer
sch87956_ch06_113-140.indd 116 11/10/18 07:50 AM116 Part Two Formulating Technological Innovation Strategymass market, the car would have to compete on value and efficiency with larger, more established rivals.History of TeslaIn the year 2003, an engineer named Martin Eberhard was looking for his next big project. A tall, slim man with a mop of gray hair, Eberhard was a serial entrepreneur who had launched a number of start-ups, including a company called NuvoMedia, which he sold to Gemstar in a $187 million deal. Eberhard was also looking for a sports car that would be environmentally friendly—he had concerns about global warming and U.S. dependence on the Middle East for oil. When he didn’t find the car of his dreams on the market he began contemplating building one himself, FIGURE 1Source: Tesla 2018 10K.2017 Select Items from Income Statement(figures in $US thousands)Automotive Sales8,534,752Automotive Leasing1,106,548Total Automotive Revenues9,641,300Energy Generation and Storage1,001,185Services and Other1,116,266Total Revenues11,758,751Cost of Revenue9,536,264Gross Profit2,222,487R&D Expense1,278,073Sales, General and Admin.2,476,500Operating Income(1,632,086)FIGURE 2Tesla Deliveries in 2017 and 2018Model SModel XModel 3Total2017Q113,45011,55025,000Q212,00010,00022,000Q314,06511,86522026,150Q415,20013,120155029,870Total54,71546,5351770103,0202018Q111,73010,070818029,980Final PDF to printer
sch87956_ch06_113-140.indd 117 11/10/18 07:50 AMChapter 6 Defining the Organization’s Strategic Direction 117even though he had zero experience in the auto industry. Eberhard noticed that many of the driveways that had a Toyota Prius hybrid electric vehicle (or “dork mobile” as he called it) also had expensive sports cars in them—making Eberhard speculate that there could be a market for a high performance environmentally friendly car. As explained by Eberhard, “It was clear that people weren’t buying a Prius to save money on gas—gas was selling close to inflation–adjusted all-time lows. They were buying them to make a statement about the environment.”aEberhard began to consider a range of alternative fuel options for his car: hydrogen fuel cells, natural gas, diesel. However, he soon concluded the highest efficiency and performance would come from a pure electric vehicle. Luckily for Eberhard, Al Cocconi (founder of AC Propulsion and one of the original engineers for GM’s ill-fated EV-1) had concluded the same thing and had produced a car called the tzero. The tzero could go from 0 to 60 miles per hour in 4.1 seconds, but it was powered with extremely heavy lead-acid batteries, limiting its range to about 60 miles between charges. Eberhard approached Cocconi with the idea of using the lighter lithium-ion batteries, which offered six times more energy per pound. Cocconi was eager to try out the idea (he had, in fact, been experi-menting with lithium-ion batteries himself), and the resulting lithium-ion based tzero accelerated to 60 miles per hour in 3.6 seconds, and could travel more than 300 miles. Eberhard licensed the electric-drive-train technology from AC Propulsion, and founded his company, Tesla Motors (named after Nikola Tesla, a late 19th century and early 20th century inventor who developed, among other things, the AC electrical systems used in the United States today).bMeanwhile, there was another entrepreneur—one with much deeper pockets—also interested in developing electric vehicles based on the tzero: Elon Musk. In 2002, Elon Musk was a 31-year-old South African living in California, who had founded a company that ultimately became PayPal. After selling PayPal to eBay in 2002 for $1.5 billion, he started a company called SpaceX with the ambitious goal of developing cheap, consumer space travel. (SpaceX’s Dragon space-craft ultimately made history in May of 2012 by becoming the first commer-cial vehicle to launch and dock at the International Space Station.c) Musk’s assertive style, and his astonishing record of high-tech entrepreneurship, made him one of the inspirations for the portrayal of Tony Stark character in Jon Favreau’s Iron Man movies.Like Eberhard, Musk thought electric cars were the key to the United States achieving energy independence, and he approached Cocconi about buying the tzero. Tom Gage, who was then AC Propulsion’s CEO, suggested that Musk col-laborated with Eberhard. After a two-hour meeting in February of 2004, Musk agreed to fund Eberhard’s plan with $6.3 million. He would be the company’s chairman and Eberhard would serve as CEO.The RoadsterThe first Tesla prototype, named the Roadster, was based on the $45,000 Lotus Elise, a fast and light sports car that seemed perfect for the creation of Eberhard and Musk’s grand idea (see Figure 3A). The car would have 400 volts of electric potential, liquid-cooled lithium-ion batteries, and a series of silicon transistors Final PDF to printer
sch87956_ch06_113-140.indd 118 11/10/18 07:50 AM118 Part Two Formulating Technological Innovation Strategythat would give the car acceleration so powerful the driver would be pressed back against their seat.d It would be about as fast as a Porsche 911 Turbo, would not create a single emission, and would get about 220 miles on a single charge from the kind of outlet you would use to power a washing machine.eAfter a series of clashes between Musk and Eberhard that led to delays in launching the Roadster, Eberhard was pushed out of the company. The Road-ster missed its deadline for beginning production at the Lotus facility, triggering a penalty built into the manufacturing contract Eberhard had signed with Lotus: a $4 million fee. However, when the car finally launched in 2008, the enthusiastic response it received was astonishing—it boasted an all-star list of celebrities with reservations to buy, and everywhere the Roadster drove, people stopped to stare.fThe Model SMusk’s ambitions did not stop at a niche high-end car. He wanted to build a major U.S. auto company—a feat that had not been successfully accomplished since the 1920s. To do so, he knew he needed to introduce a less expensive car that could attract a higher volume of sales, if not quite the mass market. In June of 2008, Tesla announced the Model S, a high performance all-electric sedan that would sell for a price ranging from $57,400 to $77,400, and compete against cars like the BMW 5 Series (see Figure 3B). The car would have an all-aluminium body and a range of up to 300 miles per charge.g Estimates suggested that the Model S cost $500 million to develop, however offsetting that cost was a $465 million loan Tesla received from the U.S. government to build the car, as part of the U.S. government’s initiative to promote the development of technologies that would help the United States to achieve energy independence.hBy May of 2012, Tesla reported that it already had 10,000 reservations for cus-tomers hoping to buy the Model S, and Musk confidently claimed the company would soon be producing, and selling, 20,000 Model S cars a year. Musk also noted that after ramping up production, he expected to see “at least 10,000 units a year from demand in Europe and at least 5000 in Asia.”i The production of the Model S went more smoothly than that of the Roadster, and by June of 2012 the first Model S cars were rolling off the factory floor. The very first went to Jeff Skoll, eBay’s first pres-ident, and a major investor in Tesla. On the day of the launch, Skoll talked with Musk about whether it was harder to build a rocket or a car (referring to Musk’s SpaceX company): “We decided it was a car. There isn’t a lot of competition in space.”jTo build the car, Tesla bought a recently closed automobile factory in Fre-mont California that had been used for the New United Motor Manufacturing Inc. (NUMMI) venture between Toyota and General Motors. The factory, which was capable of producing 1000 cars a week, was far bigger than Tesla’s immediate needs and would give the company room to grow. Furthermore, though the plant and the land it was on had been appraised at around $1 billion before NUMMI was shut down, Tesla was able to snap up the idled factory for $42 million.k Tesla also used the factory to produce battery packs for Toyota’s RAV4, and a char-ger for a subcompact Daimler AG electric vehicle. These projects supplemented Tesla’s income while also helping it to build scale and learning-curve efficiencies in its technologies.Final PDF to printer
sch87956_ch06_113-140.indd 119 11/10/18 07:50 AMChapter 6 Defining the Organization’s Strategic Direction 119In the first quarter of 2013, Tesla announced its first quarterly profit. The com-pany had taken in $562 million in revenues, and reported an $11.2 million profit. Then more good news came: the Model S had earned Consumer Reports’ high-est rating, and had outsold similarly priced BMW and Mercedes models in the first quarter.l In May of 2013, the company raised $1 billion by issuing new shares, and then surprised investors by announcing that it had paid back its government loan. After repaying the loan, Tesla had about $679 million in cash. Musk had announced confidently that he felt it was his obligation to pay back taxpayer money as soon as possible, and that the company had sufficient funds now to develop its next generation of automobiles without the loan, and without issuing further shares.mFIGURE 3BTesla Model S©Melissa SchillingFIGURE 3ATesla Roadster©Ian GiblinFIGURE 3CTesla Model X©Melissa SchillingFIGURE 3DTesla Model 3©Melissa SchillingFinal PDF to printer
sch87956_ch06_113-140.indd 120 11/10/18 07:50 AM120 Part Two Formulating Technological Innovation StrategyModel XThe Model X, unveiled in 2015, was designed as a high-end sport utility vehicle (SUV) that seats seven. It had several distinctive features that set it apart from the crowded luxury SUV market (Figure 3C). In addition to being all-electric and able to go from 0 to 60 miles per hour in just 3.2 seconds, it featured a pan-oramic windshield and distinctive gull wing doors (that open upward rather than swinging out) that open automatically in response to the driver’s approach. “It will triangulate my position,” Musk said, “It will open the front door without touching. When you sit down, it will close the door.”n The Model X had a range of about 250 miles (like the Model S) but could tow 5000 pounds. Its selling price would start at $70,000 but could exceed $100,000 depending on the options selected.In the United States, the mid-size luxury SUV market was about five times the size of the high-end luxury sedan market, and the Model X rapidly attracted a long waiting list of people who placed deposits for the car. Musk projected a fast produc-tion ramp up, with goals of producing 85,000 to 90,000 Model X and S vehicles in 2017. Analysts at the time doubted that production could be ramped up so quickly, but despite several supplier parts shortages, Tesla’s estimates ended up being very close to the mark: The company produced a total of 83,922 cars in 2017.oReviews of the car were mixed. Consumer Reports found the car disappoint-ing, citing rear doors that were prone to pausing, the car’s limited cargo capacity, and a ride that was “too firm and choppy for a $110,000 car.”p Car and Driver’s review also expressed some doubts about the wing doors, but gave the car overall a rating of five out of five stars, stating, “There are no other electric SUVs at the moment. And even against fossil-fuel-fed SUVs, the Tesla’s effortless per-formance and efficiency can’t be matched.”qBy the end of 2016, the Model X had accumulated total sales of 25,524, rank-ing it seventh among the best-selling plug-in cars in the world (notably, cumu-lative sales of Tesla Model S reached 158,159 by the end of 2016, making it the second best-selling plug-in car in the world, behind only the Nissan Leaf).r By the end of 2017, cumulative sales of the Model X reached approximately 72,059 units.sModel 3To achieve Musk’s goal of making a real dent in fossil fuel use, Tesla needed a truly mass-market car. Thus, in the fall of 2016, he announced the Model 3, a mid-size all-electric four-door sedan with a range of 220 to 310 miles (depend-ing on the battery option), and a base price of $35,000 (see Figure 3D). Within a week, Tesla had received 325,000 reservations for the car, ranking it among the most sought-after cars in the world. A review in Road and Track said that the “Model 3 proves that Tesla is thinking far beyond the edges of the Model S and X. Stepping out of the 3, you realize that, as far as the S and X pushed the envelope, they were always meant as intermediaries, stepping stones designed to draw people away from comfortable convention and into the future of the automobile.”t Popular Mechanics gave the car its 2018 Car of the Year award, and Automobile Magazine gave it the 2018 Design of the Year Award.Final PDF to printer
sch87956_ch06_113-140.indd 121 11/10/18 07:50 AMChapter 6 Defining the Organization’s Strategic Direction 121The company announced an extremely ambitious production ramp up plan, with a goal of being able to produce 500,000 total units (across all three mod-els) by the end of 2018. This would require a massive expansion in production capacity that many experts viewed as unattainable in such a short time frame. The Model 3 would also incorporate new hardware and software to enable auto-mated driving that created significant new design and production challenges. By early 2018, it was clear that Model 3 production was well behind Musk’s initial ambitious projections, and criticism from analysts and the press were coming at a furious pace. As one analyst at Cowen and Co noted, “Tesla needs to slow down and more narrowly focus its vision and come up for a breath of fresh air. . . . Elon Musk needs to stop over promising and under delivering.”uOther ProjectsIn 2016, Tesla opened Gigafactory 1—a giant lithium-ion battery factory built near Reno, Nevada with its partner Panasonic. Musk justified the vertical inte-gration move by arguing that the Gigafactory 1 would ultimately drive battery production costs down by as much as 30 percent. In addition to producing bat-teries for Tesla automobiles, the factory would build Powerwall and Powerpack energy storage devices. The Powerwall was a device for consumers to store solar energy at home. The Powerpack enabled industrial users to manage vari-able energy needs and provided a source for backup power.In August of 2016, Tesla also finalized a plan to acquire SolarCity, a company that leases and installs solar panels, for $2.6 billion. Solar City was founded in 2006 by Peter and Lyndon Rive, Elon Musk’s cousins. Musk had sketched out the concept for the company around the time of Tesla’s founding and had helped his cousins start the company. He also served as its Chairman of the Board. The company had an innovative business model that enabled consumers to have solar panels installed on their roofs with no upfront costs, and to pay instead for the power generated by the panels at a price that was comparable to or less than the price they would normally pay for electricity.In the same month that the Solar City acquisition plan was finalized, Elon Musk announced that the company would begin producing house roofs made entirely from solar panels. “I think this is a really fundamental part of achieving differenti-ated product strategy, where you have a beautiful roof,” Musk said. “It’s not a thing on the roof. It is the roof.”v By early 2018, Tesla had also built a new Giga-factory 2 in Buffalo, New York and reported that manufacture of solar roofs was already underway.Tesla’s FutureTesla’s cars had rapidly attracted a large and loyal fan base, and sales were growing at an impressive rate. However, designing and launching multiple major car platforms while building a large-scale battery company, a network of charg-ing stations, and operating Solar City was a lot for a company to take on in its first fifteen years. This left some analysts scratching their heads. Was Tesla trying to do too much too quickly?Final PDF to printer
sch87956_ch06_113-140.indd 122 11/10/18 07:50 AM122 Part Two Formulating Technological Innovation StrategyDiscussion Questions 1. What were Musk’s and Eberhard’s goals in founding Tesla? 2. How would you characterize competition in the auto industry? 3. What do you think are Tesla’s core competencies? Does it have any sources of sustainable competitive advantage? 4. What is your assessment of Tesla’s moves into (a) mass-market cars, (b) batteries (car batteries and Powerwall), (c) solar panels? Please consider both the motivation for the moves, and the opportunities and challenges for Tesla to compete in these businesses. 5. Do you think Tesla will be profitable in all of these businesses? Why or why not? 6. What do you think Tesla’s (or Elon Musk’s) strategic intent is? a Copeland, M. V., Tesla’s Wild Ride. Fortune, 158, no. 2 (2008):82–94. b Ibid. c Boudreau, J. In a Silicon Valley Milestone, Tesla Motors Begins Delivering Model S Electric Cars. Oakland Tribune (June 24, 2012), Breaking News Section. d Copeland, M. V., Tesla’s Wild Ride. Fortune, 158, no. 2 (2008):82–94. e Williams, A. Taking a Tesla for a Status Check in New York. New York Times (July 19, 2009):ST.7. f Ibid. g Ramsey, M., Tesla Sets 300-Mile Range for Second Electric Car. Wall Street Journal (Online) (March 7, 2011). h Overly, S. This Government Loan Program Helped Tesla at a Critical Time. Trump Wants to Cut It. Wash-ington Post, March 16, 2017. i Sweet, C., Tesla Posts Its First Quarterly Profit. Wall Street Journal (Online) (May 9, 2013). j Boudreau, J. In a Silicon Valley Milestone, Tesla Motors Begins Delivering Model S Electric Cars. Oakland Tribune (June 24, 2012), Breaking News Section. k Anonymous. Idle Fremont Plant Gears Up for Tesla. Wall Street Journal (Online) (October 20, 2010). l Levi, M. How Tesla Pulled Ahead of the Electric-Car Pack. Wall Street Journal (June 21, 2013):A.11. m White, J. B., Corporate News: Electric Car Startup Tesla Repays U.S. Loan. Wall Street Journal (May 23, 2013):B.3. n Hirsch, J., and R. Mitchell, Model X: Under the Hood of Tesla’s SUV Strategy. Los Angeles Times September 29th, 2015. o Tesla Q4 Production and Delivery Report (January 3, 2016). p Tesla Model X Review: Fast and Flawed. Consumer Reports (2016). q Tesla Model S. Car and Driver (May, 2016). r Cobb, J., Tesla Model S Is world’s Best-Selling Plug-in Car for Second Year in a Row. HybridCars (January 26, 2017). s Estimate based on Tesla quarterly production and delivery reports for quarter 1-4 in 2017. In some years Tesla only provides rounded numbers for breakdown between Model X and Model S, thus only an approximate number can be given here. t Sorokanich, B., Tesla Model 3: The Road & Track Review. Road and Track (January 12, 2018). u Panchadar, A., Tesla Must Stop Overpromising, Could Need More Finance: Analysts. Reuters Business News (November 2, 2017). v Milman, O., Elon Musk Leads Tesla Effort to Build House Roofs Entirely Out of Solar Panels. The Guardian (August 19, 2016).Final PDF to printer
sch87956_ch06_113-140.indd 123 11/10/18 07:50 AMChapter 6 Defining the Organization’s Strategic Direction 123OVERVIEWThe first step in formulating a company’s technological innovation strategy is to assess its current position and define its strategic direction for the future. This chapter reviews some of the basic tools used in strategic analysis to assess the firm’s current position and help chart its direction for the future. These tools help the manager answer such questions as: ∙ What threats and opportunities are most pressing in the firm’s environment? ∙ What are the firm’s key strengths and weaknesses? ∙ Does the firm have any sources of sustainable competitive advantage? ∙ What are the firm’s core competencies, and what kind of value propositions do those core competencies offer to customers? How do managers want those value propositions to evolve? ∙ What key resources and capabilities does the firm need to develop or acquire to meet its long-term objectives?The outputs of the analytical tools in this chapter are crucial inputs for the tools used in Chapter Seven, Choosing Innovation Projects. A coherent technological innovation strat-egy both leverages and enhances the firm’s existing competitive position, and it provides direction for the future development of the firm. Formulating a technological innovation strategy first requires an accurate appraisal of where the firm currently is. It then requires articulating an ambitious strategic intent—one that creates a gap between a company’s existing resources and capabilities and those required to achieve its intent.1 The ability of the firm to cohesively leverage all its resources around a unified vision can enable it to create a competitive advantage that is very difficult for competitors to imitate.2ASSESSING THE FIRM’S CURRENT POSITIONTo assess the firm’s current position in the marketplace, it is useful to begin with some standard tools of strategic analysis for analyzing the external and internal environment of the firm.External AnalysisThe two most commonly used tools for analyzing the external environment of the firm include Porter’s five-force model and stakeholder analysis.Porter’s Five-Force ModelIn this model, the attractiveness of an industry and a firm’s opportunities and threats are identified by analyzing five forces (see Figure 6.1).3While the five-force model was originally developed to assess industry attractive-ness (i.e., “Is this a desirable industry in which to compete?”), in practice the model is often used to assess a specific firm’s external environment (i.e., “What factors in the firm’s external environment create threats and opportunities for the firm?”). The dif-ference between these two approaches is subtle but important. In the former approach, Final PDF to printer
sch87956_ch06_113-140.indd 124 11/10/18 07:50 AM124 Part Two Formulating Technological Innovation Strategythe analysis focuses on the industry level, treating all competitors as roughly the same, and its objective is to ascertain whether the industry as a whole will tend to be prof-itable. In the latter approach, the analysis may take the perspective of a particular firm, often identifying ways in which the external forces differentially affect the firm vis-à-vis its competitors, and its objective is to identify threats and opportunities for the firm.4 For example, an external analysis of the discount retailing industry that is focused only on industry attractiveness might conclude that the industry is relatively unattractive given high price competition and limited opportunities to differentiate. An external analysis of the discount retailing industry focused on Walmart, on the other hand, might conclude that while the industry is a difficult one in which to be profit-able, Walmart is likely to be more profitable than its competitors because its scale, its use of advanced technology for inbound and outbound logistics, and its location strategies give it considerable bargaining power over both suppliers and buyers. The latter approach will be emphasized here because it better suits our purpose of helping a particular firm to chart its strategic direction.The five forces are: 1. The degree of existing rivalry. An industry’s degree of rivalry is influenced by a number of factors. First, the number and relative size of competitors will shape the nature of rivalry. In general, the more firms competing that are of comparable size, the more competitive the industry will be. There are, however, exceptions to this generality. For example, oligopolistic industries (those that have a few large competitors) can be fiercely competitive if firms choose to engage in price wars (as happened in the personal digital assistant industry). On the other hand, oli-gopolistic industries can have a low degree of rivalry if the competitors choose to avoid competing head-to-head in the same market segments, or if they engage in oligopolistic industriesHighly consoli-dated industries with a few large competitors.FIGURE 6.1Porter’s Five-Force ModelSource: Michael Porter, Competitive Strategy: Techniques for Analyzing Indus-tries and Competitors.Threat ofSubstitutesThreat ofPotentialEntrantsBargainingPowerof SuppliersBargainingPower ofBuyersDegree ofExistingRivalryFinal PDF to printer
sch87956_ch06_113-140.indd 125 11/10/18 07:50 AMChapter 6 Defining the Organization’s Strategic Direction 125tacit price collusion. Rivalry is also influenced by the degree to which competitors are differentiated from each other. For example, if competitors are highly differen-tiated, they will experience less direct rivalry because their products are likely to appeal to different market segments. For example, even though Genzyme operated in the extremely competitive biotech industry, its unique focus on orphan drugs meant that it typically was not competing head-on with other rivals for its cus-tomers. This enabled it to charge much higher margins on its products. Demand conditions also influence degree of rivalry. When demand is increasing, there are more revenues to go around and firms will experience less competitive pressure. On the other hand, when demand is declining, firms have to compete for a shrink-ing pool of revenues, and competition can become very aggressive. In declining industries, high exit barriers (fixed capital investments, emotional attachment to the industry, etc.) can also intensify rivalry by making firms reluctant to abandon the industry. 2. Threat of potential entrants. The threat of potential entrants is influenced by both the degree to which the industry is likely to attract new entrants (e.g., is it profitable, growing, or otherwise alluring?) and the height of entry barriers. Entry barriers can include such factors as large start-up costs, brand loyalty, dif-ficulty in gaining access to suppliers or distributors, government regulation, threat of retaliation by existing competitors, and many others. While profitability and growth may attract new entrants, entry barriers will deter them. For example, while high projected growth in the smart phone market attracts potential entrants to this market, the challenge of competing against large, well-established, and effi-cient competitors such as Nokia and Ericsson deters many entrants. To effectively compete against these companies requires that an entrant be able to manufacture, advertise, and distribute on a large scale, suggesting significant start-up costs for an entrant to achieve a competitive position. However, some of these capabilities could be obtained through partnerships with other firms, such as having contract manufacturers handle production and having mobile phone service providers han-dle distribution, thereby lowering start-up costs. 3. Bargaining power of suppliers. The degree to which the firm relies on one or a few suppliers will influence its ability to negotiate good terms. If there are few suppliers or suppliers are highly differentiated, the firm may have little choice in its buying decision, and thus have little leverage over the supplier to negotiate prices, delivery schedules, or other terms. On the other hand, if suppliers are very abundant and/or are not highly differentiated, the firm may be able to force the suppliers to bid against one another for the sale. The amount the firm purchases from the supplier is also relevant. If the firm’s purchases constitute the bulk of a supplier’s sales, the supplier will be heavily reliant upon the firm and the supplier will have little bargaining power. Likewise, if the supplier’s sales constitute a large portion of the firm’s purchases, the firm will be heavily reliant upon the supplier and the supplier will have more bargaining power. For example, manufacturers that sell to Walmart often have little bargaining power because Walmart’s enor-mous volume often makes its purchases a significant portion of a manufacturer’s yearly sales. Walmart’s suppliers typically have little bargaining power. When Intel sells to personal computer manufacturers, on the other hand, it typically wields exit barriersCosts or other commitments that make it dif-ficult for firms to abandon an industry (large fixed-asset investments, emotional com-mitment to the industry, etc.).entry barriersConditions that make it difficult or expensive for new firms to enter an industry (government regulation, large start-up costs, etc.).Final PDF to printer
sch87956_ch06_113-140.indd 126 11/10/18 07:50 AM126 Part Two Formulating Technological Innovation Strategyconsiderable supplier bargaining power. When computer manufacturers consider potential suppliers for microprocessors, they often have little choice but to go with Intel—many consumers demand that their systems include Intel microprocessors, and the majority of personal computer hardware and software has been optimized for the Intel architecture. If the firm faces switching costs that make it difficult or expensive to change suppliers, this will also increase the supplier’s bargaining power. Finally, if the firm can backward vertically integrate (i.e., produce its own supplies), this will lessen supplier bargaining power, and if the supplier can threaten to forward vertically integrate into the firm’s business, this will increase the supplier’s bargaining power. 4. Bargaining power of buyers. Many of the same factors that influence the bar-gaining power of suppliers have an analogous role with the bargaining power of buyers. The degree to which the firm is reliant on a few customers will increase the customer’s bargaining power, and vice versa. If the firm’s product is highly differentiated, buyers will typically experience less bargaining power, and if the firm’s product is undifferentiated, buyers will typically experience greater bar-gaining power. If buyers face switching costs, this is likely to lower their bar-gaining power, and if the firm faces switching costs to work with other buyers, this will increase the buyer’s bargaining power. Finally, if the buyers can threaten to backward vertically integrate, this will increase their bargaining power, and if the firm can threaten to forward vertically integrate, it will lower customer bargaining power. 5. Threat of substitutes. Substitutes are products or services that are not considered competitors, but fulfill a strategically equivalent role for the customer. For exam-ple, Starbucks may consider other coffeehouses as competitors, but other social destinations (such as bars or restaurants) or beverages (such as soft drinks or beer) as substitutes. The more potential substitutes there are, and the closer they are in function to the firm’s product or service, the greater the threat of substitution. Furthermore, the threat of substitutes will also be shaped by the relative price. For example, while traveling by bus versus air is not particularly comparable in terms of speed, traveling by bus is often considerably less expensive; thus, it poses a threat of substitution, particularly for shorter distances to be traveled. Note that distinguishing between a competitor and a substitute depends on how the industry is defined. For example, if one considers the airline industry as the unit of analy-sis, then bus service is a substitute for airlines. However, if one were considering the transportation industry as the unit of analysis, then bus services would be competitors of airlines.Recently, Porter has acknowledged the role of complements.5 As has been dis-cussed in several of the earlier chapters, complements are products that enhance the usefulness or desirability of a good. For example, software is an important complement for computers, and gasoline is an important complement for automobiles. The avail-ability, quality, and price of complements will influence the threats and opportunities posed by the industry. It is important to consider (1) how important complements are in the industry, (2) whether complements are differentially available for the products of various rivals (impacting the attractiveness of their goods), and (3) who captures the value offered by the complements. For example, desktop printer manufacturers such as vertical integrationGetting into the business of one’s suppliers (backward verti-cal integration) or one’s buyers (forward vertical integration). For example, a firm that begins producing its own supplies has practiced backward verti-cal integration, and a firm that buys its distribu-tor has practiced forward vertical integration.switching costsFactors that make it difficult or expensive to change suppliers or buyers, such as investments in specialized assets to work with a particular sup-plier or buyer.complementsProducts or services that enhance the usefulness or desirability of another product.Final PDF to printer
sch87956_ch06_113-140.indd 127 11/10/18 07:50 AMChapter 6 Defining the Organization’s Strategic Direction 127Hewlett Packard and Lexmark make a considerable portion of their desktop printing profits from the ink cartridges that consumers have to replace when empty. The printer manufacturers thus design the printer cartridges to be specific to each printer model, avoiding standardized designs that would facilitate consumers purchasing printer car-tridges from other vendors for their Hewlett Packard and Lexmark printers. The mar-ket for ink cartridges is so lucrative, however, that a number of third-party vendors have emerged that either clone Hewlett Packard and Lexmark cartridges or offer to refill the consumer’s empty cartridges with ink.Stakeholder AnalysisStakeholder models are often used for both strategic and normative purposes. A strategic stakeholder analysis emphasizes the stakeholder management issues that are likely to impact the firm’s financial performance, while a normative stakeholder analysis emphasizes the stakeholder management issues the firm ought to attend to due to their ethical or moral implications.6 Typically, the first step of a stakeholder analysis is to identify all the parties that will be affected by the behavior of the firm (and thus have a “stake” in the firm). For each party, the firm identifies what that stakeholder’s interests are, what resources they contribute to the organization, what claims they are likely to make on the organization, and which will be most important from the firm’s perspective. Stakeholders include (but are not limited to) stockholders, employees, customers, suppliers, lenders, the local community, government, and rivals (see Figure 6.2).Internal AnalysisThe analysis of the internal environment of the firm most often begins with identifying the firm’s strengths and weaknesses. Sometimes this task is organized by examining each of the activities of the value chain (see Figure 6.3).7 In Michael Porter’s model of a value chain, activities are divided into primary activities and support activities. stakeholderAny entity that has an interest (“stake”) in the organization.FIGURE 6.2Stakeholder AnalysisCustomersEmployeesStockholdersLendersLocalCommunityGovernmentSuppliersRivalsFirmFinal PDF to printer
sch87956_ch06_113-140.indd 128 11/10/18 07:50 AM128 Part Two Formulating Technological Innovation StrategyPrimary activities include inbound logistics (all activities required to receive, store, and disseminate inputs), operations (activities involved in the transformation of inputs into outputs), outbound logistics (activities required to collect, store, and distribute outputs), marketing and sales (activities to inform buyers about products and ser-vices and to induce their purchase), and service (after-sales activities required to keep the product or service working effectively). Support activities include procurement (the acquisition of inputs, but not their physical transfer, as that would be covered in inbound logistics), human resource management (activities such as recruiting, hiring, training, and compensating personnel), technology development (activities involved in developing and managing equipment, hardware, software, procedures, and knowl-edge necessary to transform inputs into outputs), and infrastructure (functions such as accounting, legal counsel, finance, planning, public affairs, government relations, quality assurance, and general management necessary to ensure smooth functioning of the firm). This generic model can be adapted to better fit a particular firm’s needs. For example, for a biotechnology firm or software developer, research and development is likely to be a primary activity and inbound logistics may be insignificant.Each activity can then be considered from the point of view of how it contributes to the overall value produced by the firm, and what the firm’s strengths and weaknesses are in that activity. For example, Figure 6.4 illustrates what a value-chain analysis might look like for Take-Two Interactive Software, which produces the Grand Theft Auto video game. In the figure, research and development is considered a primary activity, but the support activity of the technology development is not considered. Because all the game manufacturing is performed by the console producers rather than by Take-Two its primary technology activities center on design of the games, which is covered in the research and development section.FIGURE 6.3Porter’s Value ChainSource: Michael Porter, Competitive Advantage: Creating and Sustaining Superior Performance.Support ActivitiesPrimary ActivitiesServiceMarketingOutboundLogisticsOperationsInboundLogisticsFirmInfrastructureHumanResourceManagementTechnologyDevelopmentProcurementFinal PDF to printer
sch87956_ch06_113-140.indd 129 11/10/18 07:50 AMChapter 6 Defining the Organization’s Strategic Direction 129Value-Chain ActivityStrengthsWeaknessesInbound LogisticsInsignificant; few inputs necessary.Research & DevelopmentAbility to incorporate state-of-the-art graphics capabilities, sound, and innova-tive themes significantly differentiates the product in the eyes of the consumer.Take-Two game maximized the polygon processing potential of the video game console, making play more lifelike.Parallel development processes kept the development cycles short.Lack of experience in developing online games could become major liability if the market for playing games over the Internet takes off.OperationsCompany focuses on producing a few very high-quality games, introducing a new version every year. Once designed, games are manufactured by the video game console producers (e.g., Sony).Concentrating on a few games enables firm to focus significant resources on ensuring that the game is a hit.Concentrating on a few games could be risky—if a game fails, the company may have no revenues to support operations.Take-Two is completely reliant on console manufacturers for the right to develop compatible games and for manufacture of games.Outbound LogisticsProducts are sold through game retail-ers (e.g., Gamestop), general merchan-disers (e.g., Best Buy), and occasionally through bundling arrangements with video console producers, avoiding expense of maintaining the company’s own retail stores. On initial launch, Take-Two had signed an exclusive deal with Sony to offer Grand Theft Auto exclusively for PlayStation 2.Existing retailers already have excellent market penetration, providing rapid and wide deployment of the games.Since Sony PlayStation 2 was the No. 1 video game console, signing an exclusive with Sony enabled Take-Two to tap a large market.Using retailers gives company little discretion over store place-ment, promotion, and pricing.MarketingHelps build customer awareness of products, builds brand image, acceler-ates sales. Uses Web sites, advertise-ments in gaming magazines, billboards. Grand Theft Auto is targeted toward the adult market.GTA had successfully estab-lished an image as being lead-ing edge, and was the No. 1 game in 2002. In 2008, Grand Theft Auto: San Andreas made the “Top 20 console games of all times” list by selling 12 mil-lion copies.Some consumers, retailers, and regulatory agencies criticized Grand Theft Auto’s violence and sexual images, potentially tarnish-ing the company’s image.ServicePhone line for technical support helps customers resolve problems in using the product.Take-Two has had relatively few returns or warranty problems.FIGURE 6.4Example of Value-Chain Analysis for Take-Two Interactive SoftwarecontinuedFinal PDF to printer
sch87956_ch06_113-140.indd 130 11/10/18 07:50 AM130 Part Two Formulating Technological Innovation StrategyOnce the key strengths and weaknesses are identified, the firm can assess which strengths have the potential to be a source of sustainable competitive advantage. This helps the firm gain valuable perspective on which of its activities and resources should be further leveraged in its articulation of its strategic intent for the future.To be a potential source of sustainable competitive advantage, resources must be rare, valuable, durable, and inimitable.8 Resources that are rare and valuable may yield a competitive advantage, but that advantage will not be sustainable if the firm is incapable of keeping the resources, or if other firms are capable of imitating them. For example, a positive brand image can be a rare and valuable resource, but it requires ongoing investment to sustain. If a firm lacks the capital to reinvest in its brand image, it will erode. Furthermore, many valuable resources are quickly imi-tated by other firms. Technological advances are reverse-engineered, skillful mar-keting campaigns are copied, innovative human resource practices are adopted by imitators, and so on. Some resources, however, are not readily imitable. For exam-ple, if valuable resources are tacit (i.e., they cannot be readily codified in written form), path dependent (i.e., they are dependent on a particular historical sequence of events), socially complex (i.e., they arise through the complex interaction of mul-tiple people), or causally ambiguous (i.e., it is unclear how the resource gives rise to value), they will be extremely difficult to imitate.9 For example, talent is typically considered to be a tacit and causally ambiguous resource. It is thought to be an inher-ent trait that cannot be trained, and the mechanisms by which individuals acquire it or tap it are poorly understood. A first-mover advantage is a path- dependent advan-tage that cannot be copied—once a firm has become the first mover in a category, other firms no longer have the opportunity to be first. Once the firm has established a baseline internal analysis, it can move on to identifying its core competencies and formulate its strategic intent.tacit resourcesResources of an intangible nature (such as knowledge) that cannot be readily codified.socially com-plex resourcesResources or activities that emerge through the interaction of multiple individuals.causal ambiguityThe relation-ship between a resource and the outcome it produces is poorly under-stood (the causal mechanism is ambiguous).Value-Chain ActivityStrengthsWeaknessesFirm InfrastructureLegal department negotiates licenserights for games.Copyright infringement suits by other game producers are becom-ing more frequent.Human Resource ManagementHiring and retaining skilled and creative developers is crucial for the production of high-quality games. Company had 2002 full-time employees in 2007.Employees are not unionized.Employee stock option plan improves loyalty and morale.ProcurementNecessary to acquire rights to use copyright-protected characters and music.Thus far, Take-Two has been very successful in obtaining rights to use copyrighted materials.Sources: S. Balasubramanian, A. Kim, L. Lei, and S. Singh, “Beyond the Mayhem: Take-Two Interactive Software,” New York University teaching case, 2003; PDF to printer
sch87956_ch06_113-140.indd 131 11/10/18 07:50 AMChapter 6 Defining the Organization’s Strategic Direction 131IDENTIFYING CORE COMPETENCIES AND DYNAMIC CAPABILITIESCore CompetenciesA company’s core competencies are typically considered to be those that differentiate it strategically. A core competency is more than just a core technology. A core compe-tency arises from a firm’s ability to combine and harmonize multiple primary abilities in which the firm excels into a few key building blocks of specialized expertise. Com-petencies often combine different kinds of abilities, such as abilities in managing the market interface (e.g., advertising, distribution), building and managing an effective infrastructure (e.g., information systems, logistics management), and technological abilities (e.g., applied science, process design).10 This combination and harmonization of multiple abilities make core competencies difficult to imitate. Consider, for exam-ple, Sony’s core competency in miniaturization.11 This competency arises from the harmonization of multiple technologies (liquid crystal displays, semiconductors, etc.) and is leveraged into multiple markets (televisions, radios, personal digital assistants, etc.). A firm’s core competencies also depend on building high-quality relationships across different functions and business units.Prahalad and Hamel compare core competencies to roots, from which grow core products such as major components or subassemblies. Core products, in turn, give rise to business units, whose fruits are the various end products of the company (see Figure 6.5).Several core competencies may underlie an individual business unit, and several business units may draw upon the same core competency. This indicates the organiza-tion’s structure and incentives must encourage cooperation and exchange of resources across strategic business unit boundaries. If managers or resources are wed too closely to their business units, there will be underinvestment in the development and leverage of core competencies.12 Prahalad and Hamel go so far as to argue that strategic busi-ness units should be expected to bid for people in the firm who have particular skills to contribute to a project. Instead of viewing individuals as being employed by a particu-lar strategic business unit, individuals should be considered corporate assets that can be redeployed across the organization.Prahalad and Hamel offer the following tests to identify the firm’s core competencies: 1. Is it a significant source of competitive differentiation? Does it provide a unique sig-nature to the organization? Does it make a significant contribution to the value a customer perceives in the end product? For example, Sony’s skills in miniaturization have an immediate impact on the utility customers reap from its portable products. 2. Does it transcend a single business? Does it cover a range of businesses, both current and new? For example, Honda’s core competence in engines enables the company to be successful in businesses as diverse as automobiles, motorcycles, lawn mowers, and generators. 3. Is it hard for competitors to imitate? In general, competencies that arise from the complex harmonization of multiple technologies will be difficult to imitate. The competence may have taken years (or decades) to build. This combination of resources and embedded skills will be difficult for other firms to acquire or duplicate.Final PDF to printer
sch87956_ch06_113-140.indd 132 11/10/18 07:50 AM132 Part Two Formulating Technological Innovation StrategyAccording to Prahalad and Hamel, few firms are likely to be leaders in more than five or six core competencies. If a company has compiled a list of 20 to 30 capabilities, it probably has not yet identified its true core competencies. By viewing the business as a portfolio of core competencies, managers are better able to focus on value creation and meaningful new business development, rather than cost cutting or opportunistic expansion.13The Risk of Core RigiditiesSometimes the very things that a firm excels at can enslave it, making the firm rigid and overly committed to inappropriate skills and resources.14 Incentive systems may FIGURE 6.5Visualizing the Firm’s Core Competencies, Core Products, Business Units, and End ProductsSource: C. K. Prahalad and G. Hamel, “The Core Competence of the Corporation,” Harvard Business Review, May–June 1990. Core Product 1 Core Product 2 Business 4 Business 3 Business 2 10111223456789End ProductsBusiness 1 Competence 1 Competence 3 Competence 4 Competence 2 1Final PDF to printer
sch87956_ch06_113-140.indd 133 11/10/18 07:50 AMChapter 6 Defining the Organization’s Strategic Direction 133evolve that favor activities that reinforce the firm’s core competencies. The organiza-tional culture may reward employees who are most closely connected to core compe-tencies with higher status and better access to other organizational resources. While these systems and norms can prove beneficial in reinforcing and leveraging the firm’s existing core competencies, they can also inhibit the development of new core com-petencies. For example, a firm’s emphasis on a scientific discipline that is central to its core competency can make the firm less attractive to individuals from other disci-plines. Rewards for engaging in core competency activities can discourage employees from pursuing more exploratory activities. Finally, as noted in Chapter Four, knowl-edge accumulation tends to be very path dependent. Firms that have well-developed knowledge sets along a particular trajectory may find it very hard to assimilate or uti-lize knowledge that appears unrelated to that trajectory, potentially limiting the firm’s flexibility.15Dynamic CapabilitiesIn fast-changing markets, it can be extremely useful for a firm to develop a core competency in responding to change. Whereas in Prahalad and Hamel’s model, core competencies relate to sets of specific core products, it is also possible for a firm to develop core competencies that are not specific to any set of technologies or products, but rather to a set of abilities that enable it to quickly reconfigure its organizational structure and routines in response to new opportunities.16 Such com-petencies are termed dynamic capabilities. Dynamic capabilities enable firms to quickly adapt to emerging markets or major technological discontinuities. For example, Corning has made its own evolvability one of its most important core competencies. It invests heavily in research in areas likely to provide scientific breakthroughs (such as opal glasses and their solvents). It develops pilot plants to experiment with new products and production processes.17 It even manages its relationships with alliance partners not as individual relationships focused on par-ticular projects, but rather as an integrative and flexible system of capabilities that extend the firm’s boundaries.18STRATEGIC INTENTA firm’s purpose is to create value. This entails more than just improving operations or cutting costs; it means leveraging corporate resources to create more performance for customers, more well-being for employees, and more returns for shareholders. This is accomplished through developing new businesses and markets, and leveraging cor-porate resources, all guided by the firm’s strategic intent.19A company’s strategic intent is a long-term goal that is ambitious, builds upon and stretches the firm’s existing core competencies, and draws from all levels of the organization. Hamel and Prahalad’s examples include Canon’s obsession with overtaking Xerox in copiers, Apple’s mission of ensuring that every individual has a personal computer, and Yahoo’s goal of becoming the world’s largest Internet shop-ping mall. Typically, a strategic intent looks 10 to 20 years ahead and establishes clear milestones for employees to target.20 This forward-looking orientation is cru-cial; without it companies can easily become focused on markets they have served in dynamic capabilitiesA set of abilities that make a firm more agile and responsive to change.Final PDF to printer
sch87956_ch06_113-140.indd 134 11/23/18 08:07 AM134 Part Two Formulating Technological Innovation StrategyResearch Brief Blue Ocean StrategyIn a series of articles and a booka, Renée Mauborgne and W. Chan Kim describe firms who crafted what they call “blue ocean” strategies by innovating in a way that allowed them to enter untapped market space. In most industries, the rules of the game are well-understood and accepted, and firms compete by trying to outdo each other on the accepted dimensions of competition. Each firm hopes to capture a greater share of existing demand, and as the industry becomes crowded, the likelihood of firm profits or growth diminishes. Cut-throat competition turns the ocean bloody (also known as “red ocean”). Blue oceans refer to untapped market space that firms create by redefining the dimensions of competition. They are uncharted, and there are no (or few) competitors. Blue ocean strategies are thus fun-damentally about differentiation through innovation.Mauborgne and Chan suggest that firms can iden-tify “blue ocean” strategies by first using a visualization tool, the “strategy canvas,” to help them understand how different players are competing in an industry, and how they might choose to compete differently. The horizontal axis lists the factors that the industry competes on/invests in, and the vertical axis indicates “high” or “low.” Managers can then plot “value curves” for different product offerings. For example, you might draw a graph as indicated in the figure below.Eating facilitiesArchitectural aestheticsLoungesRoom sizeReceptionAmenitiesBed qualityHygieneSilencePriceDimensions of CompetitionRelative Level of Offering1 Star2 StarRed Ocean StrategyBlue Ocean StrategyCompete in existing market spaceBeat the competitionExploit existing demandMake the value-cost trade-offAlign the whole system of a firm’s activities with its strategic choice of differentiation or low cost.Create uncontested market spaceMake the competition irrelevantCreate and capture new demandBreak the value-cost trade-offAlign the whole system of a firm’s activities in pursuit of differentiation and low cost.continuedFinal PDF to printer
sch87956_ch06_113-140.indd 135 11/10/18 07:50 AMChapter 6 Defining the Organization’s Strategic Direction 135the past. Focusing on the firm’s existing markets results in the development of prod-ucts and services that meet current market requirements, rather than future market requirements. Successful and innovative firms question existing price– performance assumptions. They lead customers by developing and introducing products that extend well beyond current market requirements and help mold the market’s expec-tations for the future.21Once the strategic intent has been articulated, the company should be able to iden-tify the resources and capabilities required to close the gap between the strategic intent Managers can then challenge the industry’s strate-gic logic by asking the following four questions: 1. Which of the factors that the industry takes for granted should be eliminated? 2. Which factors should be reduced well below the industry’s standard? 3. Which factors should be raised well above the industry’s standard? 4. Which factors should be created that the industry has never offered?For example, returning to the hotel example Formule 1 found a successful market space by rejecting the idea that all hotel customers need eating facilities, lounges, and large rooms. Instead, some customers would prefer a hotel that skimped on these things and instead provided very quiet and clean rooms with high-quality beds at a moder-ate price:Mauborgne and Chan argue that the NIntendo Wii, Cirque du Soleil, and Southwest Airlines’ business model are all examples of successful “blue ocean” strategies.a Adapted from Kim, W. C. and R. Mauborgne, Blue Ocean Strategy (Boston: Harvard Business School Press, 2005).concludedEating facilitiesArchitectural aestheticsLoungesRoom sizeReceptionAmenitiesBed qualityHygieneSilencePriceDimensions of CompetitionRelative Level of OfferingFormule 12 Star1 StarFinal PDF to printer
136sch87956_ch06_113-140.indd 136 11/10/18 07:50 AMTheory in Action The Balanced ScorecardRobert Kaplan and David Norton point out that a firm’s methods of measuring performance will strongly influ-ence whether and how the firm pursues its strategic objectives. They argue that effective performance mea-surement must be more than simple reliance on finan-cial indicators; it must be a coherent and integral part of the management process. They proposed a method, the “balanced scorecard,” that they argue can motivate breakthrough improvements in product, process, cus-tomer, and market development.a The balanced score-card (see Figure 6.6) emphasizes four perspectives the firm should take in formulating goals that target critical success factors and in defining measures:1. Financial perspective. Goals might include such things as “meet shareholder’s expectations” or “double our corporate value in seven years.” Mea-sures might include return on capital, net cash flow, and earnings growth.2. Customer perspective. Goals might be to “improve customer loyalty,” “offer best-in-class customer ser-vice,” or “increase customer satisfaction.” Measures might include market share, percentage of repeat purchases, customer satisfaction surveys, and so on.3. Internal perspective. Goals might include such things as “reduce internal safety incidents,” “build best-in-class franchise teams,” or “improve FIGURE 6.6The Balanced ScorecardSource: R. Kaplan and D. Norto, “Putting the Balanced Scorecard to Work,” Harvard Business Review, September–October 1993. If my vision succeeds, how will I differ?What are the critical success factors?What are the critical measurements?The Balanced ScorecardStatement of Vision1. Definition of SBU2. Mission Statement3. Vision StatementTo myshareholdersFinancialPerspectiveTo mycustomersCustomerPerspectiveWith my internalmanagementprocessesInternalPerspectiveWith my abilityto innovate andgrowInnovation andLearningcontinuedFinal PDF to printer
137sch87956_ch06_113-140.indd 137 11/10/18 07:50 AMinventory management.” Measures might include the number of safety incidents per month, fran-chise quality ratings, stockout rates, and inventory costs.4. Innovation and learning perspective. Goals might include such things as “accelerate and improve new product development” or “improve employee skills.” Measures might include the percentage of sales from products developed within the past five years, average length of the new product develop-ment cycle, or employee training targets.Kaplan and Norton acknowledge that the balanced scorecard model often has to be adapted to fit differ-ent markets and businesses, but many firms (including IBM, Philips Electronics, Apple, and Advanced Micro Electronics) in many different industries (including elec-tronics, petrochemicals, and health care) are finding the balanced scorecard useful.b In fact, a 2002 survey by Bain & Company found that approximately 50 percent of Fortune 1000 companies in the United States and 40 percent in Europe use some version of the balanced R. Kaplan and D. Norton, “Putting the Balanced Scorecard to Work,” Harvard Business Review, September–October 1993, pp. 134–47; and R. Kaplan and D. Norton, “The Balanced Scorecard—Measures That Drive Performance,” Harvard Busi-ness Review, January–February 1992, pp. 71–80.b Kaplan and Norton, “Putting the Balanced Scorecard to Work.”c A. Gumbus and B. Lyons, “The Balanced Scorecard at Philips Electronics,” Strategic Finance 84, no. 5 (2002), pp. 45–49.concludedFIGURE 6.7Identifying the Resource and Capability GapFirm’s CurrentPositionFirm’s DesiredFuture PositionResource andCapability GapResources and capabilitiesunderlying current positionResources and capabilitiesnecessary for future positionand the current position (see Figure 6.7). This includes identifying any technologi-cal gap. Articulating the company’s strategic intent enables the company to focus its development efforts and choose the investments necessary to develop strategic tech-nologies and incorporate them into the company’s new products.22 Many companies are now pairing the articulation of their strategic intent with a multidimensional per-formance measurement system, such as the balanced scorecard, as discussed in the Theory in Action section. 1. The first step in establishing a coherent strategy for the firm is assessing the exter-nal environment. Two commonly used models of external analysis are Porter’s five-force model and stakeholder analysis. 2. Porter’s five-force model entails assessing the degree of existing rivalry, threat of potential entrants, bargaining power of suppliers, bargaining power of customers, Summary of ChapterFinal PDF to printer
sch87956_ch06_113-140.indd 138 11/10/18 07:50 AM138 Part Two Formulating Technological Innovation Strategyand threat posed by substitutes. Recently Porter added a sixth force, the role of complements. 3. Stakeholder analysis involves identifying any entity with an interest in the firm, what it wants from the company, and what claims it can make on the company. 4. To analyze the internal environment, firms often begin by identifying strengths and weaknesses in each activity of the value chain. The firm can then identify which strengths have the potential to be a source of sustainable competitive advantage. 5. Next the firm identifies its core competencies. Core competencies are integrated combinations of abilities that distinguish the firm in the marketplace. Several core competencies may underlie each business unit, and several business units may draw upon the same core competency. 6. Sometimes core competencies can become core rigidities that limit the firm’s ability to respond to a changing environment. 7. Dynamic capabilities are competencies that enable a firm to quickly reconfigure the firm’s organizational structure or routines in response to change in the firm’s environment or opportunities. 8. A firm’s strategic intent is the articulation of an ambitious long-term (10 to 20 years out) goal or set of goals. The firm’s strategic intent should build upon and stretch its existing core competencies. 9. Once the firm articulates its strategic intent, managers should identify the resources and capabilities that the firm must develop or acquire to achieve its stra-tegic intent. 10. The balanced scorecard is a measurement system that encourages the firm to con-sider its goals from multiple perspectives (financial, customer, business process, and innovation and learning) and establish measures that correspond to each of those perspectives. 1. What is the difference between a strength, a competitive advantage, and a sustain-able competitive advantage? 2. What makes an ability (or set of abilities) a core competency? 3. Why is it necessary to perform an external and internal analysis before the firm can identify its true core competencies? 4. Pick a company you are familiar with. Can you identify some of its core competencies? 5. How is the idea of strategic intent different from models of strategy that empha-size achieving a fit between the firm’s strategies and its current strengths, weak-nesses, opportunities, and threats (SWOT)? 6. Can a strategic intent be too ambitious?Discussion QuestionsFinal PDF to printer
sch87956_ch06_113-140.indd 139 11/10/18 07:50 AMChapter 6 Defining the Organization’s Strategic Direction 139ClassicsBarney, J., “Firm Resources and Sustained Competitive Advantage,” Journal of Man-agement 17 (1994), pp. 99–120.Kim, W. C., and R. Mauborgne, Blue Ocean Strategy: How to Create Uncontested Market Space and Make Competition Irrelevant (Boston: Harvard Business School Press, 2005).Penrose, E. T., The Theory of the Growth of the Firm (New York: Wiley, 1959).Porter, M. E., Competitive Advantage (New York: Free Press, 1985).Brandenburger, A. M., and B. J. Nalebuff, Co-opetition (New York: Doubleday, 1996).Recent WorkLeatherbee, M., and R. Katila, “Stay the Course or Pivot? Antecedents of Cognitive Refinements of Business Models in Young Firms,” (2018) Stanford Working Paper.Schilke, O., “On the Contingent Value of Dynamic Capabilities for Competitive Advantage: The Nonlinear Moderating Effect of Environmental Dynamism,” Strategic Management Journal, 35 (2014):179–203.Tushman, M. L., W. K. Smith, and A. Binns, “The Ambidextrous CEO,” Harvard Business Review (2011), pp. 74–80.Suggested Further Reading 1. G. Hamel and C. K. Prahalad, “Strategic Intent,” Harvard Business Review, May–June 1991, pp. 63–76. 2. C. K. Prahalad, “The Role of Core Competencies in the Corporation,” Research Technology Management, November–December 1993, pp. 40–47. 3. M. A. Porter, Competitive Strategy. (New York: Free Press, 1980). 4. Michael Porter is fully supportive of both ways of applying the five-force model. Personal com-munication with Michael Porter, March 25, 2006. 5. M. A. Porter, “Strategy and the Internet,” Harvard Business Review 79, no. 3 (2001), pp. 62–78; and personal communication, March 13, 2006. 6. S. L. Berman, A. Wicks, S. Kotha, and T. M. Jones, “Does Stakeholder Orientation Matter? The Relationship between Stakeholder Management Models and Firm Financial Performance,” Academy of Management Journal 42 (1999), pp. 488–507; T. Donaldson, and L. Preston, “The Stakeholder Theory of the Corporation: Concepts, Evidence, and Implications,” Academy of Management Review 20 (1995), pp. 65–91; and W. Evan and R. E. Freeman, “A Stakeholder Theory of the Modern Corporation: Kantian Capitalism,” in Ethical Theory in Business, eds. T. Beauchamp and N. Bowie (Englewood Cliffs, NJ: Prentice Hall, 1983), pp. 75–93. 7. M. A. Porter, Competitive Advantage (New York: Free Press, 1985). 8. J. Barney, “Firm Resources and Sustained Competitive Advantage,” Journal of Management 17 (1991), pp. 99–120. 9. R. Reed and R. J. DeFillippi, “Causal Ambiguity, Barriers to Imitation, and Sustainable Com-petitive Advantage,” Academy of Management Review 15, no. 1 (1990), pp. 88–102.EndnotesFinal PDF to printer
sch87956_ch06_113-140.indd 140 11/10/18 07:50 AM140 Part Two Formulating Technological Innovation Strategy 10. M. Gallon, H. Stillman, and D. Coates, “Putting Core Competency Thinking into Practice,” Research Technology Management, May–June 1995, pp. 20–28. 11. Prahalad, “The Role of Core Competencies in the Corporation.” 12. Prahalad and Hamel, “The Core Competence of the Corporation.” 13. Prahalad, “The Role of Core Competencies in the Corporation.” 14. Leonard-Barton, “Core Capabilities and Core Rigidities.” 15. G. Dosi, “Sources, Procedures, and Microeconomic Effects of Innovation,” Journal of Economic Literature, September 26, 1988, p. 1130; and M. Tripsas and G. Gavetti, “Capabili-ties, Cognition, and Inertia: Evidence from Digital Imaging,” Strategic Management Journal 21 (2000), p. 1147. 16. A. King and C. Tucci, “Incumbent Entry into New Market Niches: The Role of Experience and Managerial Choice in the Creation of Dynamic Capabilities,” Management Science 48 (2002), pp. 171–86; and K. M. Eisenhardt and J. A. Martin, “Dynamic Capabilities: What Are They?” Strategic Management Journal 21 (2000), pp. 1105–21. 17. M. B. Graham and A. T. Shuldiner, Corning and the Craft of Innovation (New York: Oxford University Press, 2001); and C. L. Tucci, “Corning and the Craft of Innovation,” Business History Review 75 (2001), pp. 862–65. 18. C. A. Bartlett and A. Nanda, “Corning, Inc.: A Network of Alliances,” Harvard Business School case no. 9-391-102, 1990. 19. Prahalad, “The Role of Core Competencies in the Corporation.” 20. Hamel and Prahalad, “Strategic Intent.” 21. Prahalad, “The Role of Core Competencies in the Corporation.” 22. K. Marino, “Developing Consensus on Firm Competencies and Capabilities,” Academy of Man-agement Executive 10, no. 3 (1996), pp. 40–51.Final PDF to printer
141sch87956_ch07_141-166.indd 141 11/10/18 07:42 AMChapter SevenChoosing Innovation ProjectsWhere Should We Focus Our Innovation Efforts? An Exercise.aTechnological change can make the world feel very uncertain—how can we know what customers will want, or competitors will do, in the future? The future of a technology, however, is not as unknowable as it might seem. If you can get the big picture of the dimensions along which a technology is improving, and where the big payoffs are still yet to be reaped, you can gain insight into where the next big breakthroughs are likely to, or should, be. This can help manag-ers understand where to focus their R&D efforts, and to anticipate the moves of competitors.The story of Sony’s SACD provides a great example. In the mid-1990s, the compact disc market was approaching saturation and both the consumer elec-tronics and recording industries were eager to introduce a next-generation audio format that would usher in a new era of growth. In 1996, Hitachi, JVC, Mitsubishi, Toshiba, Universal Music Group, Time Warner, and others formed a consortium to back a new standard, DVD audio, that offered superior fidelity and surround sound. The plan was twofold: to drive consumers to upgrade their players and libraries and to do an end-run around Sony and Philips which owned the com-pact disc standard and extracted a licensing fee for every CD and player sold.Sony and Philips, however, were not going to go down without a fight. They counterattacked with their own new format, Super Audio CD, an extension of the old one which would have allowed them to control the royalties for the new discs and players. The industry gave a collective groan; manufacturers, distribu-tors, and consumers all stood to lose big if they placed bets on the wrong for-mat. Nonetheless, Sony launched the first super-audio players in late 1999; DVD audio players began to hit the market in mid-2000 and prices for both rapidly fell and converged. A costly format war seemed inevitable.You may be scratching your head at this point, wondering why you’d never heard about this format war. What happened? MP3 happened. While the consumer Final PDF to printer
sch87956_ch07_141-166.indd 142 11/10/18 07:42 AM142 Part Two Formulating Technological Innovation Strategyelectronics giants were pursuing new heights in audio fidelity, an algorithm that slightly depressed fidelity in exchange for reduced audio file size was taking off. Soon after the file-sharing platform Napster launched in 1999, consumers were downloading free music files by the millions and Napster-like services were sprouting up like weeds.It’s easy to think that Sony, Philips, and the DVD Audio consortium just got unlucky. After all, who could have predicted the disruptive arrival of MP3? How could the consumer electronics giants have known that a format trajectory of ever-increasing fidelity would be overtaken by a technology with less fidelity? Actually, they all should have seen that the next big breakthrough success was far more likely to be about portability and selection than fidelity.Here is an exercise that can help you get the “big picture” of technology evo-lution in an area, and to prioritize innovation investments.Step One: Identify the DimensionsTechnologies typically progress along several dimensions at once. For example, computers became faster and smaller in tandem; speed was one dimension, size another. Developments in any dimension come with specific costs and ben-efits and have measurable and changing utility to customers. Identifying the key dimensions that a technology has progressed along is the first step in predicting its future.One of the best ways to identify these dimensions is to trace the technology’s path to date, and for each major change in the technology’s form, identify the dimensions that were affected. The further back in time you can go, to the most primitive way of fulfilling the need the technology meets, the easier it will be to see the high-level dimensions along which the technology has changed.For example, prior to the phonograph, people could hear music or a speech only when and where it was performed. The first phonographs introduced in the 1800s desynchronize the time and place of a performance so that it could be heard at any-time, anywhere. That was a huge accomplishment. Those phono-graphs, however, were cumbersome. The sound quality was “tinny” and music selection was extremely limited. When Emile Berliner introduced flat disc-shaped records, it dramatically increased the sound fidelity, while dramatically lowering the cost, which in turn led to a huge increase in the selection of music available. Later, in the 1960s eight-track tape cartridges would bring portability to recorded music. Cassette tapes rose to dominance in the 1970s further enhancing por-tability, but also offering customizability for the first time—the ability to record your own music, speeches, and more. Then in 1982, Sony and Philips intro-duced the compact disc standard which offered greater fidelity than cassette tapes and rapidly became the dominant format. Tracing this history thus reveals six key dimensions that have driven the evolution of audio format technology: De synchronization, cost, fidelity, selection, portability, and customizability.Now repeat this process in the area you are interested, starting far back in the past and following the path of the technology forward in time. Look for each major inflection point. Try to identify the three to five most important high-level dimensions along which the technology has evolved. Getting to a high level of Final PDF to printer
sch87956_ch07_141-166.indd 143 11/10/18 07:42 AMChapter 7 Choosing Innovation Projects 143a dimension is important because it helps you to see the big picture rather than being caught up in the details.Step Two: Where Are We on the Utility Curve for Each Dimension?For each dimension, we now want to determine the shape of the utility curve—the plot of the value customers derive from a technology according to its per-formance on a given dimension—and where we currently are on the curve. This will help reveal where the most opportunity for improvement lies.For example, the history of audio formats suggests that the selection of music available has a concave parabolic utility curve: utility increases with increasing selection, but at a decreasing rate, and not indefinitely (see Figure 1). When there’s little music to choose from, even a small increase in selection signifi-cantly enhances utility. When the first phonographs appeared, for example, there were few recordings to play on them. As more recordings became available, customers eagerly bought them, and the appeal of owning a player grew dra-matically. Over the ensuing decades, selection grew exponentially and the utility curve ultimately began to flatten; people still valued new releases, but each new recording added less additional value. Today digital music services like iTunes, Amazon Prime Music, and Spotify offer tens of millions of songs. With this virtu-ally unlimited selection, most customers’ appetites are sated—and we are prob-ably approaching the top of the curve.Now let’s consider the fidelity dimension, the primary focus of Super Audio CD and DVD audio. Fidelity also likely has a concave parabolic utility curve. The first phonographs had awful fidelity; music sounded thin and tinny, though it was still a remarkable benefit to be able to hear any recorded music at all. The early FIGURE 1A Parabolic Utility Curve for the Selec-tion of Music AvailableUtility Consumers Derive from Recorded MusicCatalogs of one million plussongs satiate most buyers’ needsSelection of Recorded Music AvailableFirst songs released yield big valuegains over not having recorded musicWider selections enable customersto find idiosyncratic preferencesFinal PDF to printer
sch87956_ch07_141-166.indd 144 11/10/18 07:42 AM144 Part Two Formulating Technological Innovation Strategyimprovements in fidelity that records offered made a big difference in people’s enjoyment of music. Then along came compact discs which offered even more fidelity, though many people felt that vinyl records were “good enough” and some even preferred their “warmth.” The fidelity curve was already leveling out when Sony, Philips, and the DVD Audio consortium introduced their new formats in the early 2000s. Super Audio CD and DVD Audio offered significantly higher fidelity than the compact disc. For example, whereas CDs have a frequency range up to about 20 thousand cycles per second (kHz), the new formats offered ranges that reached 100 kHz. That’s an impressive high end—but as human hearing peaks out at about 20 kHz, only the family dog was likely to appreciate it. In 2007, the Audio Engineering Society released results of a year-long trial assessing how well subjects (including professional recording engineers) could detect the difference between Super Audio and regular CDs. Subjects correctly identified the Super Audio CD format only half the time, no better than if they’d been simply guessing!Had the companies analyzed the utility curve for fidelity they could have seen that there was little payoff for investing in this dimension. Meanwhile, even a cur-sory look at the portability, selection, and cost curves would have revealed the opportunity there, and MP3 offered big payoffs on all three.Step Three: Where Should We Invest Our Money and Effort?Using a matrix like the one below can help us assess which technology- development investments are likely to yield the biggest bang for the buck (see Figure 2). First, list the performance dimensions you’ve identified as most impor-tant to customers. Then, score each dimension on a scale of 1 to 5 in three areas: importance to customers (1 means “not important” and 5 means “very important”); room for improvement (i.e., how far we are from the utility curve flat-tening out, where 1 means “minor opportunity for improvement” and 5 means “large opportunity for improvement”); and ease of improvement (1 means “very difficult” and 5 means “very easy”).For example, the scores created by a company that makes glucose- monitoring devices are shown in the matrix (Figure 2). The feature most impor-tant to customers is reliability—reliable measures can mean life or death for a patient. However, existing devices (mostly finger-prick devices that test a drop of blood with a portable reader) are already very reliable, and thus scored low FIGURE 2Ranking Areas of FocusRankDimensionImportance to Buyers (1–5 scale)Room for Improvement (1–5 scale)Ease of Improvement (1–5 scale)Total ScoreCost4228Comfort44311Reliability5117Ease of use3238Final PDF to printer
sch87956_ch07_141-166.indd 145 11/10/18 07:42 AMChapter 7 Choosing Innovation Projects 145on the “room for improvement” measure. They are also fairly easy to use, and reasonably low cost. However, they are uncomfortable. Comfort is a dimension that is ranked highly by users (though not as high as reliability), yet is much fur-ther from the optimum. Both comfort and ease of use are modestly difficult to improve (scoring 3s in this example), yet because comfort is both more important to customers than ease of use, and further from the optimum, comfort ends up with a significantly higher total score. The team that provided the scores for this example ended up proposing that the company develop a patch worn on the skin that would detect glucose levels based on sweat that would be sent via Bluetooth to the user’s smartphone.Notably, we can adjust the scale of the scores to reflect the organization’s objectives (e.g., a cash-strapped firm might weigh “ease of improvement” higher, thus we could change the scale to 1–10), and we can repeat this analy-sis for different market segments that have different ratings for the importance of a dimension or its room for improvement. For example, we could divide the glucose-monitoring device market into a market for children’s devices versus adults’ devices. Comfort and ease of use are particularly important for glucose monitors for children. We might thus score comfort and ease of use as 5 for “importance to customer” in the children’s device market, indicating that in this market, these dimensions are often more important than cost.Shifting the Organization’s Focal PointThis exercise can help managers broaden their perspective on their industry, and shift their focus from “this is what we do” to “this is where our market is (or should be) heading.” It can also help overcome the bias and inertia that tend to lock an organization’s focus on technology dimensions that are less important to consumers than they once were. To be truly innovative, it is not enough for orga-nizations to merely improve what they are doing; they need to be able to look into the future and identify what could be done in the industry that is better—much better—than what the industry is doing today.Discussion Questions 1. Why did the consumer electronic giants invest so much in developing audio technology that exceeded the hearing capacity of humans? 2. Can you think of other companies or industries that are currently investing in technology dimensions where the utility payoff of improving the technol-ogy has flattened? 3. Can you come up with an example of a firm that would likely weight “importance to customers” much higher than “ease of improvement”? Can you come up with an example of a firm that would likely weight “ease of improvement” much higher than “importance to customers”? a Adapted from Schilling, M. A., “What’s Your Best Innovation Bet?” Harvard Business Review (July–August 2017) 86–93.Final PDF to printer
sch87956_ch07_141-166.indd 146 11/10/18 07:42 AM146 Part Two Formulating Technological Innovation StrategyOVERVIEWDeveloping innovative new products and services is expensive and time-consuming. It is also extremely risky—most studies have indicated that the vast majority of develop-ment projects fail. Firms have to make difficult choices about which projects are worth the investment, and then they have to make sure those projects are pursued with a rig-orous and well-thought-out development process. In this chapter, we will explore the various methods used to evaluate and choose innovation projects. The methods range from informal to highly structured, and from entirely qualitative to strictly quantita-tive. We will start by considering the role of capital rationing in the R&D investment decision, and then we will cover various methods used to evaluate projects including strictly quantitative methods, qualitative methods, and approaches that combine quan-titative and qualitative techniques.THE DEVELOPMENT BUDGETWhile many project valuation methods seem to assume that all valuable projects will be funded, most firms face serious constraints in capital and other resources, forcing them to choose between multiple valuable projects (or obtain external financing as discussed in the Theory in Action section on Financing New Technology Ventures). Many firms use a form of capital rationing in formulating their new product devel-opment plans. Under capital rationing, the firm sets a fixed research and develop-ment budget (often some percentage of the previous year’s sales), and then uses a rank ordering of possible projects to determine which will be funded. Firms might establish this budget on the basis of industry benchmarks or historical benchmarks of the firm’s own performance. To provide a sense of what firms in different industries spend on R&D, Figure 7.1 shows the 10 industries with the highest R&D intensity (R&D expenditures as a percentage of sales), based on North American publicly held firms in 2016. Some industries (notably drugs, special industry machinery, and semiconductors and electronic components) spend considerably more of their revenues on R&D than other industries, on average.There is also considerable variation within each of the industries in the amount that individual firms spend. For example, as shown in Figure 7.2, Merck’s R&D inten-sity is significantly higher than the average for drug producers (25 percent versus 20  percent), whereas Pfizer’s is somewhat lower than the industry average (16 percent versus 20 percent). Figure 7.2 also reveals the impact of firm size on R&D budgets: Whereas the absolute amount spent on R&D at Volkswagen surpasses the R&D spend at most other firms by a large amount, Volkswagen’s R&D intensity is relatively low due to its very large sales base.The rank ordering used in capital rationing may be established by any number of methods, including quantitative methods, such as discounted cash flow analysis or options analysis, or qualitative methods, such as screening questions and portfolio mapping, or a combination of multiple methods. Knowing the requirements, strengths, and weaknesses of each method helps managers make sound decisions about which valuation techniques to employ.R&D intensityThe ratio of R&D expendi-tures to rationingThe allocation of a finite quantity of resources over different possible uses.Final PDF to printer
sch87956_ch07_141-166.indd 147 11/10/18 07:42 AMChapter 7 Choosing Innovation Projects 147FIGURE 7.1Top 10 Industries (Three Digit SIC) by R&D Intensity, 2016Based on Compustat data; only industries with 20 or more firms were included. Sales and R&D were aggregated up to the industry level prior to calculating R&D intensity to minimize the effect of large firm-level outliers.RankThree Dig. SIC CodeIndustry DescriptionNumber of Publicly Held FirmsIndustry R&D Spend ($millions)Industry Revenues ($millions)Industry R&D Intensity (R&D/Sales)12830Drugs, biological products, and diagnostics782$137,560$   704,2340.2023550Special industry machinery38$     4504$     35,7110.1333670Semiconductors and electronic components191$  48,136$   439,1690.1147370Software and computer programming services633$  89,310$   871,9040.1053840Medical equipment211$  12,046$   151,3160.0863660Communication equipment79$  22,624$   306,6190.0773820Measuring equipment and instruments83$     7996$   109,9670.0783570Computers and peripherals81$  25,580$   354,5890.0795960Nonstore retailers41$  16,120$   245,2970.07103710Motor vehicles and motor vehicle equipment82$  70,509$1,691,3570.04FIGURE 7.2Top 20 Global R&D Spenders, 2016Source: Data from Compustat.CompanySales ($millions)R&D ($millions)R&D Intensity (R&D/Sales)AMAZON.COM$135,987$16,08512%ALPHABET$  90,272$13,94815%INTEL$  59,387$12,74021%VOLKSWAGEN$231,205$12,1445%MICROSOFT$  85,320$11,98814%ROCHE HOLDING$  51,807$11,35022%MERCK & CO$  39,807$10,12425%APPLE$215,091$10,0455%TOYOTA MOTOR$252,652$   93904%JOHNSON & JOHNSON$  71,890$   912413%NOVARTIS$  48,518$   903919%PFIZER$  52,824$   837516%GENERAL MOTORS$166,380$   81005%FORD MOTOR$151,800$   73005%CISCO SYSTEMS$  49,247$   629613%FACEBOOK$  27,638$   591921%ASTRAZENECA$  23,408$   589025%HONDA MOTOR CO$129,880$   58404%ORACLE$  37,047$   578716%IBM$  79,920$   57517%Source: Based on Compustat data.Final PDF to printer
148sch87956_ch07_141-166.indd 148 11/10/18 07:42 AMTheory in Action Financing New Technology VenturesWhile large firms can fund innovation projects internally, new technology start-ups must often obtain external financing. This can sometimes be daunting. Because technology start-ups often have both an unproven tech-nology and an unproven business concept (and some-times an unproven management team), they typically face a much higher cost of capital than larger competi-tors, and their options for obtaining capital can be very limited. In the first few stages of start-up and growth, entrepreneurs may have to turn to friends, family, and personal debt. Start-ups might also be able to obtain some initial funding through government agencies. If the idea and the management team seem promising enough, the entrepreneur can tap “angel investors” and venture capitalists as sources of both funds and mentoring.FAMILY, FRIENDS, AND CREDIT CARDSWhen a new venture is starting out, often the technol-ogy and/or management is unproven, making the ven-ture appear very risky. In this stage, entrepreneurs must often rely on friends and family members who are will-ing to provide initial funding either in the form of a loan or an exchange for equity in the company. Alternatively, the entrepreneur may try to obtain debt financing from a local bank. A very large number of start-ups are actu-ally funded with credit cards, resulting in a very high rate of interest!GOVERNMENT GRANTS AND LOANSSome new ventures obtain start-up funds from govern-ment sources. In the United States, the Small Business Administration (SBA) is designed to foster entrepreneur-ship and innovation by administering grants, loans, and venture capital programs from many different federal agencies including the Department of Commerce, Depart-ment of Agriculture, Department of Energy, NASA, and others. Similarly, in the United Kingdom, the Enterprise Fund administers a series of programs designed to fund small- to medium-size technology firms, and in Germany there are more than 800 federal and state government programs established to finance new firms.aANGEL INVESTORSAngel investors are private investors who fund projects without utilizing a venture capital limited partnership structure. They are often wealthy individuals who have been very successful in business, and who enjoy the thrill of vicarious entrepreneurship afforded by investing in—and sometimes mentoring— start-up firms. Angels typically fund projects that are $1  million or less. While angel investors lose money in a significant share of their investments, those investments that pay off can earn very high returns. Angels are usually not listed in pub-lic directories, but are identified through professional networks (e.g., through one’s former colleagues, pro-fessors, or lawyers). A large number of start-ups obtain “seed-stage” (before there is a real product or company organized) financing from angel investors. While it is dif-ficult to get data on angel investing because most of the transactions are not publicly reported, estimates from the Center for Venture Research indicate that angel investors funded 64,380 entrepreneurial ven-tures in 2016 for a total of $21.3  billion (an average of $330,000 per deal).VENTURE CAPITALFor projects that require more than $1 million, entre-preneurs often turn to venture capital, either from inde-pendent venture capital firms or from corporate venture capital sources.Independent venture capital firms manage a pool of funds that they invest in projects they believe to have rapid growth potential. Many venture capital firms specialize in particular industries, making them better able to evaluate the potential of start-ups in that industry. They also prefer to make deals with firms within driving distance so that they can have frequent face-to-face contact.bThe venture capital funds are likely to be provided in a complex debt-equity hybrid contract that essen-tially looks more like equity if the firm performs well, or debt if the firm performs poorly.c If and when the busi-ness is successful, the venture capitalist can cash out of the investment by negotiating an initial public offer-ing or a buyout of the company by another firm. Ven-ture capitalists are very selective and reject the vast majority of proposals considered. However, for those projects that are funded, the support of the venture capitalist provides a number of valuable benefits includ-ing credibility among other investors (and thus better continuedFinal PDF to printer
149sch87956_ch07_141-166.indd 149 11/10/18 07:42 AMaccess to capital) and mentoring. While some venture capitalists specialize in providing seed-stage funding, venture capitalists are more likely to provide funding during early stages—after the company has been orga-nized and the product has shown early signs of success, but before it is able to sustain its development activi-ties and growth through its own revenues. According to estimates by Crunchbase, in 2017 venture capitalists invested about $213.6  billion on 22,700 deals globally. The most prolific venture capital firm, Sequoia Capital, lead 70  venture rounds in 2017.Corporate venture capital is provided by firms that wish to take a minority equity stake in another firm’s technology development, often to gain access to cutting-edge technology that they may wish to develop further should it prove technically and commercially promising. Such firms may establish an internal ventur-ing group that is closely tied to the firm’s own devel-opment operations, or they may create a dedicated external fund that has more independence from the firm’s own operations.d The benefit of the former struc-ture is that the firm should be better able to use its own expertise and resources to help the new venture suc-ceed. However, under this structure, the entrepreneur may have concerns about the larger firm expropriating the entrepreneur’s proprietary technology. Under the latter structure, the independence of the external ven-ture fund provides some reassurance that the entrepre-neur’s technology will not be stolen, but it also limits the ability of the entrepreneur to leverage any of the larger firm’s nonfinancial resources.e According to CB Insights, there were 1791 corporate venture capital deals glob-ally in 2017, totaling $31.2 billion (averaging over $17 million per deal). According to CB Insights, the most active corporate venture capital programs in 2017 were GV (formerly Google Ventures), Intel Capital, Salesforce Ventures, Qualcomm Ventures, GE Ventures, Legend Capital, Microsoft Ventures, K Cube Ventures, Fosun RZ Capital, and Samsung Ventures.a B. Hall, “The Financing of Research and Development,” Oxford Review of Economic Policy 18 (2002), pp. 35–51.b Gompers, P. A., and J. Lerner, The Venture Capital Cycle (Boston: MIT Press, 2004); Pahnke, E. C., R. Katila, and K. Eisenhardt, “Who Takes You to the Dance? How Partners’ Institutional Logics Influence Innovation in Young Firms,” Administrative Science Quarterly, 60 (2015):596–633.c Hall, “The Financing of Research and Development.”d P. A. Gompers, “Corporations and the Financing of Innovation: The Corporate Venturing Experience,” Economic Review—Federal Reserve Bank of Atlanta 87, no. 4 (2002), pp. 1–18.e G. Dushnitsky, “Limitations to External Knowledge Acquisi-tion: The Paradox of Corporate Venture Capital,” doctoral dis-sertation, New York University, 2003.concludedQUANTITATIVE METHODS FOR CHOOSING PROJECTSQuantitative methods of analyzing new projects usually entail converting projects into some estimate of future cash returns from a project. Quantitative methods enable man-agers to use rigorous mathematical and statistical comparisons of projects, though the quality of the comparison is ultimately a function of the quality of the original esti-mates. The accuracy of such estimates can be questionable—particularly in highly uncertain or rapidly changing environments. The most commonly used quantitative methods include discounted cash flow methods and real options.Discounted Cash Flow MethodsMany firms use some form of discounted cash flow analysis to evaluate projects. Discounted cash flows are quantitative methods for assessing whether the antici-pated future benefits are large enough to justify expenditure, given the risks. Dis-counted cash flow methods take into account the payback period, risk, and time value of money. The two most commonly used forms of discounted cash flow analy-sis for evaluating investment decisions are net present value (NPV) and internal rate of return (IRR). Both methods rely on the same basic discounted cash flow net present value (NPV)The discounted cash inflows of a project minus the discounted cash outflows.internal rate of return (IRR)The rate of return yielded by a project, normally calculated as the discount rate that makes the net present value of an investment equal zero.Final PDF to printer
sch87956_ch07_141-166.indd 150 11/10/18 07:42 AM150 Part Two Formulating Technological Innovation Strategymechanics, but they look at the problem from different angles. NPV asks, “Given a particular level of expenditure, particular level(s) and rate of cash inflows, and a discount rate, what is this project worth today?” IRR asks instead, “Given a particu-lar level of expenditure and particular level(s) and rate of cash inflows, what rate of return does this project yield?” For either method, managers must use estimates of the size and timing of expenditures and cash inflows. Both methods enable the deci-sion maker to incorporate some basic measure of risk. For example, riskier projects may be examined by using a higher discount factor in NPV analysis. Managers also often calculate discounted cash flow measures using best-case and worst-case cash flow estimates.Net Present Value (NPV)To calculate the NPV of a project, managers first estimate the costs of the project and the cash flows the project will yield (often under a number of different “what if” sce-narios). Costs and cash flows that occur in the future must be discounted back to the current period to account for risk and the time value of money. The present value of cash inflows can then be compared to the present value of cash outflows: NPV = Present value of cash inflow − Present value of cash outflows If this value is greater than 0, then the project generates wealth, given the assumptions made in calculating its costs and cash inflows.To find the present value of cash inflow and outflows, each cash flow must be discounted back to the current period using a discount rate (see Figure 7.3). If there is a single expenditure at the beginning of the project (year 0), the original expenditure can be compared directly to the present value of the future expected cash flows. In the example in Figure 7.3, the present value of the future cash flows (given a discount rate of 6 percent) is $3465.11. Thus, if the initial cost of the project were less than $3465.11, the net present value of the project is positive. If there are cash outflows for $3465.11 Total present value, discount rate = 6%Time(Years)04321$1 000$1 000$1 000$1 000$890.00$943.40$839.62$792.09×1/1.06×1/1.064×1/1.062×1/1.063ExpectedCash InflowsFIGURE 7.3Example of Present Value of Future Cash FlowsFinal PDF to printer
sch87956_ch07_141-166.indd 151 11/10/18 07:42 AMChapter 7 Choosing Innovation Projects 151multiple periods (as is common with most development projects), those cash outflows would have to be discounted back to the current period.If the cash inflows from the development project were expected to be the same each year (as they were in Figure 7.3), we can use the formula for calculating the present value of an annuity instead of discounting each of the cash inflows individually. This is particularly useful when cash inflows are expected for many years. The present value of C dollars per period, for t periods, with discount rate r is given by the follow-ing formula: Annuity present value = C × 1 − {1/ (1 + r) 1 } __________ r This amount can then be compared to the initial investment. If the cash flows are expected in perpetuity (forever), then a simpler formula can be used: Perpetuity present value = C × 1 / r The present value of the costs and future cash flows can also be used to calculate the discounted payback period (i.e., the time required to break even on the project using discounted cash flows). Suppose for the example above, the initial investment required was $2000. Using the discounted cash inflows, the cumulative discounted cash flows for each year are:YearCash Flow1$ 934.4021833.4032673.0243465.11Thus, the investment will be paid back sometime between the end of year 2 and the end of year 3. The accumulated discounted cash flows by the end of year 2 are $1833.40, so we need to recover $166.60 in year 3. Since the discounted cash flow expected for year 3 is $839.62, we will have to wait $166.60/$839.61 ≈ 0.20 of a year. Thus, the payback period is just over two years and two months.Internal Rate of Return (IRR)The internal rate of return of a project is the discount rate that makes the net pres-ent value of the investment zero. Managers can compare this rate of return to their required return to decide if the investment should be made. Calculating the IRR of a project typically must be done by trial and error, substituting progressively higher interest rates into the NPV equation until the NPV is driven down to zero. Calculators and computers can perform this trial and error. This measure should be used cau-tiously, however; if cash flows arrive in varying amounts per period, there can be mul-tiple rates of return, and typical calculators or computer programs will often simply report the first IRR that is found.Both net present value and internal rate of return techniques provide concrete finan-cial estimates that facilitate strategic planning and trade-off decisions. They explicitly consider the timing of investment and cash flows, and the time value of money and risk. They can make the returns of the project seem unambiguous, and managers may discounted payback periodThe time required to break even on a project using discounted cash flows.Final PDF to printer
sch87956_ch07_141-166.indd 152 11/10/18 07:42 AM152 Part Two Formulating Technological Innovation Strategyfind them very reassuring. However, this minimization of ambiguity may be decep-tive; discounted cash flow estimates are only as accurate as the original estimates of the profits from the technology, and in many situations it is extremely difficult to anticipate the returns of the technology. Furthermore, such methods discriminate heavily against projects that are long term or risky, and the methods may fail to capture the strategic importance of the investment decision. Technology development projects play a crucial role in building and leveraging firm capabilities, and creating options for the future. Investments in new core technologies are investments in the organization’s capabilities and learning, and they create opportunities for the firm that might other-wise be unavailable.1 Thus, standard discounted cash flow analysis has the potential to severely undervalue a development project’s contribution to the firm. For example, Intel’s investment in DRAM technology might have been considered a total loss by NPV methods (Intel exited the DRAM business after Japanese competitors drove the price of DRAM to levels Intel could not match). However, the investment in DRAM technology laid the foundation for Intel’s ability to develop microprocessors—and this business has proved to be enormously profitable for Intel. To better incorporate strate-gic implications in the new product development investment decision, some managers and scholars have recently begun promoting the idea of treating new product develop-ment decisions as real options, as described below.Real OptionsWhen a firm develops new core technologies, it is simultaneously investing in its own learning and in the development of new capabilities. Thus, development proj-ects can create valuable future opportunities for the firm that would otherwise be unavailable.2 Even development projects that appear unsuccessful (as Intel’s DRAM discussed above) may prove to be very valuable when they are considered from the perspective of the options they create for the future of the firm. Some managers and scholars have begun arguing that new product development decisions should be eval-uated as real options.To understand real options, it is first useful to consider the financial model upon which they are based—stock options. A call option on a stock enables an investor to purchase the right to buy the stock at a specified price (the exercise price) in the future. If, in the future, the stock is worth more than the exercise price, the holder of the option will typically exercise the option by buying the stock. If the stock is worth more than the exercise price plus the price paid for the original option, the option holder makes money on the deal. If the stock is worth less than the exercise price, the option holder will typically choose not to exercise the option, allowing it to expire. In this case, the option holder loses the amount of money paid for the initial option. If, at the time the option is exercised, the stock is worth more than the exercise price but not more than the exercise price plus the amount paid for the original option, the stockholder will typically exercise the option. Even though the stockholder loses money on the deal (some portion of the price paid for the original option), he or she loses less than if he or she allowed the option to expire (the entire price paid for the original option).In real options, the assets underlying the value of the option are nonfinan-cial resources.3 An investor who makes an initial investment in basic R&D or in real optionsThe applica-tion of stock option valuation methods to investments in nonfinancial assets.Final PDF to printer
sch87956_ch07_141-166.indd 153 11/10/18 07:42 AMChapter 7 Choosing Innovation Projects 153breakthrough technologies is, it is argued, buying a real call option to implement that technology later should it prove to be valuable: ∙ The cost of the R&D program can be considered the price of a call option. ∙ The cost of future investment required to capitalize on the R&D program (such as the cost of commercializing a new technology that is developed) can be considered the exercise price. ∙ The returns to the R&D investment are analogous to the value of a stock purchased with a call option.4As shown in Figure 7.4, the value of a call stock option is zero as long as the price of the stock remains less than the exercise price. If the value of the stock rises above the exercise price, however, the value of the call rises with the value of the stock, dollar for dollar (thus the value of the call rises at a 45-degree angle).5Options are valuable when there is uncertainty, and because technology trajectories are uncertain, an options approach may be useful. Though there has not yet been much empirical work in the area, several authors have developed methodologies and applica-tions of options analysis to valuing technology development investments.6 Also, some evidence shows that an options approach results in better technology investment deci-sions than a cash flow analysis approach.7Other authors, however, warn against liberal application of the approach, pointing out that technology investment scenarios often do not conform to the same capital market assumptions upon which the approach is based.8 For instance, implicit in the value of options is the assumption that one can acquire or retain the option for a small price, and then wait for a signal to determine if the option should be exercised.9 While this assumption might hold true for an outside firm investing venture capital in another firm’s innovation effort, it would be rare for this assumption to hold for a company investing in its own development efforts. In the case of a firm undertaking FIGURE 7.4The Value of a Call Option at ExpirationIf the stock price is less thanthe exercise price at point ofexpiration, call value is equalto zero.If the stock price is greater thanthe exercise price, the value ofthe call is equal to the stockprice minus the exercise price.45°Stock price atexpiration (S1)Call option valueat expiration (C1)Exercise price(E)S1 ≤ ES1 > EFinal PDF to printer
sch87956_ch07_141-166.indd 154 11/10/18 07:42 AM154 Part Two Formulating Technological Innovation Strategysolo new product development, it may not be possible to secure this option at a small price; it may require full investment in the technology before a firm can determine if the technology will be successful.10 Furthermore, while the value of a stock is inde-pendent of the call holder’s behavior (i.e., the call holder can simply wait and observe whether the value of the stock rises or falls), the value of an R&D investment is not independent of the investor’s behavior. A firm’s degree of investment, its development capabilities, its complementary assets, and its strategies can all significantly influence the future returns of the development project.11 Therefore, rather than simply waiting and observing the value of the investment, the investor is an active driver of the value of the investment.DISADVANTAGES OF QUANTITATIVE METHODSQuantitative methods for analyzing potential innovation projects can provide con-crete financial estimates that facilitate strategic planning and trade-off decisions. They can explicitly consider the timing of investment and cash flows and the time value of money and risk. They can make the returns of the project seem unambigu-ous, and managers may find them very reassuring. However, this minimization of ambiguity may be deceptive; discounted cash flow estimates are only as accurate as the original estimates of the profits from the technology, and in many situations, it is extremely difficult to anticipate the returns of the technology. As noted by Professor Freek Vermeulen, author of Business Exposed, one of the most common mistakes managers make in their innovation strategy is to insist on “seeing the numbers”—for truly innovative products, it is impossible to reliably produce any numbers. It is very difficult to compute the size of a market that does not yet exist.12 Furthermore, such methods discriminate heavily against projects that are long term or risky, and the methods may fail to capture the strategic importance of the investment decision. Technology development projects play a crucial role in building and leveraging firm capabilities and creating options for the future. Investments in new core technolo-gies are investments in the organization’s capabilities and learning, and they create opportunities for the firm that might otherwise be unavailable. QUALITATIVE METHODS FOR CHOOSING PROJECTSMost new product development projects require the evaluation of a significant amount of qualitative information. Many factors in the choice of development projects are extremely difficult to quantify, or quantification could lead to misleading results. Almost all firms utilize some form of qualitative assessment of potential projects, ranging from informal discussions to highly structured approaches.Screening QuestionsAs a starting point, a management team is likely to discuss the potential costs and ben-efits of a project, and the team may create a list of screening questions that are used to structure this discussion. These questions might be organized into categories such as Final PDF to printer
sch87956_ch07_141-166.indd 155 11/10/18 07:42 AMChapter 7 Choosing Innovation Projects 155the role of the customer, the role of the firm’s capabilities, and the project’s timing and cost.13 Some examples are provided below:Role of CustomerMarket ∙ Who are the most likely customers of the new product? ∙ How big is this market? Are there other likely markets for the product? ∙ What type of marketing will be required to create customer awareness?Use ∙ How will customers use the product? ∙ What new benefits will the product provide the customer? ∙ What other products are customers likely to consider as substitutes for this product?Compatibility and Ease of Use ∙ Will the product be compatible with the customer’s existing complements? ∙ Will the product require significant new learning on the part of the customer? ∙ How will the customer perceive the product’s ease of use? ∙ Will the product require the customer to bear other costs?Distribution and Pricing ∙ Where will the customer buy the product? ∙ Will the product require installation or assembly? ∙ How much are customers likely to be willing to pay for the product?Role of CapabilitiesExisting Capabilities ∙ Does the new project leverage the firm’s core competencies or sources of sustain-able competitive advantage? ∙ Will the project render some of the firm’s existing competencies obsolete or can-nibalize existing products? If so, does the firm have a transition strategy to handle possible cash flow implications? ∙ Does the firm have the necessary manufacturing capabilities, and if not, will those capabilities be developed in-house or acquired externally (e.g., outsourcing)? ∙ Will the firm need to hire employees with new skills?Final PDF to printer
sch87956_ch07_141-166.indd 156 11/10/18 07:42 AM156 Part Two Formulating Technological Innovation StrategyCompetitors’ Capabilities ∙ Do one or more competitors have better capabilities for developing this project? ∙ If the company does not develop this technology, are competitors likely to? ∙ Will the company be able to protect its intellectual property through patents, copy-right, trademarks, or trade secrets? ∙ Should the firm seek to form a collaboration with a potential competitor?Future Capabilities ∙ Will the project help the firm build new capabilities that will allow it to achieve its strategic intent? ∙ What other products/markets will the new capabilities enable the firm to develop? ∙ Is this project a platform that will lead to a family of new products?Project Timing and CostTiming ∙ How long will the project take to complete? ∙ Is the firm likely to be first to market? Is pioneering the technology a desirable strategy? ∙ Is the market ready for the product? (For example: Are enabling and complementary technologies well developed? Will customers perceive the value of the technology?) ∙ If the firm misses its target deadlines, what impact will this have on the potential value of the project? ∙ Are there already appropriate suppliers and distribution channels?Cost Factors ∙ How much will the project cost? What is the potential variability in these costs? ∙ What will the manufacturing costs be? At what rate are these costs expected to decline with experience? ∙ Will the firm need to bear other costs related to customer adoption (e.g., production of complements, installation, technical support, etc.)?After creating a list of questions, managers can use the questions to structure debate about a project, or they can create a scoring mechanism (such as a scaled response to each question such as “Project fits closely with existing competencies” to “Project fits poorly with existing competencies”) that can then be weighted according to impor-tance and used in subsequent analysis.While screening questions such as the ones above do not always provide concrete answers about whether or not to fund a project, they enable a firm to consider a wider range of issues that may be important in the firm’s development decisions. Consider Boeing’s development of the Sonic Cruiser, a supersonic jet that was designed by Boeing, but never made it off the drawing board. Boeing continued designing the air-craft even after it became clear that the jet would not be profitable because Boeing con-sidered the project necessary for preserving the company’s development capabilities. Final PDF to printer
sch87956_ch07_141-166.indd 157 11/10/18 07:42 AMChapter 7 Choosing Innovation Projects 157As noted by Walt Gillette, Boeing’s development program manager, “If the company doesn’t create a new airplane every 12 to 15 years, the needed skills and experience will be gone. Too many of the people who created the last new airplane will have retired or moved on to other companies, and their skills and experience will not have been passed on to the next generation of Boeing employees.”14 Thus, Boeing’s development of the Sonic Cruiser is expected to be valuable to the firm even if the only return from the proj-ect is the enhancement of the firm’s development capabilities. Such value would be dif-ficult to assess via quantitative methods, but is revealed clearly by qualitative analysis.The Aggregate Project Planning FrameworkMany companies find it valuable to map their R&D portfolio according to levels of risk, resource commitment, and timing of cash flows. Managers can use this map to compare their desired balance of projects with their actual balance of projects.15 It can also help them to identify capacity constraints and better allocate resources.16 Companies may use a project map (similar to that depicted in Figure 7.5) to aid this process. Four types of development projects commonly appear on this map—advanced R&D, breakthrough, platform, and derivative projects. Over time, a particular technology may migrate through these different types of projects. Advanced R&D projects are the precursor to commercial development projects and are necessary to develop cutting-edge strategic technologies. Breakthrough projects involve development of products that incorporate revolutionary new product and process technologies. For example, while Honda’s work on hydrogen fuel cells might be considered an advanced R&D project since it is still a significant dis-tance from a commercial application, the company’s development of its original hybrid-electric vehicle, the Insight, would be considered a breakthrough project. The Honda Insight incorporated revolutionary new technology in a commercialized application.Platform projects typically offer fundamental improvements in the cost, quality, and performance of a technology over preceding generations. Derivative projects involve FIGURE 7.5The Project MapSource: Steven C. Wheelwright and Kim B. Clark from Revolutionizing Product Development: Quantum Leaps in Speed, Efficiency, and Quality.ProcessChangeProduct ChangeNew CoreProductDerivativeEnhancementsNext-GenerationProductAddition toProduct FamilyAdvancedR&D Projects+–New CoreProcessNext-GenerationProcessSingleDepartment UpgradeIncrementalChange+–BreakthroughProjectsPlatform ProjectsDerivative ProjectsFinal PDF to printer
sch87956_ch07_141-166.indd 158 11/10/18 07:42 AM158 Part Two Formulating Technological Innovation Strategyincremental changes in products and/or processes. A platform project is designed to serve a core group of consumers, whereas derivative projects represent modifications of the basic platform design to appeal to different niches within that core group. For example, Hunter’s Care Free humidifier is a platform that offers several derivative versions to appeal to different customer segments. The water storage tank comes in different sizes (e.g., 2.0 gallon, 2.5 gallon, 3.0 gallon); some models include a digital humidistat; and some also include Nite Glo lights. However, all of the models are based on the same Permawick filter design and fan system. Similarly, Toyota’s Camry is a platform for a family of car models that includes the Camry LE, Camry SE, and Camry XLE. While all the models are based on the same basic design, each offers a different combination of features to appeal to different market segments. These varia-tions on the Camry theme are derivative products.Companies that use the project map categorize all their existing projects and projects under consideration by the resources they require (e.g., engineers, time, capital, etc.) and by how they contribute to the company’s product line. The company can then map the project types and identify gaps in the development strategy.17 Managers can also use the map to identify their desired mix of projects, and allocate resources accordingly. The mix of projects represented on such a map should be consistent both with the company’s resources, strategic position, and with its strategic intent (as analyzed in Chapter Six). For example, a typical firm experiencing moderate growth might allocate 10 percent of its R&D budget to breakthrough innovation, 30 percent to platform projects, and 60 percent to derivative projects. A firm pursuing more significant growth might allocate higher per-centages to breakthrough and platform projects, while a firm that needs to generate more short-term profit might allocate a higher percentage to derivative projects.18 Respondents to a recent survey administered by the Product Development and Management Asso-ciation indicated that roughly 8 percent of their projects were breakthrough or advanced R&D projects, 17 percent were platform projects, and 75 percent were derivative projects.Mapping the company’s R&D portfolio encourages the firm to consider both short-term cash flow needs and long-term strategic momentum in its budgeting and planning. For instance, a firm that invests heavily in derivative projects that may be immediately commercialized with little risk may appear to have good returns on its R&D investment in the short run, but then be unable to compete when the market shifts to a newer technology. On the other hand, a firm that invests heavily in advanced R&D or breakthrough projects may be on the leading edge of technology, but run into cash flow problems from a lack of revenues generated from recently commercialized platform or derivative projects. As once noted by Jack Welch, former CEO of General Electric, “You can’t grow long term if you can’t eat short term. Anyone can manage short. Anyone can manage long. Balancing those two things is what management is.”19This is poignantly illustrated in the pharmaceutical industry, where high project fail-ure rates, long product development cycles, and reliance on patent protection can cause a firm to suddenly find it has a devastating gap in its product pipeline. Studies indicate that developing a new drug takes an average of 12 years and can cost as much as $2  billion by the time a product makes it through clinical trials. In 2017, many of the world’s largest pharmaceutical companies were facing a “patent cliff” as the patents were expir-ing on many of their blockbuster drugs, exposing the firms to much heavier competi-tion from generics. Furthermore, traditional pharma companies were beginning to be Final PDF to printer
sch87956_ch07_141-166.indd 159 11/10/18 07:42 AMChapter 7 Choosing Innovation Projects 159exposed to more competition from “biologics,” treatments developed by biotech firms. This situation creates intense volatility in the revenues of a firm, which creates enormous pressures on the firm (including managing staffing, manufacturing capacity, managing R&D funds, and more). As a result, many pharmaceutical firms have begun shifting their emphasis to lower volume, specialty drugs that could potentially be more profitable because they would require less marketing investment and face less competition.Q-SortQ-sort is a simple method for ranking objects or ideas on a number of different dimen-sions. The Q-sort method has been used for purposes as diverse as identifying personal-ity disorders to establishing scales of customer preferences. Individuals in a group are each given a stack of cards with an object or idea on each card. In the case of new prod-uct development, each card could identify a potential project. Then a series of project selection criteria are presented (e.g., technical feasibility, market impact, fit with stra-tegic intent), and for each criterion, the individuals sort their cards in rank order (e.g., best fit with strategic intent) or in categories (e.g., technically feasible versus infeasible) according to that criterion. Individuals then compare their rank orderings and use these comparisons to structure a debate about the projects. After several rounds of sorting and debating, the group is expected to arrive at a consensus about the best projects.20COMBINING QUANTITATIVE AND QUALITATIVE INFORMATIONAs demonstrated above, both quantitative methods and qualitative methods offer a number of benefits to managers in choosing development projects. Thus, many firms use a com-bination of methods to arrive at an investment decision.21 For example, a firm might have screening questions that require quantitative analysis in addition to qualitative responses. Firms might also use quantitative methods to estimate the cash flows anticipated from a project when balancing their R&D portfolio on a project map. There are also valuation techniques that attempt to translate qualitative assessments into quantitative measures, such as conjoint analysis and data envelopment analysis, as discussed below.Conjoint AnalysisConjoint analysis is a family of techniques (including discrete choice, choice modeling, hierarchical choice, trade-off matrices, and pairwise comparisons) used to estimate the specific value individuals place on some attribute of a choice, such as the relative value of features of a product or the relative importance of different outcomes of a development project. While individuals may find it very difficult to accurately assess the weight they put on individual attributes of a decision, conjoint analysis enables these weights to be derived statistically. Conjoint analysis enables a subjective assessment of a complex decision to be decomposed into quantitative scores of the relative importance of different criteria.The most common use of conjoint analysis is to assess the relative importance to customers of different product attributes—these values can then be used in develop-ment and pricing decisions. For example, potential customers might be given a series of cards describing different models of a camera with different features and prices. The individuals are then asked to rate each in terms of its desirability (e.g., on a scale conjoint analysisA family of techniques that enables assess-ment of the weight individu-als put on differ-ent attributes of a choice.Final PDF to printer
160sch87956_ch07_141-166.indd 160 11/10/18 07:42 AMIn the mid-1980s, Marriott was facing a nearly saturated market for full-service, upscale hotels. Marriott’s man-agers knew that the only way to sustain the company’s 20  percent annual sales growth rate was to expand its product line. Marriott’s management believed there was a market opportunity in the moderately priced ($35 to $60 a night) hotel category. The dominant chains in this category (e.g., Holiday Inn, Howard Johnson) tended to receive poor marks for customer satisfaction, and Marriott’s managers believed that a chain that provided newer facilities and more consistent service would be enthusiastically received by customers. They also knew, however, that the compa-ny’s most valuable resource was its well- established brand name, and they were reluctant to hastily affix the Marriott name to a scaled-down version of its hotels.The company constructed a carefully structured plan for evaluating potential designs for a midprice hotel line. The company first conducted focus groups to identify different customer segments and the major factors that influenced their purchase decisions. The factors identi-fied included external surroundings, room, food, lounge, services, leisure activities, and security. Within each major factor, there were several specific attributes that could take on multiple levels of product or service qual-ity. For example, within the “services” factor, one of the attributes was “reservations,” and the company had two levels: “call the hotel directly” or “call an 800 reserva-tion number.” A sample of hotel customers was selected to participate in a research group whereby each partici-pant was given a fictional $35 with which to build his or her own hotel. Each participant was given seven cards (one card for each of the major factors identified above). On the card was listed each of the specific attributes and their possible levels, along with a price for each level. The participants would evaluate one card at a time, selecting the features they desired. If participants went over the $35 budget, they were required to eliminate some features or choose a less expensive level of ser-vice. This technique helped management understand customer priorities and the trade-offs made by differ-ent customer segments. On the basis of these priorities, the managers then developed a series of hotel profiles offering different combinations of features and levels of service. Participants were then asked to rate each of these profiles. The managers could then use regression to assess how different levels of service within a specific attribute influenced customer ratings of the hotel over-all. For example, as illustrated in Figure 7.6, after the hotel profiles are rated by the participants, the values for the levels in the profiles and the participant ratings can be entered into a spreadsheet. The ratings can then be regressed on the attribute levels, yielding a model that estimates the relative importance of each attribute.On the basis of their conjoint analysis, Marriott’s managers came up with the Courtyard concept: rela-tively small hotels (about 150 rooms) with limited ameni-ties, small restaurants, small meeting rooms, enclosed courtyards, high-security features, well-landscaped exteriors, and significantly lower room rates than its tra-ditional Marriott hotels. Courtyard by Marriott turned out to be very successful. By the end of 2017, there were 1145 Courtyard hotels (508 of those were in the United States), and their average occupancy rate of more than 70 percent was well above the industry average.Theory in Action Courtyard by Marriottcontinuedof 1 to 10) or asked to order the models in terms of which they would most likely buy. Multiple regression is then used to assess the degree to which each attribute influences the overall rating, resulting in the assignment of specific weights to individual crite-ria. These weights provide a quantitative assessment of the trade-offs that customers implicitly consider in their evaluation of products. The firm can then use these weights in a series of “what if” scenarios to consider the implications of different product configurations. For example, Marriott used conjoint analysis to determine what fea-tures customers would most value in a moderately priced hotel. This analysis enabled Marriott to develop its very successful line of Courtyard by Marriott hotels (see the accompanying Theory in Action).Final PDF to printer
concluded161sch87956_ch07_141-166.indd 161 11/10/18 07:42 AMData Envelopment AnalysisData envelopment analysis (DEA) is a method of assessing a potential project (or other decision) using multiple criteria that may have different kinds of measure-ment units.22 For instance, for a particular set of potential projects, a firm might have cash flow estimates, a ranking of the project’s fit with existing competen-cies, a ranking of the project’s potential for building desired future competencies, a score for its technical feasibility, and a score for its customer desirability. Each of these measures captures something that is qualitatively different, and the numbers assigned to them are based on different units of measure. While the first measure is in dollars and is a nearly continuous measure, the second two measures are rank orders and thus are categorical measures with little information about what the dif-ference is between one level of rank and another. The last two measures are scores that might be based on a ranking system or scaling system (e.g., a Likert measure that goes from one to seven).data envelop-ment analysis (DEA)A method of ranking projects based on mul-tiple decision criteria by comparing them to a hypotheti-cal efficiency frontier.FIGURE 7.6Hotel Profiles and Ratings for Conjoint AnalysisAttributesReservationsRoom ServiceNewspaper Delivery(others)Overall Rating (1–10)Participant 1 Hotel Profile 11508 Hotel Profile 20317 Hotel Profile 31105Participant 2 Hotel Profile 11507 Hotel Profile 20319 Hotel Profile 31104 (others)Hotel Profile 1Hotel Profile 2Hotel Profile 3. . .Reservations1–800 number (1)Call hotel directly (0)1–800 number (1)Room ServiceFull-menu, 24 hours a day (5)Limited menu, offered 6 A.M. to midnight (3)No room service (1)Newspaper DeliveryNone (0)Daily (1)None (0)(others)Source: Adapted from R. J. Thomas, New Product Success Stories (New York: John Wiley & Sons, 1995).Final PDF to printer
sch87956_ch07_141-166.indd 162 11/10/18 07:42 AM162 Part Two Formulating Technological Innovation StrategyData envelopment analysis uses linear programming to combine these different measures from the projects to create a hypothetical efficiency frontier that represents the best performance on each measure. It can also consider which measures are inputs (such as costs) versus outputs (expected benefits). It then measures the distance of each project from this frontier to give it an efficiency value. These values can then be used to rank-order the projects or identify projects that clearly dominate others.23 For example, Figure 7.7 shows a DEA ranking of projects evaluated by the Advanced Technologies Group of Bell Laboratories. The Advanced Technologies Group chose to evaluate projects in terms of three measures of discounted cash flows expected from the project (most likely, optimistic scenario, pessimistic scenario), the invest-ment required, and each project’s desirability from the perspective of intellectual property benefits and product market benefits. For the latter two measures, projects were given a score of 1, 1.5, or 2.25 based on the group’s model for intellectual prop-erty and product market benefits. These scores reflect this particular group’s scoring system—it would be just as appropriate to use a scaled measure (e.g., 1 = very strong intellectual property benefits, to 7 = no intellectual property benefits), or other type of measure used by the firm. As shown, the DEA method enabled Bell Laboratories to rank-order different projects, despite the fact that they offered different kinds of benefits and risks.The biggest advantage of DEA is that it enables comparisons of projects using mul-tiple kinds of measures. However, just as with several of the methods described pre-viously, the results of DEA are only as good as the data utilized. Managers bear the responsibility of determining which measures are most important to include and of ensuring that the measures are accurate.efficiency frontierThe range of hypothetical configurations that optimize a combination of features.FIGURE 7.7DEA Ranking of the Advanced Technologies Group’s 10 Most Attractive Projects and Every 50th Project ThereafterSource: Adapted from J. D. Linton, S. T. Walsch, and J. Morabito, “Analysis, Ranking and Selection of R&D Projects in a Portfolio,” R&D Management 32, no. 2 (2002), pp. 139–48.RankIntellectual PropertyProduct MarketInvestmentCash Flow (most likely)Cash Flow (optimistic)Cash Flow (pessimistic)12.251.5$4322$1,296,700$1,353,924$1,184,19221.51.5850525,844551,538493,91231.51.5144342.252.25478545,594822,164411,08251.51.5115151161.52.256589,144178,289071.51.51068685,1161,027,386342,55881.51.5437664707282491.51.52048004800−96101.52.252232718501.52.259116139931001.51.5156072481502.252.2540553113,82927662002.251.5389013545Final PDF to printer
sch87956_ch07_141-166.indd 163 11/10/18 07:42 AMChapter 7 Choosing Innovation Projects 163 1. Firms often use a combination of quantitative and qualitative methods to evaluate which projects should be funded. Though some methods assume that all valuable projects will be funded, resources are typically constrained and firms must use capital rationing. 2. The most commonly used quantitative methods of evaluating projects are dis-counted cash flow methods such as net present value (NPV) or internal rate of return (IRR). While both methods enable the firm to create concrete estimates of returns of a project and account for the time value of money, the results are only as good as the cash flow estimates used in the analysis (which are often unreliable). Both methods also tend to heavily discount long-term or risky projects and can undervalue projects that have strategic implications that are not well reflected by cash flow estimates. 3. Some firms now use a real options approach to assess projects. Real options better account for the long-run strategic implications of a project. Unfortunately, many new product development investment decisions do not conform to the assump-tions inherent in an options valuation approach. 4. One commonly used qualitative method of assessing development projects is to subject the project to a series of screening questions that consider the project from multiple angles. These questions may be used merely to structure the discussion of a project or to create rating scales that are then utilized in an approach that com-bines qualitative and quantitative assessment. 5. A company’s portfolio of projects typically includes projects of different types (e.g., advanced R&D, breakthrough, platform, and derivative projects) that have different resource requirements and different rates of return. Companies can use a project map to assess what their balance of projects is (or should be) and allocate resources accordingly. 6. Q-sort is a qualitative method of assessing projects whereby individuals rank each project under consideration according to a series of criteria. Q-sort is most com-monly used to provide a format for discussion and debate. 7. Conjoint analysis is a method of converting qualitative assessments of a choice into quantitative weights of the different criteria underlying the choice. It is most often used for assessing how customers value different product attributes. 8. Data envelopment analysis (DEA) is another method that combines qualitative and quantitative measures. DEA enables projects that have multiple criteria in different measurement units to be ranked by comparing them to a hypothetical efficiency frontier.Summary of Chapter 1. What are the advantages and disadvantages of discounted cash flow methods such as NPV and IRR? 2. For what kind of development projects might a real options approach be appropri-ate? For what kind of projects would it be inappropriate? 3. Why might a firm use both qualitative and quantitative assessments of a project?Discussion QuestionsFinal PDF to printer
sch87956_ch07_141-166.indd 164 11/10/18 07:42 AM164 Part Two Formulating Technological Innovation Strategy 4. Identify a development project you are familiar with. What methods do you believe were used to assess the project? What methods do you believe should have been used to assess the project? 5. Will different methods of evaluating a project typically yield the same conclusions about whether to fund its development? Why or why not?ClassicsAmram, M., and N. Kulatilaka, Real Options: Managing Strategic Investment in an Uncertain World (Boston, MA: Harvard Business School Press, 1999).Brunner, D., L. Fleming, A. MacCormack, and D. Zinner, “R&D Project Selection and Portfolio Management: A Review of the Past, a Description of the Present, and a Sketch of the Future,” in Handbook of Technology and Innovation Management, ed. S. Shane (West Sussex, England: Wiley & Sons, 2008).Danneels, E., and E. J. Kleinschmidt, “Product Innovativeness from the Firm’s Per-spective: Its Dimensions and Their Relation with Project Selection and Performance,” Journal of Product Innovation Management 18 (2001), pp. 357–373.Ding, M., and J. Eliashberg, “Structuring the New Product Development Pipeline,” Management Science 48 (2002), pp. 343–63.Wheelwright, S. C., and K. B. Clark, “Creating Project Plans to Focus Product Devel-opment,” Harvard Business Review, March–April 1992, pp. 67–82.Recent WorkBessant, J., B. von Stamm, K. M. Moeslein, and A. Neyer, “Backing Outsiders: Selection Strategies for Discontinuous Innovation,” R&D Management 40 (2010), pp. 345–356.Klingebiel, R., and C. Rammer, “Resource Allocation Strategy for Innovation Portfolio Management,” Strategic Management Journal, 35 (2014):246–68.Nagji, B., and G. Tuff, “Managing Your Innovation Portfolio,” Harvard Business Review, May (2012).Schilling, M. A., “What’s Your Best Innovation Bet?” Harvard Business Review (July–August 2017) 86–93.Suggested Further Reading 1. B. Kogut and N. Kulatilaka, “Options Thinking and Platform Investments: Investing in Oppor-tunity,” California Management Review 36, no. 2 (1994), pp. 52–72. 2. Ibid. 3. M. Amram and N. Kulatilaka, Real Options: Managing Strategic Investment in an Uncer-tain World (Boston: Harvard Business School Press, 1999); and K. D. Miller and T. B. Folta, “Option Value and Entry Timing,” Strategic Management Journal 23 (2002), pp. 655–65. 4. G. Mitchell and W. Hamilton, “Managing R&D as a Strategic Option,” Research Technology Management 31, no. 3 (1988), pp. 15–23. 5. S. A. Ross, R. W. Westerfield, and B. D. Jordan, Fundamentals of Corporate Finance (Boston: Irwin, 1993). 6. M. Amran and N. Kulatilaka, Real Options (Boston: Harvard Business School Press, 1999); F. P. Boer, “Valuation of Technology Using Real Options,” Research Technology Management EndnotesFinal PDF to printer
sch87956_ch07_141-166.indd 165 11/10/18 07:42 AMChapter 7 Choosing Innovation Projects 16543 (2000), pp. 26–31; and R. T. McGrath, “Assessing Technology Projects Using Real Options Reasoning,” Research Technology Management 43 (July–August, 2000), pp. 35–50. 7. M. Benaroch and R. Kauffman, “Justifying Electronic Banking Network Expansion Using Real Options Analysis,” MIS Quarterly 24 (June 2000), pp. 197–226. 8. M. Perlitz, T. Peske, and R. Schrank, “Real Options Valuation: The New Frontier in R&D Eval-uation?” R&D Management 29 (1999), pp. 255–70. 9. E. H. Bowman and D. Hurry, “Strategy through the Option Lens: An Integrated View of Resource Investments and the Incremental-Choice Process,” Academy of Management Review 18 (1993), pp. 760–82. 10. M. A. Schilling, “Technological Lock Out: An Integrative Model of the Economic and Strategic Factors Driving Success and Failure,” Academy of Management Review 23 (1998), pp. 267–85. 11. T. Chan, J. A. Nickerson, and H. Owan, “Strategic Management of R&D Pipelines,” Washing-ton University working paper, 2003. 12. F. Vermeulen, 2011, “Five mistaken beliefs business leaders have about innovation.” Forbes, May 30th. ( 13. K. R. Allen, Bringing New Technology to Market (Upper Saddle River, NJ: Prentice Hall, 2003). 14. L. Gunter, 2002, “The Need for Speed,” Boeing Frontiers. Retrieved November 20, 2002, from 15. Y. Wind and V. Mahajan, “New Product Development Process: A Perspective for Reexamina-tion,” Journal of Product Innovation Management 5 (1988), pp. 304–10. 16. C. Christenson, “Using Aggregate Project Planning to Link Strategy, Innovation, and the Resource Allocation Process,” Note no. 9-301-041 (2000), Harvard Business School. 17. S. C. Wheelwright and K. B. Clark, “Creating Project Plans to Focus Product Development,” Harvard Business Review, March–April 1992. 18. C. Christenson, “Using Aggregate Project Planning to Link Strategy, Innovation, and the Resource Allocation Process.” 19. J. A. Byrne, “Jack,” BusinessWeek, June 8, 1998, p. 90. 20. Allen, Bringing New Technology to Market; and A. I. Helin and W. B. Souder, “Experimental Test of a Q-Sort Procedure for Prioritising R&D Projects,” IEEE Transactions on Engineering Management EM-21 (1974), pp. 159–64. 21. R. G. Cooper, S. J. Edgett, and E. J. Kleinschmidt, “New Product Portfolio Management: Prac-tices and Performance,” Journal of Product Innovation Management 16 (1999), pp. 333–51. 22. A. W. Charnes, W. Cooper, and E. Rhodes, “Measuring the Efficiency of Decision Making Units,” European Journal of Operational Research 2 (1978), pp. 429–44. 23. J. D. Linton, S. T. Walsch, and J. Morabito, “Analysis, Ranking and Selection of R&D Projects in a Portfolio,” R&D Management 32, no. 2 (2002), pp. 139–48.Final PDF to printer
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167sch87956_ch08_167-196.indd 167 11/09/18 11:17 AMChapter EightCollaboration StrategiesEnding HIV? Sangamo Therapeutics and Gene EditingIn 1995, Edward Lanphier founded Sangamo Biosciences for the purpose of developing zinc-finger nucleases (ZFNs), a technology that could edit the genetic code of a living individual to correct genetically based diseases (e.g., hemophilia, sickle cell anemia, Huntington’s disease, and many others) or to confer genetic resistance to non genetically based diseases.ZFNs work by cutting the DNA in a chosen spot. The cell then typically attempts to repair the cut by either by polishing the two ends of DNA and seal-ing them back together or by copying the corresponding section of DNA in the other half of the chromosome pair. Since many diseases occur because of a gene on a single half of the chromosome pair, this “homologous substitution” from the other chromosome corrects the faulty gene. Alternatively, scientists can even provide a template gene sequence that they want to use to substitute for the cleaved portion of the DNA (see Figure 1).Gene editing offered a radical new way to cure or prevent diseases, but it required a significant amount of R&D work both to develop ZFNs that were pre-cise and reliable enough to safely edit human genes and to develop a delivery mechanism that would ensure the ZFNs penetrated enough of an individual’s cells to make a difference. Clinical trials to establish the treatment’s safety and efficacy to get FDA approval would also be a huge hurdle to overcome.Since none of Sangamo’s products were commercially available yet, the com-pany was entirely reliant upon grants and funding from partners for its survival. Though the company’s ZFN technology had been overshadowed in the press by CRISPR-Cas9 in the last few years, interest in ZFNs appeared to be heating back up. In early 2018, Gilead Sciences signed a $3 billion deal with Sangamo to develop a ZFN-based method of harnessing a patient’s own immune system to battle cancer,a and Case Western University had received an $11 million grant from the U.S. National Institute of Health work with Sangamo on its HIV program.b The company was already almost a year into Phase II testing of one of its HIV programs—was Sangamo at the precipice of curing HIV? And if so, did it make more sense to try to commercialize the drug alone or to work with a partner?Final PDF to printer
sch87956_ch08_167-196.indd 168 11/09/18 11:17 AM168 Part Two Formulating Technological Innovation StrategyCorrecting Monogenic DiseasesMonogenic diseases are diseases that are caused by a defect in a single gene. One example is hemophilia. People with hemophilia lack sufficient clotting factors in their blood, resulting in them bleeding longer after an injury. Internal bleeding, in particular, can cause significant damage and be life threatening. Individuals with hemophilia need regular infusions to replace the clotting factor in their blood. Sangamo’s ZFN treatment offered the hope of a cure, rather than lifelong treatment.c Sangamo had already demonstrated that its ZFN method for treat-ing hemophilia worked in mice and was preparing to file an application to begin clinical trials. Sangamo also had developed treatments for sickle cell anemia and beta thalassemia, also monogenic diseases. Normally, patients with sickle cell anemia or beta thalassemia require lifelong care or bone marrow transplants, at great expense and risk. Sangamo, however, had shown in the laboratory that its treatment could knock out the BCL11A gene causing these diseases.Another example of a monogenic disease is Huntington’s Disease (HD). HD is a devastating neurologic disease in which people lose their motor coordina-tion, cognition, and memory. The disease is progressive and usually fatal within 10–20 years of onset. The disease is a result of a mutation in a single gene, the huntingtin gene that results in a greater-than-usual number of repeats of the CAG DNA sequence, resulting in a mutant form of the huntingtin protein accumulating FIGURE 1Gene Editing with NucleasesCutPasteLoss of fewbase pairsNonhomologous end joining(NHEJ)HomologousrecombinationGene repairDNA repair matrixPasteDNA repair matrixGene insertionknock inGene inactivationknock inNucleaseChromosomeFinal PDF to printer
sch87956_ch08_167-196.indd 169 11/09/18 11:17 AMChapter 8 Collaboration Strategies 169in cells. Most individuals inherit only one copy of the faulty gene, and it takes only one copy to produce the disease. Furthermore, 50 percent of the children of an HD sufferer also inherit the disease. Though previous research had explored ways to decrease the huntingtin protein in cells, it turned out that the normal form of the protein is essential, and mice lacking the normal huntingtin protein died before birth. Sangamo, however, developed a ZFN method to identify and “turn off” only the faulty gene. This meant that an individual would have only one operational copy of the gene which would continue to produce the normal form of the huntingtin protein.Whereas there were treatments available that could at least stop or slow the progression of hemophilia, sickle cell anemia, and beta thalassemia, there were no such treatments for Huntington’s—nothing had been found that could halt its progression. Thus, Sangamo’s presentation of promising results for its HD treatment was big news—its success could mean the difference between life and death for sufferers of HD.Drug Development and Clinical TrialsDrug development is hugely expensive and risky. Most studies indicate that it costs at least $1.5 billion and a decade of research to bring a new Food and Drug Administration (FDA)–approved pharmaceutical product to market.d The statistics on drug development costs are, in fact, an understatement because they do not fully account for the costs of the many failed drugs that are aban-doned earlier in the development process. In the pharmaceutical industry, only one out of every 5000 compounds tested makes it to the pharmacist’s shelf, and only one-third of those will be successful enough to recoup the investment in researching and developing the original 5000 compounds. Accounting for investment in failed drug efforts suggests that the cost of drug development is much higher than is typically reported. A study of R&D spending and new drug approvals published in Forbes in 2012, for example, found that firms spent over $6 billion per approved drug (see Table 1).e,fMost studies suggested that the biggest cost in drug development was the cost of clinical trials—a cost that is borne by the sponsoring organization (usually the company that developed the drug). To be approved by the FDA in the United States, most drugs have to go through several phases of trials. First, in preclinical studies, the company will usually assess the safety and efficacy of the drug using animals. In Phase 0 trials, a single dose (smaller than what would be used to provide the therapeutic treatment) is given to a small number (10 to15) of human subjects to evaluate what the drug does to the body. If successful, the drug may be entered into Phase 1 clinical trials, whereby the drug is given to a some-what larger group of people (20 to 80) to evaluate its safety, determine dosage ranges, and identify side effects. Phase 1 trials are primarily to assess the safety of the drug. In Phase 2 trials, the drug is given to larger groups of people (100 to 300) to evaluate its effectiveness and further evaluate its safety and side effects. Finally, in Phase 3, the drug is given to very large groups of subjects (1000 to 3000) to confirm its effectiveness compared to alternatives and gather still fur-ther information on its safety.Final PDF to printer
sch87956_ch08_167-196.indd 170 11/09/18 11:17 AM170 Part Two Formulating Technological Innovation StrategyFinally, if the drug successfully makes it through Phase 3 clinical trials, the sponsoring organization can apply for a New Drug Approval from the FDA. The entire process typically takes at least 10 to 12 years, costs hundreds of millions of dollars, and the vast majority of new drug projects do not make it through the process successfully.Competing TechnologiesAs if drug development was not risky enough, Sangamo also faced the threat that its ZFN technology would be rendered obsolete by other gene editing alternatives. In early 2018, two other gene editing alternatives were gaining traction: TALENs (transcription activator-like effector nucleases), and CRISPR-Cas9 ( clustered regularly interspaced short palindromic repeats). TALENs are like ZFNs in that they are special nucleases that identify and bind to a specific part of the DNA and cut the genome at a desired spot. The main difference between the two is how they identify the right DNA binding location. By 2018, ZFN technology was more mature and better developed, but TALEN technology was considered more straightforward to design treatments with, and thus many considered it to have an advantage in the longer term.h According to Stephen Ekker, director of the Mayo Addiction Research Center at the Mayo Clinic Cancer Center, while ZFNs had established the proof of principle for genome- editing technology, “TALENs . . . do most of what ZFNs do, but cheaper, faster and better.”i On the other hand, TALEN molecules were larger, which made them TABLE 1Research Spending and New Drug ApprovalsgCompanyNumber of Drugs ApprovedTotal R&D Spending 1997–2011 ($Mil)R&D Spending Per Drug ($Mil)AstraZeneca558,95511,790.93GlaxoSmithKline1081,7088170.81Sanofi863,2747909.26Roche Holding1185,8417803.77Pfizer14108,1787727.03Johnson & Johnson1588,2855885.65Eli Lilly & Co1150,3474577.04Abbott Laboratories835,9704496.21Merck & Co Inc1667,3604209.99Bristol-Myers Squibb Co1145,6754152.26Novartis2183,6463983.13Amgen Inc933,2293692.14AVERAGE11.5866,872.336199.85Final PDF to printer
sch87956_ch08_167-196.indd 171 11/09/18 11:17 AMChapter 8 Collaboration Strategies 171more difficult to deliver to chosen regions of the body (a particular challenge was getting gene editing nucleases past the blood–brain barrier for treatment of diseases such as Huntington’s). Since both technologies had advantages and disadvantages, their sponsors would have to race to get effective treatments to market ahead of each other.CRISPR-Cas9 was somewhat different. CRISPR technology harnessed a natural defense system of bacteria that has evolved to recognize and elimi-nate foreign DNA, giving bacteria “adaptive immunity.” CRISPR was even more simple and efficient than TALENs, fueling enormous excitement over its poten-tial. CRISPR-Cas9 was so simple and inexpensive, in fact, that high school and college students were learning to do gene editing in school. However, because CRISPR used a very short RNA sequence to guide its activity, some people worried that its effects wouldn’t be precise enough—that is, it could result in “off target” cleavages—a highly undesirable result!As of early 2018, CRISPR appeared to be the front runner, but a lengthy patent battle over rights to the CRISPR technology, along with the ease at which anyone could work with CRISPR had created some uncertainty about who would benefit financially from the technology. Sangamo’s ZFN technology was patented and had higher technological barriers to entry. These two traits posed both benefits and costs to the development of ZFN technology.Sangamo’s PartnershipsBiotechnology firms could spend years earning only losses while they devel-oped their treatments. Sangamo was no exception—it had yet to make any money from sale of its products. All of its revenues came from research grants and collaboration agreements, and it outspent those revenues in R&D, accumu-lating losses in each year. This highlights the challenging nature of drug devel-opment: Though the company had developed ground breaking treatments that could radically improve the lives of several different patient populations, it was financially quite vulnerable.As of 2018, Sangamo had only 182 full-time employees; it did not have the resources to do its own clinical testing, manufacturing, or marketing. For these stages of drug development, Sangamo would be reliant on partnerships with much larger firms. In addition to the partnerships with Gilead and Case West-ern University, Sangamo also had partnerships with Pfizer, Bioverativ, and Shire Pharmaceuticals.Pfizer was a New York City–based company with $53 billion in sales and almost 100,000 employees. It was one of the largest pharmaceutical compa-nies in the world. In May of 2017, Sangamo had entered into an R&D alliance and exclusive licensing agreement for Sangamo hemophilia A gene editing treatment. The deal included upfront payments and royalty payments worth about $545 million. Then in early 2018, Sangamo and Pfizer announced they had also signed a $162 million deal to work together to develop a treat-ment for the genetic version of amyotrophic lateral sclerosis (Lou Gherig’s Disease).j Pfizer had clinical testing, manufacturing, and sales capabilities all over the world.Final PDF to printer
sch87956_ch08_167-196.indd 172 11/09/18 11:17 AM172 Part Two Formulating Technological Innovation StrategyBioverativ, a spinoff of Biogen, was a Waltham Massachusetts–based bio-tech firm with about 400 employees. Bioverative was working with Sangamo on treatments for sickle cell anemia and beta thalassemia. Under the terms of the deal, Bioverative would give Sangamo $20 million upfront and Sangamo would be responsible for performing all of the R&D on the treatments until they could be proven to work on humans. Then Bioverative would take over with clinical tri-als, manufacturing and marketing, and Sangamo would get milestone payments of up to $300 million and double digit royalties if the products earned sales. In early 2018, Bioverativ was acquired by the French pharmaceutical company Sanofi. With more than 110,000 employees, Sanofi was slightly larger than Pfizer and also had clinical trials, manufacturing, and distribution capabilities all over the world.Shire was one of the United Kingdom’s largest specialty biopharmaceutical companies with just over $15 billion in revenues and about 22,000 employees in 2017. One of its main products was Lamivudine, an antiretroviral therapy used to treat HIV. Though the company earned the majority (70 percent) of its sales in North America, it had direct operations in about 30 countries and sold prod-ucts to more than 50 countries. Shire was known for being a highly acquisitive company, having acquired NPS pharmaceuticals, ViroPharma, Janssen Pharma-ceuticals, and Advanced BioHealing just in the last few years. Its two most well-known drugs were treatments for attention-deficit/hyperactivity disorder (ADHD): Vyvanse and Adderall.In January 2012, Sangamo entered into an agreement with Shire AG to fur-ther develop its ZNF treatments for hemophilia, Huntington’s disease, and other diseases. Like the Biogen deal, Shire agreed to pay Sangamo an upfront fee, plus milestone fees of up to $213.5 million for each of seven targets.k How-ever, in 2015 the firms revised their agreements so that Sangamo would have exclusive worldwide rights to the hemophilia treatments and Shire would have exclusive rights to the Huntington’s disease treatments.lA World-Changing Opportunity: Creating Immunity to HIVOne of the most exciting potential applications of ZFNs was creating a treatment that could cure HIV. In 2015, approximately 37 million people were living with HIV/AIDS worldwide Figure 2. However, a small percentage of people have a mutation in their CCR5 gene—a gene that makes a protein found on the surface of cells. The mutation makes it difficult for HIV to enter their cells. Individuals receive their genes in pairs—one on a specific chromosome from one parent, and another on the paired chromosome from the other parent. Individuals with one copy of the mutated gene have some protection against HIV infection and experience a less severe form of the disease if infection occurs. Individuals with two copies of the mutated CCR5 gene are typically immune to HIV. These gene mutations appear in up to 20 percent of people of European descent (scientists hypothesize that the gene mutation conferred resistance to the Bubonic plague or smallpox epidemics, leading this gene to be more prevalent in populations of people that survived such epidemics). People with the mutation appear to suffer no health problems from the mutation.Final PDF to printer
sch87956_ch08_167-196.indd 173 11/09/18 11:17 AMChapter 8 Collaboration Strategies 173FIGURE 2HIV/AIDS Worldwide, 2015Source: UNAIDS.05101520North America and Western and Central Europe2.4Latin America and the Caribbean2.0Middle East and North Africa0.23Western and Central Africa6.5Eastern Europe and Central Asia1.5Asia and Pacific5.1(in millions)Adults and children estimated to be living with HIV | 2015Total: 36.7 millionEastern and Southern Africa19.0The potential for exploiting the CCR5 mutation gained widespread attention when a study published in 2011 revealed that an AIDS patient with leukemia had received a bone marrow stem cell transplant from a donor with the CCR5 mutation and subsequently appeared to be cured of AIDS. After the bone mar-row transplant, the patient was able to discontinue all antiretroviral therapy and the virus did not reappear in his blood.mFinding a bone marrow match with a CCR5 mutation is extremely unlikely, and getting a bone marrow transplant is risky. Sangamo thus decided to use its ZFN gene editing technology to develop a simpler method by which individuals could be given the mutation. Early results released by Sangamo in 2014 were promising: The treatment appeared to be well-tolerated and reduced the viral load of several patients who had been taken off of their antiretroviral therapy for 12 weeks during the study.n However, the percent of cells showing the muta-tion declined over time, which meant further work needed to be done to find a way to modify enough of the patients’ genes for the therapy to be a reliable and permanent treatment.The Future . . .Sangamo clearly had a lot on its plate. It had revolutionary treatments in clinical trials for several major diseases, including the potential to create a cure for HIV Figure 3. In the short term, its business was focused on developing treatments Final PDF to printer
sch87956_ch08_167-196.indd 174 11/09/18 11:17 AM174 Part Two Formulating Technological Innovation Strategythrough early-stage clinical trials that it would hand over to partners who had deeper pockets and were better positioned to conduct late stage clinical tri-als, production, and marketing. However, in the long run, Sangamo wanted to be able to do all of its own clinical testing, production, and marketing, to better capture the value of its innovative technologies. Sangamo had no revenues from actual products—only grants from research foundations and cash from upfront fees paid by its licensing partners. It was also spending over $65 million a year on R&D, and posting huge losses, year after year. Sangamo thus had to carefully weigh the pros and cons of developing its HIV treatment alone.Discussion Questions 1. What were the pros and cons of Sangamo pursuing its gene editing pro-grams alone versus working with a partner? 2. Does the HIV program offer any special opportunities or challenges? 3. What do you think Sangamo should do regarding the HIV program? Should it license the technology to a large pharmaceutical? Should it form a joint venture with another biotech or pharma company? If so, who? a Mishra, M., “Sangamo in $3 Billion Gene-Editing Deal with Gilead,” Reuters, (February 22, 2018). b Suttell, S., “Case Western Reserve, California Tech Company Receive $11 million NIH Grant,” Crain’s Cleveland Business (February 7, 2018). c Hersher, R. 2012. A whole clot of hope for new hemophilia therapies. Nature Medicine. February 2. d See Joseph A. DiMasi & Henry G. Grabowski, The Costs of Biopharmaceutical R&D: Is Biotech Different? 28 Managerial & Decision Econ. 469, 469 (2007). e M Herper, The Truly Staggering Costs of Inventing New Drugs. Forbes, February 10th (2012).FIGURE 3Summary of Sangamo’s Research Programs and Drug PipelineSource: www .sangamo.comLead IndicationProgramResearchPreclinicalPhase 1 Phase 2Phase 3HIV (T cells)SB-728-THIV (HSCs)SB-728-HSPCHemophilia APfizerHemophilia BSB-FIXMPS ISB-318MPS IISB-913Beta Thalassemia BioverativSickle Cell DiseaseBioverativFabry DiseaseST-920Huntington’s DiseaseShireAlzheimer’s DiseaseSeeking partnerOncologyMultipleFinal PDF to printer
sch87956_ch08_167-196.indd 175 11/09/18 11:17 AMChapter 8 Collaboration Strategies 175OVERVIEWFirms frequently face difficult decisions about the scope of activities to perform in-house, and whether to perform them alone as a solo venture or to perform them col-laboratively with one or more partners. As mentioned in Chapter Two, a significant portion of innovation arises not from any single individual or organization, but instead from the collaborative efforts of multiple individuals or organizations. Collaboration can often enable firms to achieve more, at a faster rate, and with less cost or risk than they can achieve alone. However, collaboration also often entails relinquishing some degree of control over development and some share of the expected rewards of innovation, plus it can expose the firm to risk of malfeasance by its partner(s). In this chapter, we will first consider the reasons that a firm might choose to engage in col-laborative development or might choose to avoid it. We will then review some of the most common types of collaborative arrangements and their specific advantages and disadvantages.REASONS FOR GOING SOLOA firm might choose to engage in solo development of a project for a number of rea-sons. First, the firm may perceive no need to collaborate with other organizations—it may possess all the necessary capabilities and resources for a particular development project in-house. Alternatively, the firm may prefer to obtain complementary skills or resources from a partner, but there may be no available partner that is appropriate or willing to collaborate. A firm might also choose to develop a project as a solo venture if it is concerned that collaborating would put its proprietary technologies at risk, or if it seeks to have full control over the project’s development and returns. Furthermore, a firm’s solo development of a technological innovation might give it more opportuni-ties to build and renew its capabilities. f According to a study by the Manhattan Institute for Policy Research, the majority of the drug develop-ment expense is due to the extremely costly and time-consuming process of clinical trials: If analysis is limited to drugs that are ultimately approved by the FDA, Phase 3 clinical trials represented over 90  percent of the total cost of development (Project FDA Report, Manhattan Institute for Policy Research, No. 5, April 2012). g Herper, M. 2012. The Truly Staggering Costs of Inventing New Drugs. Forbes, February 10. h Gaj, T, Gersbach, CA, Barbas, CF III, “ZFN, TALEN, and CRISPR/Cas-based methods for genome engineering,” Trends Biotechnol, 31:397–405, July 2013; Pennisi, E, “The CRISPR Craze,” Science, 341:833–6, August 23, 2013. i J.M. Perkel. 2013. Genome editing with CRISPRs, TALENs, and ZFNs. Biocompare, August 27th. j A. Keown, “Sangamo, Pfizer Deepen Relationship with New $162M ALS R&D Pact,” Biospace, January 3, 2018. k Renauer, C. 2014. How Sangamo BioSciences, Inc. is partnering to success. The Motley Fool, January 29th. l Sangamo press release, 2015. m Allers, K, Hugger, G, Hoffman, J, Loddenkemper, C, Riger, K, Thiel, E & Schneider, T. 2011. Evidence for the cure of HIV infection by CCR5Δ32/Δ32 stem cell transplantation. Blood, 117:2791–9. n 2014. Gene editing of CCR5 in autologous CD4 T-cells of persons infected with HIV. New England Journal of Medicine, 370:897–906.Final PDF to printer
sch87956_ch08_167-196.indd 176 11/09/18 11:17 AM176 Part Two Formulating Technological Innovation Strategy1. Availability of CapabilitiesWhether a firm chooses to partner on a project is largely determined by the degree to which it possesses all of the necessary capabilities in-house and the degree to which one or more potential partners have necessary capabilities. If a firm has all of the nec-essary capabilities for a project, it may have little need to collaborate with others and may opt to go it alone. Furthermore, if a firm finds that it lacks certain required capa-bilities but there are also no potential partners with such capabilities, it may be forced to develop the capabilities on its own.For example, in the late 1970s Monsanto was interested in developing food crop seeds that were genetically modified to survive strong herbicides. Monsanto’s Roundup, a powerful herbicide, had been introduced in 1974 and had been remark-ably successful. However, Roundup killed almost all plants that it came into contact with and thus had to be applied with great care. If crops could be developed that were genetically modified to resist Roundup, the herbicide could be used more easily and in larger quantities. The biotechnology industry was still quite young, so there were no appropriate partners from which to acquire the necessary technologies. Monsanto decided to pursue the opportunity as a solo internal venture and declared that biotech-nology was its new strategic focus.1 In 1983, Monsanto successfully developed its first transgenic plant, but it would not be until 1995 that it would have its first geneti-cally modified crop seed, Roundup Ready soybeans, approved for commercialization.2 Though many environmental groups opposed both Roundup and the genetically modi-fied Roundup Ready crops, the combination was enormously successful. By 2002, more than 130 million acres worldwide were planted with Monsanto’s Roundup Ready soybean, corn, cotton, and canola seed.32. Protecting Proprietary TechnologiesFirms sometimes avoid collaboration for fear of giving up proprietary technologies. Working closely with a partner might expose the company’s existing proprietary technologies to the prying eyes of a would-be competitor. Furthermore, the firm may wish to have exclusive control over any proprietary technologies created during the development project. Consider Sangamo’s decision about whether to collaborate in its development of a gene editing approach to curing HIV as described in the opening case. While collaborating would give Sangamo needed cash and access to valuable testing, manufacturing, and marketing capabilities, it did not possess, collaborating also meant that it would have to share the profit, control, and reputational effects from developing the treatment.3. Controlling Technology Development and UseSometimes firms choose not to collaborate because they desire to have complete con-trol over their development processes and the use of any resulting new technologies. This desire might be for pragmatic reasons (e.g., the new technology is expected to yield high margins and the firm does not wish to share rents with collaborators) or cultural reasons (e.g., a company’s culture may emphasize independence and self-reliance). Both of these reasons are demonstrated by Honda in the development of its hybrid-electric vehicle, the Insight. While other auto manufacturers were enthusias-tically forming alliances to collaborate on automobile design and the development allianceAlliance is a general term that can refer to any type of relation-ship between firms. Alliances may be short or long term and may include for-mally contracted agreements or be entirely informal in nature.Final PDF to printer
sch87956_ch08_167-196.indd 177 11/09/18 11:17 AMChapter 8 Collaboration Strategies 177of more efficient manufacturing processes, Honda was very cautious about forming collaborative relationships. Honda’s decision not to join the Alliance of Automobile Manufacturers, the industry trade group that leads the fight against tougher fuel and emissions standards, had both pragmatic and cultural reasons. From a pragmatic stand-point, Honda worried that participating in the trade group would limit its discretion over its development of environmentally friendly automobiles, an area where Honda intended to be the market leader. This decision was reinforced by Honda’s culture that emphasized retaining complete control over the firm’s technology development and direction. This is illustrated by Honda President Hiroyuki Yoshino’s statement, “It’s better for a person to decide about his own life rather than having it decided by others.”44. Building and Renewing CapabilitiesFirms may also choose to engage in solo development even when partnering could save time or money because they believe that development efforts are key to building and renewing their capabilities. Solo development of a technological innovation challenges the firm to develop new skills, resources, and market knowledge. As noted in Chapter Seven, the potential for creating and enhancing the organization’s capabilities may be more valuable than the innovation itself. This is aptly demonstrated in a quote from Walt Gillette of Boeing about the development of the Sonic Cruiser: “Industry experi-ence indicates that if the company doesn’t create a new airplane every 12 to 15 years, the needed skills and experience will be gone. Too many of the people who created the last new airplane will have retired or moved on to other companies, and their skills and experience will not have been passed on to the next generation of Boeing employees.”5Though there are several reasons a firm might choose to stick with solo devel-opment, there are also many reasons for firms to engage in collaborative develop-ment, and collaboration appears to be on the rise. In the next sections, we will discuss the advantages of collaboration and the strengths and weaknesses of various types of collaboration.ADVANTAGES OF COLLABORATINGCollaborating on development projects can offer a firm a number of advantages, including faster speed to market, greater flexibility, learning capabilities from other firms, and building a coalition around a standard.1. Acquiring Capabilities and Resources QuicklyIt is not unusual for a company to lack some of the complementary assets required to transform a body of technological knowledge into a commercial product. Given time, the company can develop such complementary assets internally. However, doing so extends cycle time.6 Instead, a company may be able to gain rapid access to important complementary assets by entering into strategic alliances or licensing arrangements.7 For example, when Apple was developing its LaserWriter, a high-resolution laser printer, it did not possess the technological expertise to produce the printer’s engine, and developing such capabilities in-house would have taken a long time. Apple per-suaded Canon, the market leader in printer engines, to collaborate on the project.8 With Canon’s help, Apple was able to bring the high-quality printer to market quickly.Final PDF to printer
sch87956_ch08_167-196.indd 178 11/09/18 11:17 AM178 Part Two Formulating Technological Innovation Strategy2. Increasing FlexibilityObtaining some of the necessary capabilities or resources from a partner rather than building them in-house can help a firm reduce its asset commitment and enhance its flexibility. This can be particularly important in markets characterized by rapid tech-nological change. High-speed technological change causes product markets to rapidly transform. Product life cycles shorten, and innovation becomes the primary driver of competition. When technology is progressing rapidly, firms may seek to avoid com-mitting themselves to fixed assets that may rapidly become obsolete. They may choose to become more narrowly specialized and to use linkages with other specialized firms to access resources they do not possess in-house.3. Learning from PartnersCollaboration with partners can be an important source of learning for the firm. Close contact with other firms can facilitate both the transfer of knowledge between firms and the creation of new knowledge that individual firms could not have created alone.9 By pooling their technological resources and capabilities, firms may be able to expand their knowledge bases and do so more quickly than they could without collaboration.4. Resource and Risk PoolingOne primary reason firms collaborate on a development project is to share the costs and risks of the project. This can be particularly important when a project is very expensive or its outcome highly uncertain.105. Building a Coalition around a Shared StandardFirms may also collaborate on a development project when such a collaboration would facilitate the creation of a shared standard. For example, as of early 2018, there were four major electric vehicle charging standards competing in the market: CHAdeMO (used by most of the Japanese electric vehicle manufacturers), SAE Combined Charg-ing System (used by most of the major European electric vehicle manufacturers plus General Motors and Ford in the United States), GB/T (used by Chinese electric vehi-cle manufacturers such as BYD, SAIC, and Dongfeng), and Tesla Supercharger (used by Tesla). Globally, in 2018 there were about 7000 CCS charging stations, 16,639 CHAdeMO charging stations (mostly in Japan and Europe), 8496 Tesla Superchargers (mostly in the United States), and 127,434 GB/T charging stations (all in China). In late 2017, Daimler, BMW, Ford, and Volkswagen group announced they would form the Charging Interface Initiative (CharIN) to collaborate on building CCS charging stations, hoping to build momentum for the standard. Tesla, meanwhile, had hedged its bets by releasing its patents on the Supercharger standard so that others could adopt it, and joining both the CharIN and CHAdeMO alliances. Furthermore, Tesla had created adapters for its vehicles for both the CHAdeMO and GB/T standards.11TYPES OF COLLABORATIVE ARRANGEMENTSCollaboration can include partnering with suppliers, customers, competitors, comple-mentors, organizations that offer similar products in different markets, organizations that offer different products in similar markets, nonprofit organizations, government Final PDF to printer
sch87956_ch08_167-196.indd 179 11/09/18 11:17 AMChapter 8 Collaboration Strategies 179organizations, universities, or others. Collaboration can also be used for many different purposes, including manufacturing, services, marketing, or technology-based objectives. In North America, as many as 23 percent of all alliances are for research and develop-ment activities, compared to 14 percent in Western Europe and 12 percent in Asia.12Collaboration arrangements can also take many forms, from very informal alliances to highly structured joint ventures or technology exchange agreements (licensing). The most common forms of collaborative arrangements used in technological innova-tion include strategic alliances, joint ventures, licensing, outsourcing, and collective research organizations.Strategic AlliancesA strategic alliance is a temporary relationship that can take many forms. It can be formalized in a contract or an informal agreement. It can be a short-term agreement or a long-term agreement, and it can include an equity investment made by the partners in each other (termed equity alliances, discussed later in the chapter). Most alliances (with the exception of joint ventures that establish a new legal subsidiary) are consid-ered temporary agreements, and thus offer a good way for firms to flexibly combine their efforts and resources. Firms may use strategic alliances to access a critical capa-bility that is not possessed in-house or to more fully exploit their own capabilities by leveraging them in another firm’s development efforts. Firms with different capa-bilities necessary for developing a new technology or penetrating a new market might form alliances to pool their resources so that collectively they can develop the product or market faster or less expensively. Even firms that have similar capabilities may collaborate in their development activities in order to share the risk of a venture or to speed up market development and penetration. Large firms might form alliances with small firms in order to take a limited stake in the smaller firm’s development efforts, while small firms might form alliances with large firms to tap the larger firm’s greater capital resources, distribution and marketing capabilities, or credibility.13 For example, many large pharmaceutical firms have allied with small biotechnology firms for their mutual benefit: The pharmaceutical firms gain access to the drug discoveries of the biotechnology companies, and the biotechnology companies gain access to the capital resources, manufacturing, and distribution capabilities of the pharmaceutical firms.Through an alliance, firms can establish a limited stake in a venture while maintain-ing the flexibility to either increase their commitment later or shift these resources to another opportunity.14 Firms can use alliances to gain an early window on emerging opportunities that they may want to commit to more fully in the future. Alliances also enable a firm to rapidly adjust the type and scale of capabilities the firm can access, which can be very valuable in rapidly changing markets.15Alliances are also used to enable partners to learn from each other and develop new competencies. Alliance partners may hope to transfer knowledge between the firms or to combine their skills and resources to jointly create new knowledge. However, alli-ance relationships often lack the shared language, routines, and coordination that facil-itate the transfer of knowledge—particularly the complex and tacit knowledge that is most likely to lead to sustainable competitive advantages.16 To use alliances for learn-ing requires a serious commitment of resources, such as a pool of dedicated people willing to travel between the home firm and partner firm, test-bed facilities, and active licensingA contractual arrangement whereby one organization or individual (the licensee) obtains the rights to use the proprietary technology (or trademark, or copyright, etc.) of another organization or individual (the licensor).joint ventureA partnership between two or more firms involving a sig-nificant equity stake by the part-ners and often resulting in the creation of a new business entity.Final PDF to printer
sch87956_ch08_167-196.indd 180 11/09/18 11:17 AM180 Part Two Formulating Technological Innovation Strategyprocedures for internalizing what has been learned.17 Alliances can thus also be costly. They require monitoring and coordination. There is also a risk of partners taking the firm’s intellectual property for their own advantage.18Yves Doz and Gary Hamel argue that it is useful to categorize a firm’s alliance strategy along two dimensions.19 The first dimension is the degree to which alliances practice capability complementation versus capability transfer. The second dimension is whether the firm manages each alliance individually or manages a col-lective network of alliances (see Figure 8.1).In quadrant A are firms that forge an individual alliance to combine complementary technologies or skills needed for a project. For example, in the mid-1970s, General Electric (GE) and SNECMA (a French jet engine producer) formed a joint venture called CFM International to develop a new jet engine. The venture would combine GE’s F101 turbojet with SNECMA’s low-pressure fan expertise to create a powerful and fuel-efficient engine. Because the F101 was considered a sensitive military tech-nology by the U.S. Air Force, the venture was set up to carefully avoid the exchange of proprietary technology between the firms. GE would build the F101 portion as a sealed “black box,” which could then be shipped to a separate assembly location. The resulting engine, the CFM-56, became the most successful jet engine in the history of aviation.20In quadrant B are firms that use a network of alliances to combine complemen-tary skills and resources. For example, Corning, known primarily as a producer of glass products, has created a web of alliances with partners that have complementary skills in order to extend its glass technology into fields as diverse as medical products, computer products, and fiber optics. Instead of attempting to internalize its partners’ technologies, Corning views its relationships with its partners as a form of extended enterprise that forms a flexible and egalitarian network of independent businesses.21In quadrant C are firms that use individual alliances to transfer capabilities between them. Doz and Hamel provide the example of the alliance between JVC and Thomson. While both companies produce VCRs, Thomson wanted to glean product technology and manufacturing expertise from JVC, whereas JVC needed to learn how to penetrate the European market from Thomson. Both sides perceived an equitable opportunity for gain from exchanging capabilities.capability complementa-tionCombining (“pooling”) the capabilities and other resources of partner firms, but not necessar-ily transferring those resources between the partners.capability transferExchange of capabilities across firms in such a manner that partners can internalize the capabilities and use them independently of the particular development project.FIGURE 8.1Technology Alliance StrategiesSource: Y. Doz and G. Hamel, 1997, “The Use of Alliances in Implementing Technology Strategies.” In M. L. Tushman and P. Anderson, Managing Strategic Innovation and Change, 1997. Individual AllianceNetwork of AlliancesCapabilityComplementationAGE-SNECMAallianceBCorning GlassalliancesCapability TransferCThomson-JVCallianceDAsplaFinal PDF to printer
sch87956_ch08_167-196.indd 181 11/09/18 11:17 AMChapter 8 Collaboration Strategies 181In quadrant D are firms that use a network of alliances to exchange capabilities and jointly develop new capabilities. The collective research organizations described later in the chapter (including Aspla and the National Center for Manufacturing Sci-ences) are examples of alliance networks in which a formal body has been created to govern the network. These organizations are designed to enable their member orga-nizations to collectively create, share, and utilize knowledge. In building an alliance portfolio, managers should think carefully about competitive effects, complementing effects, and network structure effects. First, if multiple alliances are serving the same strategic needs, there is a risk of redundant resources investment, or competitive con-flict between partners. The costs and benefits of this should be carefully weighed as alliance partners could become adversaries. Second, complementary alliances can be super-additive if carefully managed. For example, a pharmaceutical firm might be using an alliance to develop a drug target with one partner, and another alliance to develop a delivery method for that same drug, enabling it to bring the product to mar-ket faster.22 In this situation, the benefits of each alliance are accentuated by the ben-efits of the other. Finally, managers should consider how their portfolio of alliances positions them in the web of relationships that connects their firm, their partners, and their partners’ partners.23 Such networks can be very influential in the diffusion of information and other resources, and being positioned well in an alliance network can confer significant advantages (see the Research Brief on “Strategic Positions in Col-laborative Networks” later in this chapter).The opportunities and flexibility that can be gained through using alliances can come at a cost. The potential for opportunism and self-interest exists for all parties of an alliance due to limited levels of mutual commitment.24 Studies suggests that between 30 percent and 70 percent of alliances fail by neither meeting the goals of the partners nor delivering the operational or strategic benefits for which they were intended.25 Firms need to be constantly on guard to ensure that the alliance does not inadvertently result in giving too much away to a potential competitor. According to Doz and Hamel, while collegiality between partners can facilitate trust and commu-nication, too much collegiality may be a warning sign that information gatekeepers within the firm are not being sufficiently vigilant.26 Employees at all levels should be regularly informed about what information and resources are off-limits to the partner, and the firm should stringently monitor what information the partner requests and receives.27Joint VenturesJoint ventures are a particular type of strategic alliance that entails significant struc-ture and commitment. While a strategic alliance can be any type of formal or informal relationship between two or more firms, a joint venture involves a significant equity investment from each partner and often results in establishment of a new separate entity. The capital and other resources to be committed by each partner are usually specified in carefully constructed contractual arrangements, as is the division of any profits earned by the venture.For example, in April of 2018, Tencent Holdings (a Chinese multinational con-glomerate that specializes in Internet-related services such as social media, music streaming, mobile games, and more) announced it was forming a joint venture which Final PDF to printer
sch87956_ch08_167-196.indd 182 11/09/18 11:17 AM182 Part Two Formulating Technological Innovation StrategyChinese state–owned Changan Automobile Company to develop Internet-connected autonomous driving technology that would utilize artificial intelligence. Tencent would invest 102 million yuan (about $16.2 million) for a 51 percent share of the ven-ture, and Changan would invest 98 million yuan for the remaining 49 percent share. Changan had already completed a 2000 kilometer road test from Chongqing to Bei-jing, and said it had received clearance to start testing autonomous vehicles on public roads in the U.S. state of California.28LicensingLicensing is a contractual arrangement whereby one organization or individual (the licensee) obtains the rights to use the proprietary technology (or trademark, copy-right, etc.) of another organization or individual (the licensor). Licensing enables a firm to rapidly acquire a technology (or other resource or capability) it does not pos-sess. For example, when Microsoft realized it had lost precious time to Netscape and needed to get a Web browser to market fast, it licensed the software it needed to pro-duce Internet Explorer from Spyglass Inc. Microsoft also bought several companies (including Vermeer Technologies, Colusa Software, and eShop Inc.) to provide other Internet utilities.For the licensor, licensing can enable the firm’s technology to penetrate a wider range of markets than it could on its own. For example, Delphi Automotive, a sup-plier to the automotive industry, had developed a software program that can simulate various aspects of machining, including turning, milling, and drilling. The software enabled manufacturers that do high-volume machining to identify ways of improving their machining processes. Delphi had developed the software for its own use, but then realized it could make more money by licensing the software to others.29Licensing a technology from another firm is typically much less expensive for a licensee than developing a new technology in-house. As discussed in earlier chapters, new product development is both expensive and risky; through licensing, a firm can obtain a technology that is already technically or commercially proven. Though it is often presumed that a technology available for license is an unlikely source of advan-tage (because it is typically available to many potential licensees), Procter & Gamble’s experience shows that this need not be the case. Through its “Connect and Develop” program, it focuses on sourcing ideas and technologies external to the firm that it can then add value to in its labs. Thus, while a licensed technology provides the foundation for a new product, the product that arrives to market typically draws on the deep (and difficult to imitate) expertise and other resources P&G possesses.30 This approach is emblematic of the “Open Innovation” approach now being used by many firms.31Licensing agreements typically impose many restrictions on the licensee, enabling the licensor to retain control over how the technology is used. However, over time, licensees may gain valuable knowledge from working with the licensed technology that can enable them to later develop their own proprietary technologies. In the long run, the licensor’s control over the technology may erode.Sometimes firms license their technologies to preempt their competitors from developing their own competing technologies. This can be particularly important if competitors are likely to be able to imitate the primary features of the technology or if the industry has strong pressures for the adoption of a single dominant design Final PDF to printer
sch87956_ch08_167-196.indd 183 11/09/18 11:17 AMChapter 8 Collaboration Strategies 183(see Chapter Four). By licensing out the technology to potential competitors, the licen-sor gives up the ability to earn monopoly rents on the technology. However, doing so may prevent potential competitors from developing their own proprietary technolo-gies. Thus, licensing enables a firm to opt for a steady stream of royalties rather than gambling on the big gain—or big loss—of having its technology compete against oth-ers for market dominance.OutsourcingFirms that develop new technological innovations do not always possess the compe-tencies, facilities, or scale to perform all the value-chain activities for the new innova-tion effectively or efficiently. Such firms might outsource activities to other firms.One common form of outsourcing is the use of contract manufacturers. Contract manufacturing allows firms to meet the scale of market demand without committing to long-term capital investments or an increase in the labor force, thus giving the firm greater flexibility.32 It also enables firms to specialize in those activities central to their competitive advantage while other firms provide necessary support and specialized resources the firm does not possess. Contract manufacturing further enables a firm to tap the greater economies of scale and faster response time of a dedicated manu-facturer, thereby reducing costs and increasing organizational responsiveness to the environment.33 For example, when Apple redesigned a screen for its iPhone just weeks before it was due on the shelves, it was able to call a foreman at a Chinese factory it was working with, who woke up the 8000 workers sleeping in dormitories. The work-ers were given biscuits and tea, and immediately started a 12-hour shift fitting glass screens into beveled frames. Within 96 hours, the plant was manufacturing more than 10,000 iPhones a day. “The speed is breathtaking,” an Apple executive noted. “There’s no American plant that can match that.” Whereas Apple directly employs 43,000 people in the United States and 20,000 people in other countries, an additional 700,000 people work for Apple’s contractors, engineering, building, and assembling Apple products. In response to a query from U.S. President Barack Obama of “What would it take to make iPhones in the United States?” Steve Jobs replied, “Those jobs aren’t coming back.” Apple executives noted that the vast scale of overseas facto-ries, and the flexibility, diligence, and industrial skills of their workers had outpaced American counterparts. But in response to criticisms about what this had done to employment in the United States, the executives explained, “We sell iPhones in over a hundred countries. . . . Our only obligation is making the best product possible.”34Other activities, such as product design, process design, marketing, information technology, or distribution can also be outsourced from external providers. For exam-ple, large contract manufacturers such as Flextronics and Solectron now often help firms design products in addition to manufacturing them. Companies such as IBM or Siemens will provide a company with a complete information technology solu-tion, while United Parcel Service will take care of a company’s logistics and distri-bution needs. Outsourcing can have a number of downsides, however. Reliance on outsourcing may cause the firm to forfeit important learning opportunities, potentially putting it at a disadvantage in the long run.35 By not investing in development of in-house capabilities, a firm might not develop many of the skills and resources related to its products that enable the development of future product platforms. The firm risks contract manufacturingWhen a firm hires another firm (often a specialized manufacturer) to manufacture its products.Final PDF to printer
sch87956_ch08_167-196.indd 184 11/09/18 11:17 AM184 Part Two Formulating Technological Innovation Strategybecoming hollow.36 In fact, Prahalad and Hamel argue that Korean firms such as Gold-star, Samsung, and Daewoo have explicit missions to capture investment initiative away from potential competitors by serving as contract manufacturers for them. This allows the Korean firms to use would-be competitors’ funds to accelerate their own competence development, while the competitors’ competencies erode.37Outsourcing can also impose significant transaction costs for a firm.38 Contract manufacturing, for example, requires a well-specified contract: Product design, cost, and quantity requirements must be clearly communicated and generally specified up front. The contracting firm may also have to go to great lengths to protect itself from having any proprietary technology expropriated by the contract manufacturer. In addi-tion, the contract manufacturer may bear significant costs in ramping up production for a particular firm, and must therefore specify the contract to avoid being held up by the contracting firm after the manufacturer has made investments specific to the contract.39Collective Research OrganizationsIn some industries, multiple organizations have established cooperative research and development organizations such as the Semiconductor Research Corporation or the American Iron and Steel Institute.40 Collective research organizations may take a num-ber of forms, including trade associations, university-based centers, or private research corporations.Many of these organizations are formed through government or industry associa-tion initiatives. For example, the National Center for Manufacturing Sciences (NCMS) was formed in 1986 by the U.S. Defense Department, the Association for Manufac-turing Technology, the Manufacturing Studies Board, General Motors, and 20 other manufacturing companies. Its purpose was to promote collaborations among indus-try, government, and academic organizations. By 2012, the center had 175 U.S., Canadian, and Mexican corporate members. Typical NCMS projects involve 15 to 20  organizations and run for two to four years.41Other collective research organizations have been formed solely through the ini-tiative of private companies. For example, in 2002, six Japanese electronics manu-facturers (Fujitsu, Hitachi, Matsushita Electric Industrial, Mitsubishi Electric, NEC, and Toshiba) set up a collective research company called Aspla to develop designs for more advanced computer chips. Global competition had driven down margins on chips, resulting in major losses for many of the major Japanese electronics makers. Furthermore, research in advanced chip designs had become extremely expensive. The collaborative research organization would enable the companies to share the devel-opment expense and help the Japanese semiconductor industry retain its competitive edge. Each of the companies initially invested 150 million yen ($1.3 million) in the organization, and plans were for each to contribute about $85 million annually toward joint research.42 The Japanese government also agreed to contribute $268 million.CHOOSING A MODE OF COLLABORATIONFigure 8.2 summarizes some of the trade-offs between solo internal development and various modes of collaboration. Solo internal development is, on average, a relatively slow and expensive way of developing a technology. The firm bears all the costs and Final PDF to printer
sch87956_ch08_167-196.indd 185 11/09/18 11:17 AMChapter 8 Collaboration Strategies 185risks, and may spend considerable time learning about the new technology, refining its designs, and developing production or service processes to implement the new tech-nology. However, a firm that engages in solo internal development retains total control over how the technology is developed and used. Solo internal development also offers great potential for the firm to leverage its existing competencies and to develop new competencies, but offers little to no potential for accessing another firm’s competen-cies. Therefore, solo internal development might make sense for a firm that has strong competencies related to the new technology, has access to capital, and is not under great time pressure.Because strategic alliances can take many forms, the speed, cost, and degree of con-trol they offer vary considerably. Some strategic alliances may enable a firm to rela-tively quickly and cheaply gain access to another firm’s technology, but give the firm a low level of control over that technology. Other strategic alliances might be aimed at utilizing the firm’s own technology in a broader range of markets, which can be fast and cost-effective, and still enable the firm to retain a considerable amount of control. Most alliances offer opportunities for leveraging existing competencies or developing new competencies. Strategic alliances may or may not offer potential for accessing another firm’s competencies, depending on the alliance’s purpose and structure.By comparison, a joint venture is much more structured. While a joint venture typi-cally involves developing a new technology and can take almost as long as solo internal development, it may be slightly faster due to the combination of the capabilities of multiple firms. Joint ventures enable partners to share the cost of the development effort, but they must also share control. Because joint ventures typically entail a long-term relationship between two or more firms that results in the development of a new product or business, joint ventures offer great potential for leveraging a firm’s existing competencies, developing new competencies, and accessing its partners’ competencies. SpeedCostControlPotential for Leveraging Existing CompetenciesPotential for Developing New CompetenciesPotential for Accessing Other Firms’ CompetenciesSolo Internal DevelopmentLowHighHighYesYesNoStrategic AlliancesVariesVariesLowYesYesSometimesJoint VenturesLowSharedSharedYesYesYesLicensing InHighMediumLowSometimesSometimesSometimesLicensing OutHighLowMediumYesNoSometimesOutsourcingMedium/HighMediumMediumSometimesNoYesCollective Research OrganizationsLowVariesVariesYesYesYesFIGURE 8.2Summary of Trade-Offs between Different Modes of DevelopmentFinal PDF to printer
sch87956_ch08_167-196.indd 186 11/09/18 11:17 AM186 Part Two Formulating Technological Innovation StrategyJoint ventures may be more appropriate than a strategic alliance or solo internal devel-opment when the firm places great importance on access to other firms’ competencies.Licensing in technology offers a fast way to access a new technology that is typi-cally lower in cost than developing it internally. The firm typically has limited discre-tion over what it can do with the technology, however, and thus has a low degree of control. Depending on the firm’s capability mix and the nature of what it has licensed, licensing can sometimes offer the potential of leveraging a firm’s existing compe-tencies, developing new competencies, and accessing another organization’s compe-tencies. For example, many potential drugs or medical therapies are first developed in university research centers or medical schools. Pharmaceutical and biotechnology firms then license the right to explore whether the discovery has potential as a com-mercially viable medical treatment using their own drug development, testing, and manufacturing capabilities. Licensing the promising compounds or therapies enables the pharmaceutical and biotechnology firms to obtain drug targets quickly, thus help-ing them keep their pipelines full. It also helps the firms focus their development efforts on projects that have already demonstrated some treatment potential.Licensing can also be a good way for a firm to obtain enabling technologies that are necessary for its products or services, but that are not central to the firm’s competitive advantage. For example, while producers of digital cameras need to be able to incor-porate batteries that are long-lasting, light, and affordable in their camera designs, most camera producers do not perceive battery power as being central to their com-petitive advantage, and thus rely on externally sourced technology to meet this need. Licensing can also be an effective way for a firm that lacks technological expertise to gain initial market entry and experience that it can later build upon in developing its own technological capabilities.Licensing out a technology offers a fast way for a firm to extend the reach of its tech-nology that is nearly free and offers the potential for royalties. The firm relinquishes some control over the technology, but also retains a moderate amount of control through restrictions in the license agreement. Licensing out a technology explicitly leverages the firm’s existing competencies by enabling the technology to be deployed in a wider range of products or markets than the firm participates in itself. It offers little opportu-nity for developing new competencies, however. Sometimes licensing out a technology is a way of accessing another firm’s competencies, as when a firm uses licensing to expand its technology into products or markets in which it has little expertise.When a firm outsources design, production, or distribution of its technology, it is intentionally giving up a moderate amount of control to rapidly gain access to another firm’s expertise and/or lower cost structure. While the firm pays to outsource activi-ties, it typically pays less than it would to develop the capability of performing those activities in-house, and it gains access to those activities more quickly than it could develop them in-house. While outsourcing offers little opportunity for building new competencies, it can leverage the firm’s existing competencies by enabling it to focus on those activities in which it earns its greatest returns. For example, Nike’s strategy of outsourcing nearly all its athletic shoe production to contract manufacturers in Asia enables Nike to focus on its competitive advantages in design and marketing while tapping the lower labor and capital costs of its manufacturers. Thus, outsourcing might sometimes be appropriate for (a) firm activities that are not central to its competitive Final PDF to printer
sch87956_ch08_167-196.indd 187 11/09/18 11:17 AMChapter 8 Collaboration Strategies 187advantage, (b) activities that would cause the firm to give up crucial flexibility if per-formed in-house, or (c) activities in which the firm is at a cost or quality disadvantage.Participation in a collective research organization is typically a long-term com-mitment rather than an effort to rapidly access capabilities or technology. As with strategic alliances, the nature of a firm’s participation in a collective research organi-zation can take many forms; thus, cost and control can vary significantly. Collective research organizations can be very valuable ways for the firm to leverage and build upon its existing competencies, as well as to learn from other participating organiza-tions. Though collective research organizations may not yield immediate returns in the form of new products or services, participating in collective research organizations can be extremely useful in industries that have complex technologies and require con-siderable investment in basic science. By pooling their knowledge and effort, firms in collective research organizations can share the cost and risk of basic research, while accelerating the rate at which it yields useful new solutions.CHOOSING AND MONITORING PARTNERSGaining access to another firm’s skills or resources through collaboration is not with-out risks.43 It may be difficult to determine if the resources provided by the partner are a good fit, particularly when the resource gained through the collaboration is some-thing as difficult to assess as experience or knowledge. It is also possible that a collab-oration partner will exploit the relationship, expropriating the company’s knowledge while giving little in return. Furthermore, since managers can monitor and effectively manage only a limited number of collaborations, the firm’s effectiveness at managing its collaborations will decline with the number of collaborations to which it is com-mitted. This raises the possibility of not only diminishing returns to the number of collaborations, but also negative returns as the number of collaborations grows too large.44 These risks can be minimized if the company limits the number of collabora-tions in which it engages, chooses its partners very carefully, and establishes appropri-ate monitoring and governance mechanisms to limit opportunism.45Partner SelectionThe success of collaborations will depend in large part on the partners chosen. A num-ber of factors can influence how well suited partners are to each other, including their relative size and strength, the complementarity of their resources, the alignment of their objectives, and the similarity of their values and culture.46 These factors can be boiled down to two dimensions: resource fit and strategic fit.47Resource fit refers to the degree to which potential partners have resources that can be effectively integrated into a strategy that creates value.48 Such resources may be either complementary or supplementary. Most collaborations are motivated by the need to access resources the firm does not possess; such collaborations are based on the combination of complementary resources. Most of the examples in this chapter have entailed complementary resources, such as the combination of Apple’s computer technology with Canon’s printer engine technology, or the combination of Sangamo’s gene editing technology with the clinical testing and manufacturing expertise of larger Final PDF to printer
sch87956_ch08_167-196.indd 188 11/09/18 11:17 AM188 Part Two Formulating Technological Innovation Strategybiotechnology and pharmaceutical firms. Other collaborations seek supplementary stocks of resources that are similar to those possessed by the firm. The pooling of supplementary resources can enable partners to achieve market power or economies of scale. For example, British Petroleum and Mobil consolidated many of their opera-tions in Europe to gain economies of scale and lower their cost structure.49Strategic fit refers to the degree to which partners have compatible objectives and styles. The objectives of the partners need not be the same as long as the objectives can be achieved without harming the alliance or the partners. Not knowing a partner’s true objec-tives or forging an alliance with a partner with incompatible objectives can result in con-flict, wasted resources, and forfeited opportunities. Das and Teng provide an example of an alliance forged between General Motors and South Korea’s Daewoo. While GM desired to use the alliance to drive down costs on its existing automobile models, Daewoo’s objective was to develop new technologies and design new models. The alliance ultimately failed because of the incompatibility of GM’s cost orientation and Daewoo’s R&D orientation.50Firms can also evaluate potential partners using many of the same tools used to evaluate the firm’s own position and strategic direction (for a review of these, see Chapter Six). This includes assessing how collaboration with the partner is likely to impact the firm’s opportunities and threats in its external environment; its internal strengths, weaknesses, or potential for sustainable competitive advantage; and the firm’s ability to achieve its strategic intent.Impact on Opportunities and Threats in the External EnvironmentAssessing the collaboration’s impact on the firm’s opportunities and threats includes asking such questions as: ∙ How would the collaboration change the bargaining power of customers or suppliers? ∙ Would the collaboration impact the threat of entry? For example, is the partner likely to become a new competitor? Does the partnership raise barriers to entry for other potential entrants? ∙ Would the collaboration impact the firm’s position vis-à-vis its rivals? ∙ Would the collaboration influence the availability of complementary goods or the threat of substitutes?Impact on Internal Strengths and WeaknessesAssessing the collaboration’s impact on the firm’s strengths and weaknesses includes asking such questions as: ∙ How would the collaboration leverage or enhance the firm’s strengths? Does the collaboration put any of those strengths at risk? ∙ How would the collaboration help the firm overcome its weaknesses? ∙ Is the collaboration likely to yield a position of competitive advantage that is diffi-cult for competitors to imitate? Is such a competitive advantage achievable without collaborating? ∙ Would the collaboration leverage or enhance the firm’s core capabilities? ∙ Is the collaboration likely to impact the firm’s financial strengths or weaknesses?Final PDF to printer
sch87956_ch08_167-196.indd 189 11/09/18 11:17 AMChapter 8 Collaboration Strategies 189Research Brief Strategic Positions in Collaborative NetworksaA growing body of research suggests that a firm’s position within a collaborative network influences its access to information and other resources, and its influence over desired outcomes. For example, a firm with a highly central position in the network is typically expected to have access to a greater amount of information and to be able to access that information more quickly than a firm in a more peripheral role. A firm that occupies a key broker-age role in a network (e.g., a firm that serves as a bridge between two otherwise disconnected groups of firms) is thought to benefit both by hav-ing exposure to diverse information (assuming the two groups of firms have quite distinct informa-tion resources) and by occupying a key gatekeep-ing position that controls the flow of information between the two groups. A firm’s position within the network may also serve as a valuable signal to other potential partners about the value of its resources. For example, if a firm is young or small but has alli-ances with important and innovative firms, these alliances can serve as reputation endorsements when the quality of the firm is otherwise difficult to assess.b Such endorsements may enhance the firm’s likelihood of receiving financing or attracting other important alliances.Consider Figure 8.3, which shows the “main component” (the largest connected group) of the global technology collaboration network in 1998 (based on R&D alliances, cross-technology trans-fer agreements, and cross-licensing agreements formed from 1996 to 1998, as reported by SDC’s alliance database).c The large group on the top of the network is mostly composed of organiza-tions in industries whose underlying technology is electronics-based (computer hardware and soft-ware, communication equipment and service, trans-portation equipment, etc.), and the group on the bottom is dominated by organizations in the chemi-cal and medical-based industries (pharmaceuticals, chemicals, health services, medical equipment, etc.). This grouping also includes a large concentration of educational organizations (primarily universities). As can be seen, some firms (e.g., IBM, Toshiba, Eli Lilly) have significantly more alliances than oth-ers. The number of links an organization has in a network is known as its “degree centrality.” In gen-eral, the degree centrality of an organization tends to be strongly related to its size and prominence. The size and prominence of an organization help to determine how attractive it is to potential part-ners, and only large organizations typically have the resources necessary to manage a large number of alliances. An organization does not, however, have to be large or prominent to occupy a key brokerage position. Brokerage refers to how crucial an organi-zation is to the transmission of information or other resources through the network. It is often measured with “betweenness centrality,” which is the number of times an organization lies on the shortest path between other pairs of organizations. The three organizations with the highest betweenness cen-trality scores in this network are IBM, Eli Lilly, and PPD (Pharmaceutical Product Development Inc., a contract research organization). PPD had only three alliances during the 1996 to 1998 time period, but Figure 8.3 shows just how important those alliances were to the overall connectivity of the network. IBM’s link to PPD and PPD’s link to Eli Lilly provide a bridge from the center of the electronics group to the center of the chemical/medical group. This link is one of only three observed bridges between the two groups, and is the most central of those three.There is still considerable debate about the rela-tive benefits of centrality and brokerage. While many scholars argue that highly central firms have the greatest access to information and influence over information transmission, others argue that highly central firms are constrained by their many relation-ships to other organizations and suggest that it is better to occupy a brokerage role. There are similar debates about brokerage—while a broker is likely to have access to diverse information and serves as a key gatekeeper for the transmission of information continuedFinal PDF to printer
sch87956_ch08_167-196.indd 190 11/09/18 11:17 AM190 Part Two Formulating Technological Innovation Strategybetween otherwise disconnected groups, it is unclear to what degree brokers typically benefit from this position. Some have argued that brokers can have difficulty assimilating and utilizing such diverse information, and that it might be better to be fully embedded in one group rather than be the only bridge between multiple groups. In other words, it might be better to have a relationship with a broker than to be the broker. There generally is consensus, however, that it is less desirable to be isolated (i.e., not connected to the network) or in a “pendulum” position (i.e., have only one link, and thus hang from the network like a pendulum).a Adapted from M. A. Schilling, “The Global Technology Collaboration Network: Structure, Trends, and Implica-tions,” New York University working paper, 2009.b T. Stuart, “Interorganizational Alliances and the Perfor-mance of Firms: A Study of Growth and Innovation Rates,” Strategic Management Journal 21 (2000), pp. 791–811.c Adapted from Schilling, “The Global Technology Collabo-ration Network: Structure, Trends, and Implications.”d Ibid.concludedFIGURE 8.3The Global Technology Collaboration Network (Main Component) in 1998dAdapted from Schilling, “The Global Technology Collaboration Network: Structure, Trends, and Implications.”Belmont Research Inc.Eli Lilly & Co.Fulcrum Technologies Inc.IBM Corp.Informix Software Inc.PPD Inc.Texaco Inc.Toshiba Corp.Abbott LaboratoriesFinal PDF to printer
sch87956_ch08_167-196.indd 191 11/09/18 11:17 AMChapter 8 Collaboration Strategies 191Impact on Strategic DirectionAssessing the fit of the collaboration with the firm’s strategic direction includes ask-ing such questions as: ∙ How does this collaboration fit with the firm’s statement of strategic intent? ∙ Is the collaboration likely to help the firm close any resource or technology gap between where it is now and where it would like to be? ∙ Are the objectives of the collaboration likely to change over time? How are such changes likely to be compatible or incompatible with the firm’s strategic direction?Partner Monitoring and GovernanceSuccessful collaboration agreements typically have clear, yet flexible, monitoring and governance mechanisms.51 Not surprisingly, the more resources put at risk by the collaboration (e.g., the greater the upfront investment or the more valuable the intellectual property contributed to the collaboration), the more governance struc-ture partner firms are likely to impose on the relationship.52 There are three main types of governance mechanisms organizations use to manage their collaborative relationships: alliance contracts, equity ownership, and relational governance.53 Alliance contracts are legally binding contractual arrangements to ensure that partners (a) are fully aware of their rights and obligations in the collaboration and (b) have legal remedies available if a partner should violate the agreement. Such contracts typically include: ∙ What each partner is obligated to contribute to the collaboration, including money, services, equipment, intellectual property, and so on. ∙ How much control each partner has in the arrangement. For example, the contract may stipulate whether partners have the right to admit new partners to the relation-ship or change the terms of the agreement. It may also stipulate the rights partners will have over any proprietary products or processes developed in the course of the collaboration. ∙ When and how proceeds of the collaboration will be distributed. For example, the collaboration agreement may stipulate whether cash, intellectual property rights, or other assets will be distributed and the schedule of such distribution.Such contracts also often include mechanisms for monitoring each partner’s adher-ence to the agreement, such as through regular review and reporting requirements.54 Some collaboration agreements include provisions for periodic auditing either by the partner organizations or by a third party. Many agreements also include provisions for terminating the relationship if the need for the alliance ends (e.g., if the mission of the alliance is completed or the goals of the partner firms have changed) or partners encounter disputes they cannot resolve.55 Markets and strategies change over time, and effective collaboration agreements should be flexible enough to be adapted in the event of change and provide a graceful exit strategy for members that no longer wish to participate in the collaboration.Many alliances involve shared equity ownership, that is, each partner contributes capital and owns a share of the equity in the alliance. Equity ownership helps to align governanceThe act or pro-cess of exerting authority and/or control.alliance contractsLegally binding contractual arrangements to ensure that partners (a) are fully aware of their rights and obligations in the collaboration and (b) have legal remedies avail-able if a partner should violate the agreement.equity ownershipWhen each part-ner contributes capital and owns a specified right to a percentage of the proceeds from the alliance.Final PDF to printer
sch87956_ch08_167-196.indd 192 11/09/18 11:17 AM192 Part Two Formulating Technological Innovation Strategythe incentives of the partners (because the returns to their equity stake are a function of the success of the alliance) and provides a sense of ownership and commitment to the project that can facilitate supervision and monitoring of the alliance.Finally, many alliances also rely on relational governance. Relational gover-nance is the self-enforcing governance based on the goodwill, trust, and reputation of the partners that is built over time through shared experiences of repeatedly working together. Research suggests that relational governance can help to reduce contracting and monitoring costs of managing an alliance, and facilitate more extensive coopera-tion, sharing, and learning by alliance partners.56relational governanceSelf-enforcing norms based on goodwill, trust, and reputation of the partners. These typically emerge over time through repeated experiences of working together. 1. A number of factors will influence whether a firm chooses to collaborate on an inno-vation. Some of the most important include whether the firm (or a potential partner) has the required capabilities or other resources, the degree to which collaboration would make proprietary technologies vulnerable to expropriation by a potential competitor, the importance the firm places on controlling the development process and any innovation produced, and the role of the development project in building the firm’s own capabilities or permitting it to access another firm’s capabilities. 2. Firms may choose to avoid collaboration when they already possess the necessary capabilities and other resources in-house, they are worried about protecting pro-prietary technologies and controlling the development process, or they prefer to build capabilities in-house rather than access a partner firm’s capabilities. 3. Some of the advantages of collaboration include sharing costs and risks of devel-opment, combining complementary skills and resources, enabling the transfer of knowledge between firms and the joint creation of new knowledge, and facilitat-ing the creation of shared standards. 4. The term strategic alliances refers to a broad class of collaboration activities that may range from highly structured (e.g., joint ventures) to informal. Strategic alli-ances can enable simple pooling of complementary resources for a particular proj-ect, or they may enable the transfer of capabilities between partners. The transfer of capabilities often requires extensive coordination and cooperation. 5. A joint venture is a partnership between firms that entails a significant equity investment and often results in the creation of a new separate entity. Joint ventures are usually designed to enable partners to share the costs and risks of a project, and they have great potential for pooling or transferring capabilities between firms. 6. Licensing involves the selling of rights to use a particular technology (or other resource) from a licensor to a licensee. Licensing is a fast way of accessing (for the licensee) or leveraging (for the licensor) a technology, but offers little opportu-nity for the development of new capabilities. 7. Outsourcing enables a firm to rapidly access another firm’s expertise, scale, or other advantages. Firms might outsource particular activities so that they can avoid the fixed asset commitment of performing those activities in-house. Outsourcing can give a firm more flexibility and enable it to focus on its core competencies. Overreliance on outsourcing, however, can make the firm hollow.Summary of ChapterFinal PDF to printer
sch87956_ch08_167-196.indd 193 11/09/18 11:17 AMChapter 8 Collaboration Strategies 193 8. Groups of organizations may form collective research organizations to jointly work on advanced research projects that are particularly large or risky. 9. Each form of collaboration mode poses a different set of trade-offs in terms of speed, cost, control, potential for leveraging existing competencies, potential for develop-ing new competencies, or potential for accessing another firm’s competencies. An organization should evaluate these trade-offs in formulating a collaboration strategy. 10. Successful collaboration requires choosing partners that have both a resource fit and a strategic fit. 11. Successful collaboration also requires developing clear and flexible monitoring and governance mechanisms to ensure that partners understand their rights and obligations, and have methods of evaluating and enforcing each partner’s adher-ence to these rights and obligations. 1. What are some advantages and disadvantages of collaborating on a development project? 2. How does the mode of collaborating (e.g., strategic alliance, joint venture, licens-ing, outsourcing, collective research organization) influence the success of a collaboration? 3. Identify an example of collaboration between two or more organizations. What were the advantages and disadvantages of collaboration versus solo development? What collaboration mode did the partners choose? What were the advantages and disadvantages of the collaboration mode? 4. If a firm decides it is in its best interest to collaborate on a development project, how would you recommend the firm choose a partner, a collaboration mode, and governance structure for the relationship?Discussion QuestionsClassicsChesbrough, H., Open Innovation: The New Imperative for Creating and Profiting from Technology (Boston: Harvard Business School Press, 2003).Hagedoorn, J., “Understanding the Rationale of Strategic Technology Partnering: Interorganizational Modes of Cooperation and Sectoral Differences,” Strategic Man-agement Journal 14 (1993), pp. 371–86.Powell, W. W., K. W. Koput, and L. Smith-Doerr, “Interorganizational Collaboration and the Locus of Innovation: Networks of Learning in Biotechnology,” Administrative Science Quarterly 41 (1966), pp. 116–45.Rothaermel, F. T., Hitt, M. A., and Jobe, L. A. “Balancing Vertical Integration and Strategic Outsourcing: Effects on Product Portfolio, Product Success, and Firm Per-formance,” Strategic Management Journal 27 (2006), pp. 1033–56.Sampson, R., “The Cost of Misaligned Governance in R&D Alliances,” Journal of Law, Economics, and Organization 20 (2004), pp. 484–526.Schilling, M. A., and C. Phelps, “Interfirm Collaboration Networks: The Impact of Large-Scale Network Structure on Firm Innovation,” Management Science 53 (2007), pp. 1113–26.Suggested Further ReadingFinal PDF to printer
sch87956_ch08_167-196.indd 194 11/09/18 11:17 AM194 Part Two Formulating Technological Innovation Strategy 1. C. W. L. Hill, “Monsanto: Building a Life Sciences Company,” in Cases in Strategic Manage-ment, eds. C. W. L. Hill and G. Jones (Boston: Houghton Mifflin, 2004); and S. Brooks, M. A. Schilling, and J. Scrofani, “Monsanto: Better Living through Genetic Engineering?” in Strate-gic Management, Competitiveness and Globalization, 5th ed., eds. M. Hitt, R. Hoskisson, and R. D. Ireland (Minneapolis/St. Paul: West Publishing, 2002). 2. R. T. Fraley, S. B. Rogers, and R. B. Horsch, “Use of a Chimeric Gene to Confer Antibiotic Resistance to Plant Cells. Advances in Gene Technology: Molecular Genetics of Plants and Animals,” Miami Winter Symposia 20 (1983a), pp. 211–21. 3. R. Melcer, “Monsanto Wants to Sow a Genetically Modified Future,” St. Louis Post Dispatch, February 24, 2003. 4. M. Takanashi, J. Sul, J. Johng, Y. Kang, and M. A. Schilling, “Honda Insight: Personal Hybrid,” New York University teaching case, 2003; and “Toyota, Honda Forge Ahead in Hybrid Vehicle Development,” AP Newswire, March 13, 2002. 5. L. Gunter, “The Need for Speed,” Boeing Frontiers. Retrieved November 20, 2002, from www 6. Su Han Chan, W. John Kensinger, J. Arthur Keown, and D. John Martin, “Do Strategic Alli-ances Create Value?” Journal of Financial Economics 46 (1997), pp. 199–221. 7. G. Hamel, Y. L. Doz, and C. K. Prahalad, “Collaborate with Your Competitors—and Win,” Harvard Business Review, January–February 1989, pp. 133–39; W. Shan, “An Empirical Analy-sis of Organizational Strategies by Entrepreneurial High-Technology,” Strategic Management Journal 11 (1990), pp. 129–39; G. P. Pisano, “The R&D Boundaries of the Firm: An Empirical Analysis,” Administrative Science Quarterly 35 (1990), pp. 153–76; and R. Venkatesan, “Strate-gic Sourcing: To Make or Not to Make,” Harvard Business Review 70, no. 6 (1992), pp. 98–107. 8. D. Teece, “Profiting from Technological Innovation: Implications for Integration, Collabora-tion, Licensing and Public Policy,” Research Policy 15 (1986), pp. 285–305. 9. D. C. Mowery, J. E. Oxley, and B. S. Silverman, “Technological Overlap and Interfirm Coop-eration: Implications for the Resource-Based View of the Firm,” Research Policy 27 (1998), pp.  507–24; J. A. C. Baum, T. Calabrese, and B. S. Silverman, “Don’t Go It Alone: Alliance Network Composition and Startups’ Performance in Canadian Biotechnology,” Strategic Manage-ment Journal 21 (2000), p. 267; J. P. Liebeskind, A. L. Oliver, L. Zucker, and M. Brewer, “Social Networks, Learning, and Flexibility: Sourcing Scientific Knowledge in New Biotechnology Firms,” Organization Science 7 (1996), pp. 428–44; and L. Rosenkopf and P. Almeida, “Over-coming Local Search through Alliances and Mobility,” Management Science 49 (2003), p. 751. 10. J. Hagerdoon, A. N. Link, and N. S. Vonortas, “Research Partnerships,” Research Policy 29 (2000), pp. 567–86. 11. EndnotesRecent WorkBouncken, R. B., T. Claus, and V. Fredrich, “Product Innovation through Coopetition in Alliances: Singular or Plural Governance?” Industrial Marketing Management, 53 (2016):77–90.Schilling, M. A., “Technology Shocks, Technological Collaboration, and Innovation Outcomes,” Organization Science 26 (2015):668–86.West, J., and M. Bogers, “Leveraging External Sources of Innovation: A Review of Research on Open Innovation,” Journal of Product Innovation Management, 31 (2014):814–831.Final PDF to printer
sch87956_ch08_167-196.indd 195 11/09/18 11:17 AMChapter 8 Collaboration Strategies 195 12. N. H. Kang and K. Sakai, “International Strategic Alliances: Their Role in Industrial Globalisa-tion,” Paris, Organisation for Economic Co-operation and Development, Directorate for Sci-ence, Technology, and Industry, working paper 2000/5. 13. Teece, “Profiting from Technological Innovation.” 14. R. McGrath, “A Real Options Logic for Initiating Technology Positioning Investments,” Academy of Management Review 22 (1997), pp. 974–96. 15. M. A. Schilling, “Technology Shocks, Technological Collaboration, and Innovation Outcomes,” Organization Science, 26 (2015), pp. 668–686. 16. S. Ghoshal and P. Moran, “Bad for Practice: A Critique of the Transaction Cost Theory,” Academy of Management Review 21 (1996), pp. 13–47. 17. C. K. Prahalad and G. Hamel, “The Core Competence of the Corporation,” Harvard Business Review, May–June 1990, pp. 79–91; and Hamel, Doz, and Prahalad, “Collaborate with Your Competitors—and Win.” 18. H. Hottenrott and C. Lopes-Bento, “R&D Partnerships and Innovation Performance: Can There Be too Much of a Good Thing?” Journal of Product Innovation Management, 33 (2016), pp. 773–794; M. A. Schilling, “Technology Shocks, Technological Collaboration, and Innova-tion Outcomes,” Organization Science, 26 (2015), pp. 668–686. 19. Y. Doz and G. Hamel, “The Use of Alliances in Implementing Technology Strategies,” in Man-aging Strategic Innovation and Change, eds. M. L. Tushman and P. Anderson (Oxford, U.K.: Oxford University Press, 1997). 20. G. W. Weiss, “The Jet Engine That Broke All the Records: The GE-SNECMA CFM-56,” Case Studies in Technology Transfer and National Security; and P. Siekman, “GE Bets Big on Jet Engines,” Fortune, December 19, 2002. 21. A. Nanda and C. A. Bartlett, “Corning Incorporated: A Network of Alliances,” Harvard Busi-ness School case no. 9-391-102, 1990. 22. P. Kale and H. Singh, “Managing Strategic Alliances: What Do We Know Now, and Where Do We Go From Here?” Academy of Management Perspectives (2009) August, pp. 45–62. 23. M. A. Schilling and C. Phelps, “Interfirm Collaboration Networks: The Impact of Large-Scale Network Structure on Firm Innovation,” Management Science 53 (2007), pp. 1113–26. 24. K. R. Harrigan, “Strategic Alliances: Their New Role in Global Competition,” Columbia Jour-nal of World Business 22, no. 2 (1987), pp. 67–70. 25. P. Kale and H. Singh, “Managing Strategic Alliances: What Do We Know Now, and Where Do We Go From Here?” Academy of Management Perspectives (2009) August, pp. 45–62. See also J. Bamford, B. Gomes-Casseres, and M. Robinson, “Envisioning collaboration: Mastering alli-ance strategies.” San Francisco: Jossey-Bass. 26. Hamel, Doz, and Prahalad, “Collaborate with Your Competitors—and Win.” 27. Ibid. 28. J. Tan, “Quick Take: Tencent, Changan Auto Announce Autonomous Vehicle Joint Venture,” Caixin, April 13 2018 29. P. E. Teague, “Other People’s Breakthroughs,” Design News 58, no. 2 (2003), pp. 55–56. 30. L. Huston and N. Sakkab, “Connect and Develop: Inside Procter & Gamble’s New Model for Innovation,” Harvard Business Review, (2006), March 1st. 31. H. W. Chesbrough, Open Innivation: The New Imperative for Creating and Profiting From Technology. (2003) Boston: Harvard Business School Press. 32. J. Holmes, “The Organization and Locational Structure of Production Subcontracting,” in Production, Work, Territory: The Geographical Anatomy of Industrial Capitalism, eds. M. Storper and A. J. Scott (Boston: Allen and Unwin, 1986), pp. 80–106; and Teece, “Profiting from Technological Innovation.” 33. Final PDF to printer
sch87956_ch08_167-196.indd 196 11/09/18 11:17 AM196 Part Two Formulating Technological Innovation Strategy 34. C. Duhigg and K. Bradsher, “How U.S. Lost Out on IPhone Work,” The New York Times, January 22, 2012, pp. 1, 20–21. 35. D. Lei and M. A. Hitt, “Strategic Restructuring and Outsourcing: The Effect of Mergers and Acquisitions and LBOs on Building Firm Skills and Capabilities,” Journal of Management 21 (1995), pp. 835–60. 36. Prahalad and Hamel, “The Core Competence of the Corporation.” 37. Ibid. 38. Pisano, “The R&D Boundaries of the Firm.” 39. Schilling and Steensma, “The Use of Modular Organizational Forms.” 40. V. K. Narayanan, Managing Technology and Innovation for Competitive Advantage (Upper Saddle River, NJ: Prentice Hall, 2001). 41. C. Pellerin, “Consortia: Free Enterprise Meets Cooperation and the Results Can Be Good for Robotics,” The Industrial Robot 22, no. 1 (1995), p. 31. 42. Associated Press, July 11, 2002. 43. C. W. L. Hill, “Strategies for Exploiting Technological Innovations: When and When Not to License,” Organization Science 3 (1992), pp. 428–41; W. Shan, “An Empirical Analysis of Organizational Strategies by Entrepreneurial High-Technology,” Strategic Management Jour-nal 11 (1990), pp. 129–39; and Teece, “Profiting from Technological Innovation.” 44. M. A. Schilling and C. W. L. Hill, “Managing the New Product Development Process: Strategic Imperatives,” Academy of Management Executive 12, no. 3 (1998), pp. 67–81. 45. O. E. Williamson, The Economic Institutions of Capitalism (New York: Free Press, 1985). 46. J. Bleeke and D. Ernst, “Is Your Strategic Alliance Really a Sale?” Harvard Business Review 73, no. l (1995), pp. 97–105; T. K. Das and B. Teng, “Between Trust and Control: Developing Confidence in Partner Cooperation in Alliances,” Academy of Management Review 23 (1998b), pp.  491–512; R. M. Kanter, “Collaborative Advantage: The Art of Alliances,” Harvard Business Review 72, no. 4 (1994), pp. 96–108; and B. Uzzi, “Social Structure and Competition in Interfirm Networks: The Paradox of Embeddedness,” Administrative Science Quarterly 42 (1997), pp. 35–67. 47. T. K. Das and B. S. Teng, “Managing Risks in Strategic Alliances,” Academy of Management Executive 13, no. 4 (1999), pp. 50–62. 48. Ibid. 49. J. G. Crump, “Strategic Alliances Fit Pattern of Industry Innovation,” Oil & Gas Journal, March 31, 1997, p. 59; and Das and Teng, “Managing Risks in Strategic Alliances.” 50. Das and Teng, “Managing Risks in Strategic Alliances.” 51. T. Pietras and C. Stormer, “Making Strategic Alliances Work,” Business and Economic Review 47, no. 4 (2001), pp. 9–12. 52. R. Gulati and H. Singh, “The Architecture of Cooperation: Managing Coordination Costs and Appropriation Concerns in Strategic Alliances,” Administrative Science Quarterly 43 (1998), pp. 781–814. 53. P. Kale and H. Singh, “Managing Strategic Alliances: What Do We Know Now, and Where Do We Go From Here?” Academy of Management Perspectives (2009) August, pp. 45–62. 54. L. Segil, “Strategic Alliances for the 21st Century,” Strategy & Leadership 26, no. 4 (1998), pp. 12–16. 55. Pietras and Stormer, “Making Strategic Alliances Work.” 56. I. Filatotchev, J. Stephan, and B. Jindra. “Ownership Structure, Strategic Controls and Export Intensity of Foreign Invested Firms in Emerging Economies.” Journal of International Business Studies 39 (2008), pp. 1133–48. See also R. Gulati, “Does familiarity breed trust? The implica-tions of repeated ties for contractual choice in alliances,” Academy of Management Journal 38 (1995), pp. 85–112; and B. Uzzi. “Social Structure and Competition in Interfirm Networks: The Paradox of Embeddedness,” Administrative Science Quarterly 42 (1997), pp. 35–67.Final PDF to printer
197sch87956_ch09_197-222.indd 197 11/09/18 11:21 AMChapter NineProtecting InnovationThe Digital Music Distribution RevolutionaFraunhofer and MP3In 1991, Fraunhofer IIS of Germany developed an algorithm that would set in motion a revolution in how music was distributed, stored, and consumed. The algorithm (commonly referred to as a codec) allowed compression of digital audio to approximately one-tenth of its original size with minimal compromise in audible quality. The format also enabled song information such as the song title and artist to be embedded within the file. This format for compressed audio files was later dubbed MPEG-1 layer 3—a.k.a. MP3. By 1995, software programs were available that enabled consumers to convert tracks from compact discs to MP3 files. This technology transformed how music could be manipulated—a song was now a file that could be kept on a hard drive, and the file was small enough to be shared over the Internet. The MP3 format became wildly popu-lar by users sharing their music online, and software companies began releas-ing many variants of MP3 encoders (utilities that compress files into MP3s) and decoders (utilities that play back MP3s). Hardware manufacturers decided to capitalize on this new trend and several hardware MP3 players began appearing on the market.With the growing popularity of the file format, Fraunhofer was faced with a dilemma—should it enforce its patent on the use of the MP3 algorithm and attempt to collect royalties for its use, or should it allow users and software/hard-ware manufacturers to make free use of the algorithm, allowing the momentum of the format to build? If it was to limit the use of the algorithm, it faced the risk of established rivals such as Microsoft and Sony developing competing formats, yet if it allowed free use of the algorithm, it would be difficult to profit on its invention.Fraunhofer decided to pursue a partially open licensing approach, partner-ing with Thomson Multimedia as the exclusive licensing representative of MP3 patents in 1995.b Thomson, in turn, negotiated agreements with several compa-nies including Apple, Adobe, Creative Labs, Microsoft, and many others. Such a broad base of MP3 licensees (100 by April 2001) provided consumers with easy access to encoders, decoders, and the format in general. Licensees generally Final PDF to printer
sch87956_ch09_197-222.indd 198 11/09/18 11:21 AM198 Part Two Formulating Technological Innovation Strategyopted to provide decoders free of charge, while charging a nominal fee to those who wished to encode MP3s.Fraunhofer continued to innovate, introducing the mp3PRO format and work-ing on the Advanced Audio Coding (AAC) format with Dolby that Apple would later use. Many other companies also developed or adapted their own audio compression codecs including Sony (ATRAC codec, originally developed in 1991 for use with Mini Discsc) and Microsoft (WMA, launched in April 1999d). However, by 1996, MP3s could be found on computers worldwide, and it appeared that MP3 had won the battle for dominant design in compressed audio formats.Napster Takes the LeadIn 1999, while a student at Northeastern University in Boston, Shawn Fanning released Napster—a software program that allowed users with Internet access to easily share MP3 files. Napster provided a user-friendly solution to music fans wish-ing to share and find music online. Napster provided a user interface with a search box that pointed individuals to other users with the files they wished to download. The Napster servers did not host any MP3 files; rather they hosted a database with information on which users had which files to share and whether they were online, and connected one computer to another for downloading. Napster was one of the first widely adopted “peer-to-peer” applications, and helped popularize the term.Napster was free, and as the growing number of people with Internet access realized, so was the music that it allowed them to access. Users were increas-ingly trading copyrighted material—commercial records and songs. In fact, the great majority of music downloaded through Napster was copyrighted material. By March 2000, 5 million copies of Napster had already been downloaded.e At its peak, there were 70 million Napster users.fWhile “music pirates” around the world embraced Napster, the Recording Industry Association of America (RIAA), the trade group that represents the lead-ing music business entities in the United States, grew increasingly alarmed. The RIAA worried that the growing illegal trade of music would result in a loss of prof-its for its constituents—record labels that owned the rights to much of the popular commercial music that was being traded online. The RIAA initiated legal action against Napster and Napster users in an effort to take the service offline and curtail illegal file sharing. This move was controversial for several reasons. Some analysts believed that it would be difficult to fight a technological advance such as this by legal action alone, and that the RIAA would not be successful unless it offered a legitimate alternative for users who wished to purchase music online. Other analysts took an even stronger stance, arguing that the record labels were not only fighting to protect the rights of artists, but to protect a business model that had become outdated.g They argued that the popularity of Napster was par-tially due to the rigid and overpriced traditional music distribution model, where fans were forced to buy albums for prices that some felt were inflated, and did not have the choice to buy individual songs. This was not the first time the enter-tainment industry had resisted a change in business models and was reluctant to embrace a new technology. A 2001 article in The Economist pointed out that “Phonographs were going to kill sheet music, the rise of radio threatened to Final PDF to printer
sch87956_ch09_197-222.indd 199 11/09/18 11:21 AMChapter 9 Protecting Innovation 199undermine sales of phonograph discs, video recorders were going to wipe out the film industry, and cassette recorders spelt doom for the music business. . . . In each case, their fears proved unfounded. The new technologies expanded the markets in unprecedented ways.”h Some commentators believed that the new technology could be beneficial for the recording industry. If harnessed appro-priately, it could enable an inexpensive distribution method, as well as direct intimate interaction with consumers that allowed for targeted marketing.In 2001, Napster offered the RIAA a partnership that included a legitimate dig-ital distribution model that would make online music available via a subscription service. The RIAA declined, and instead continued to pursue a legal judgment against Napster. In July 2001, the court ruled in the RIAA’s favor, and the Napster service was taken offline. It was a blow to peer-to-peer fans worldwide.Though the record labels had won the battle against Napster, they began to realize the war was far from over. Services similar to Napster began to sprout up online, offering “users in the know” the opportunity to continue pirating music. The record labels continued to pursue legal action against peer-to-peer ser-vices and users who engaged in illegal file trading, while coming to terms with the need to offer a legitimate alternative service. Subsequently, Warner Music teamed up with BMG, EMI, and RealNetworks to introduce MusicNet, and Sony Entertainment and Universal created Pressplay, both of which were subscrip-tion services that enabled individuals to download music legally from the Web. However, in an attempt to control their music catalogs, the labels used propri-etary file formats and severely limiting digital rights management (DRM) schemes that confused users. Furthermore, neither service offered the breadth of selec-tion offered by unauthorized peer-to-peer services such Kazaa or Gnutella. The popularity of peer-to-peer music swapping continued to grow. The RIAA needed a savior. Steve Jobs offered to be that guy.iTunes Just in TimeOn April 28, 2003, Apple opened its iTunes Music Store. After striking agreements with the five major record labels (Sony, Universal, BMG, Warner Music Group, and EMI), iTunes launched with an initial catalogs of 200,000 songs for purchase at 99 cents per song.i iTunes showed immediate signs of success, boasting 50  million downloads within the first year, and quickly became the leading distributor of music online.j Apple got the blessing of the recording industry after guaranteeing them that the files offered via the Music Store would allow for protection against illegal sharing thanks to the “FairPlay” DRM scheme. In essence, the iTunes Music Store offered audio in two file formats—Advanced Audio Coding (AAC) and modified MP3s. With Apple’s Fairplay DRM, song files could be loaded on up to five comput-ers only, and could not be played on non-iPod MP3 players. In addition, the files could not be e-mailed or distributed over the Web, and files were “hidden” on the iPod through a subdirectory structure that made it difficult to copy songs from a friend’s iPod. All of these features helped to prevent users from mass-distributing songs to others, helping to ease the minds of record company executives.The success of iTunes was fueled by a number of factors. The company had a “cool” image that was attractive to the recording industry and users alike. Final PDF to printer
sch87956_ch09_197-222.indd 200 11/09/18 11:21 AM200 Part Two Formulating Technological Innovation StrategyThe company also used the familiar MP3 format, offered an attractive price tag for online music, and its licensing agreements with all five major labels enabled it to offer a one-stop source for customers. In addition, the FairPlay DRM was not as restrictive as other competing formats,k and this was important to many users. The success of iTunes was also accelerated by the success of Apple’s iPods. iPods are hard-disk–based portable MP3 players that are well designed, well marketed, and user-friendly. Though there had been some criticisms concern-ing their dependability (chiefly related to battery life)l and sound quality issues,m casual music consumers took to these players in large numbers. To the appreci-ation of the RIAA, the iPods required synchronization with one’s music collection via the iTunes application, thereby making it difficult to share music stored on the iPod, or purchased from iTunes.The recording industry had found a new channel of distribution that earned significant revenues (about $0.70 of every $0.99 sale on iTunes is delivered directly to the record labelsn), and Apple had licensing agreements with all the major labels, which afforded Apple access to huge catalogs. Apple leveraged these catalogs to entice users to buy music through its iTunes Music Store, and this in turn helped drive sales of the Apple iPod, since files bought on iTunes could not be played on rival MP3 players. Apple was well positioned, but threats loomed on the horizon.In March 2006, the French National Assembly approved a bill requiring Apple to open its FairPlay DRM technology to industry rivals in France.o This meant that Apple would have to allow songs downloaded from the French iTunes Music Store to be played on non-iPod MP3 players, and that iPods would need to play competing file formats, such as Sony’s ATRAC3 files purchased through the Sony Connect online music store. Many users could appreciate this interoperability, yet it would challenge the “single operator license model” that had eased the minds of the recording industry and created a large and loyal customer base for Apple. Initially analysts speculated that Apple would withdraw from the French market, but instead Apple began working on negotiating fewer DRM restrictions from the record labels. By March of 2009, Apple had convinced all the major labels to permit their songs to be sold through iTunes without DRM. In return, Apple adopted the tiered pricing model that the major labels had long requested.The rise of smartphones that could hold users’ music digital libraries in addition to offering a host of other useful functions helped to fuel the growth of digital music sales. By 2011, digital music sales exceeded physical sales in both the United States and South Korea, and by 2016 digital music sales exceeded physical music sales in roughly half of the major music markets of the world.p However, an even bigger transition was also changing the landscape of music. Rapidly growing ser-vices such as Spotify, Pandora, and Apple Music were now streaming music over the Internet, enabling listeners to hear whatever music they wanted, whenever they wanted, on a wide range of devices, without the user ever taking ownership of the music. Though many had feared that a transition to streaming would be disastrous to the recorded music industry, instead paid music streaming subscriptions fueled record-setting market growth. In 2016, the global recorded music market grew by almost 6 percent—the highest rate since 1997—to a total of US$15.7 billion.Final PDF to printer
sch87956_ch09_197-222.indd 201 11/09/18 11:21 AMChapter 9 Protecting Innovation 201OVERVIEWA crucial element of formulating a firm’s technological innovation strategy is deter-mining whether and how to protect its technological innovation. Traditionally, eco-nomics and strategy have emphasized the importance of vigorously protecting an innovation in order to be the primary beneficiary of the innovation’s rewards, but the decision about whether and to what degree to protect an innovation is actually com-plex. Sometimes not vigorously protecting a technology is to the firm’s advantage—encouraging other producers (and complementary goods providers) to support the technology may increase its rate of diffusion and its likelihood of rising to the position of dominant design. In this chapter, we first will review the factors that shape the degree to which a firm is likely to appropriate the returns from its innovation, and the mecha-nisms available to the firm to protect its innovation. We then will consider the con-tinuum between a wholly proprietary strategy and a wholly open strategy, examining the trade-offs inherent in decisions about whether (and to what degree) to protect or diffuse a technological innovation. The chapter concludes by listing factors the firm should consider in formulating its protection strategy.Discussion Questions 1. What industry conditions led to the revolution in audio distribution described above? Which stakeholders stand to benefit most (or least) from this revolution? 2. Why did the music stores created by the record labels fail to attract many sub-scribers? What, if anything, should the record labels have done differently? 3. What factors led iTunes to be successful? 4. How do you think a move away from owning music led to record-setting music revenues? a Adapted from a New York University teaching case by Shachar Gilad, Christopher Preston, and Melissa A. Schilling. b “Thomson Multimedia Signs 100th mp3 Licensee,” press release (PR Newswire), April 18, 2001. c Junko Yoshida, “Sony Sounds Off about Mini Disc,” Electronic World News, no. 41 (June 3, 1991), p.15. d Jack Schofield, “Music Definitions,” The Guardian, October 5, 2000, p. 3. e Karl Taro Greenfeld, “The Free Juke Box: College Kids Are Using New, Simple Software Like Napster to Help Themselves to Pirated Music,” Time, March 27, 2000, p. 82. f Michael Gowan, “Easy as MP3,” PC World 19, no. 11 (November 2001), p. 110. g “The Same Old Song,” The Economist 358, no. 8210 (January 24, 2002), pp. 19, 20. h Ibid. i Michael Amicone, “Apple Took a Big Bite Out of the Market,” Billboard 116, no. 16 (April 17, 2004), p. 2. j “iTunes Music Store Downloads Top 50 Million Songs,” press release, March 15, 2004. k Ibid. l “Apple Faces Class Action Suits on iPod Battery,” Reuters, February 10, 2004. m Randall Stross, “From a High-Tech System, Low-Fi Music,” New York Times, July 4, 2004, p. 3. n Alex Veiga, “Recording Labels, Apple Split over Pricing,” Associated Press, April 2, 2006. o Rob Pegoraro, “France Takes a Shot at iTunes,”, March 26, 2006, p. F06. p International Federation of the Phonographic Industry Global Music Report 2017.Final PDF to printer
sch87956_ch09_197-222.indd 202 11/09/18 11:21 AM202 Part Two Formulating Technological Innovation StrategyAPPROPRIABILITYThe degree to which a firm can capture the rents from its innovation is termed appropriability. In general, the appropriability of an innovation is determined by how easily or quickly competitors can imitate the innovation. The ease with which competi-tors can imitate the innovation is, in turn, a function of both the nature of the technol-ogy itself and the strength of the mechanisms used to protect the innovation.Some technological innovations are inherently difficult for competitors to copy; the knowledge underlying the technology may be rare and difficult to replicate. A firm’s unique prior experience or talent pool may give it a foundation of technical know-how that its competitors do not possess. If this knowledge base is tacit (i.e., it cannot be read-ily codified into documents or procedures) or socially complex (i.e., it arises through complex interactions between people), competitors will typically find it very difficult to duplicate.1 For example, a firm that has a team of uniquely talented research scientists may have a rare and difficult-to-imitate knowledge base. While some of the skill of the research scientists may be due to imitable training procedures, talent typically implies that an individual (or group) has a natural endowment or ability that is very difficult, if not impossible, to replicate through training. Furthermore, if the unique capabilities of the research team arise in part from the nature of the interactions between the scien-tists, their performance will be socially complex. Interactions between individuals can significantly shape what each individual perceives, and thus what each individual—and the collective group—discovers or learns. The outcomes of these interactions are path dependent, and thus are idiosyncratic to the combination of individuals, the moment of the interaction, and the nature of the interaction. This means that knowledge can emerge from the interaction of a group that could not be replicated by any individual or any different group.Many innovations, however, are relatively easy for competitors to imitate. Individu-als and firms often employ legal mechanisms to attempt to protect their innovations. Most countries offer legal protection for intellectual property in the form of patent, trademark, copyright, and trade secret laws.PATENTS, TRADEMARKS, AND COPYRIGHTSWhile patents, copyrights, and trademarks are all ways of protecting intellectual prop-erty, they are each designed to protect different things. A patent protects an inven-tion, and a trademark protects words or symbols intended to distinguish the source of a good. A copyright protects an original artistic or literary work. Thus, a typical computer might have components whose designs are protected by patents, logos such as the Starbuck’s mermaid that are protected by trademark law, and software that is protected by copyright (though as discussed later in the section on patents, many types of software are now also eligible for patent protection).The purpose of intellectual property protection is to provide recognition and incen-tive for creative work. Patents and copyrights, for example, provide a legal means for individuals to protect their creative work and earn rewards from it, in exchange for making the knowledge underlying their work public. Making this knowledge public is important because it helps others to build upon that knowledge, driving technological appropriabilityThe degree to which a firm is able to capture the rents from its innovation.tacit knowledgeKnowledge that cannot be readily codified or trans-ferred in written form.socially complex knowledgeKnowledge that arises from the interaction of multiple individuals.patentA property right protecting a pro-cess, machine, manufactured item (or design for manufactured item), or variety of plant.trademarkAn indicator used to distin-guish the source of a good.Final PDF to printer
sch87956_ch09_197-222.indd 203 11/09/18 11:21 AMChapter 9 Protecting Innovation 203and social advance. In absence of those protections, people might prefer to keep their discoveries and inventions secret.PatentsIn many countries, inventors can apply for patent protection for their inventions. An invention can be a product, such as a new type of battery, or a process, such as a new way to manufacture bagels. In the United States, patents are categorized into different types such as a utility patent for a new and useful process, machine, manufactured item, or combination of materials; a design patent for an original and ornamental design for a manufactured item; or a plant patent for the discovery and asexual reproduction of a distinct and new variety of plant.Each country has its own patent system with different requirements, and unless a patent is filed under a regional patent office or an international treaty, the rights it is granted are applicable only in the country in which the patent is filed.To qualify for a patent, an invention must usually meet the following criteria: 1. It must be useful (i.e., it must produce a desirable result, solve a problem, improve on or propose a new use for an existing development or show potential of doing so). 2. It must be novel (i.e., it must not already be patented or described in public litera-ture, or be in public use for more than a year). 3. It must not be obvious (i.e., a person with experience or skill in the particular art of the patent would not be expected to achieve the same invention with a normal amount of effort).In most countries, the discovery of scientific principles that pertain to natural laws (e.g., gravity) cannot be patented because they are considered to have always existed. Additionally, the following are not typically patentable: ∙ Substituting one material for another (e.g., plastic for metal). ∙ Merely changing the size of an already existing device. ∙ Making something more portable. ∙ Substituting an element for an equivalent element. ∙ Altering an item’s shape.Printed materials are not typically patentable, but it may be possible to protect them by copyright, as discussed in the next section. Historically software algorithms were not considered patentable, but in 1998, a U.S. Supreme Court case upheld a patent on a computerized method of managing mutual funds that relied on software algo-rithms, unleashing a flood of patent applications for software. From 1997 to 2000, patent filings in the United States for software-enabled methods of doing business increased more than 700 percent.2 For example, Amazon patented its “1-click” system that streamlines the process by which customers place orders.3Patenting an invention is a serious undertaking. To apply for a patent, the inven-tor must explain how to make and use the invention, and make claims about what it does that makes it a new invention. Drawings of the new invention are also often required. In the United States, this application is reviewed by a patent examiner who may modify the scope of the claims made by the patent. The patent is then published copyrightA property right protecting works of authorship.Final PDF to printer
sch87956_ch09_197-222.indd 204 11/09/18 11:21 AM204 Part Two Formulating Technological Innovation Strategyfor a time in which other inventors can challenge the patent grant (if, e.g., they believe that the patent infringes on previously granted patents). If the standards for patentabil-ity are met, the patent is then granted. The entire process from application to granting is lengthy. For example, the time from filing to grant is between two and five years in the United States, three and five years in Europe, five and six years in Japan, and five and seven years in India. In industries in which product lifecycles are short, such delays significantly diminish the usefulness of patenting. This has led to a number of proposals for how the patenting system might be reformed to make it more efficient.The number of patent applications being filed is growing around the world, but nowhere faster than China, which had both the largest number of patent applications in 2015 and 2016, and the largest rate of growth in patent applications (21.5 percent) between 2015 and 2016 (see Figure 9.1).A number of costs are also involved in filing and maintaining a patent. Fees vary by patenting office. In the United States, the entire patenting process for a “small entity” (e.g., an independent inventor, a small business, or a nonprofit organization) costs around $1500 in filing fees (and roughly double that for large entities), and $5000–$10,000 in attorney fees. In most countries, patent protection lasts for 20 years.In a major study of historical success rates for U.S. patent applications, Michael Carley, Deepak Hegde, and Alan Marco followed the history of the 2.15 million new patent applications filed at the USPTO after 1996 and found that only 55.8 percent of the applications became granted. Patent applications in the “Drugs and Medical Instruments” sector had the lowest success on average (42.8 percent), and applications in the “Electrical and Electronics” had the highest (66.6 percent). They also found that success was generally lower for small firms and that overall, success rates for all types of applications had gone down over time.4Major International Patent TreatiesThere is currently no “world patent,” and a patent granted in one country does not automatically provide protection in other countries. In some regions, however, there FIGURE 9.1Patent Applications in 2015 and 2016 in the 10 Largest Patent Offices around the WorldSource: WIPO Patent Statistics Database, September 2017.AustraliaCanadaRussian FederationIndiaGermanyEuropean Patent OfficeRep. of KoreaJapanUnited StatesChina500,000–1,000,0001,500,000Patent applications 2016Patent applications 2015Final PDF to printer
sch87956_ch09_197-222.indd 205 11/09/18 11:21 AMChapter 9 Protecting Innovation 205are regional patent offices (such as the European Patent Office and the Africa Regional Intellectual Property Organization) that grant patents valid in all the member nations of that program.Significant differences exist in national patent laws. For example, in most coun-tries, publication of information about the invention before applying for a patent will bar the right to a patent, but the United States allows a one-year grace period (i.e., an inventor can publish an invention up to a year before applying for the patent). Thus, if international patent protection will eventually be sought, inventors must uphold the stricter standard of applying for patent before publishing information about the pat-ent, even if they plan to first patent the invention in the United States. Many countries also require that the invention be manufactured in the country in which a patent was granted within a certain time frame (often three years) from the time the patent is granted. This is called the “working requirement,” and it effectively prevents inven-tors from patenting inventions in countries in which they have no intention of setting up production.Many inventors wish to patent their inventions in many countries simultaneously. To make that easier, several international treaties have been negotiated between coun-tries that seek to harmonize the patent laws around the world. Two of the most signifi-cant are the Paris Convention for the Protection of Industrial Property and the Patent Cooperation Treaty.The Paris Convention for the Protection of Industrial Property (also known as the Paris Convention Priority) is an international intellectual property treaty adhered to by 177 countries as of March 2018. Under the Paris Convention, a citizen of any member country may patent an invention in any of the member countries and enjoy the same benefits of patent protection as if the inventor were a citizen of those countries. That is, the Paris Convention eliminates (for its member countries) any differential patent rights afforded to citizens of the country versus foreign nationals. Furthermore, the treaty also provides the right of “priority” for patents and trademarks. Once an inven-tor has applied for patent protection in one of the member countries, the inventor may (within a certain time period) apply for protection in all the other member countries. The time period is 12 months for utility patents and six months for design patents and trademarks. Most important, the applications to these later countries will be treated as if they were made on the same date as the first application. This enables the inventor to establish priority over any other patents applied for in those countries after the inven-tor made the first application. For example, if an inventor applied for a utility patent for an invention in Madagascar in January 2003, and another inventor applied for a patent for a very similar invention in France in June 2003, the Madagascar inventor could have applied for patent protection in France in December 2003 and claim prior-ity over the French invention. The French inventor would have to prove that his or her invention was substantively different from the Madagascar invention, or the French inventor’s patent would be denied.As mentioned previously, in many countries, public disclosure of an invention makes it impossible to subsequently patent that invention. However, with the priority rights established under the Paris Convention, an inventor who patents an invention in one of the member countries can then publicly disclose information about that inven-tion without losing the right to patent the invention in the other countries—each patent Final PDF to printer
sch87956_ch09_197-222.indd 206 11/09/18 11:21 AM206 Part Two Formulating Technological Innovation Strategyapplication will be treated as if it were applied for at the same time as the first applica-tion, and thus as if it were applied for before public disclosure. Without this treaty, it would be nearly impossible for an inventor to patent an invention first in the United States and then in other countries because U.S. patent applications are made available to the public.Another very significant international patent treaty is the Patent Cooperation Treaty, or PCT. This treaty facilitates the application for a patent in multiple coun-tries. An inventor can apply for a patent to a single PCT governmental receiving office, and that application reserves the inventor’s right to file for patent protection in 152  countries for up to two-and-half years. Once the inventor has filed the application, a PCT governmental searching office will perform the patent search for the application (this search verifies that the invention is not already subject to a prior claim). Once the search is completed, the inventor can choose to enter Chapter II of the process wherein the PCT governmental office assesses the patentability of the invention subject to the standards of the Patent Cooperation Treaty. Eventually, the inventor must have the PCT application filed in each of the national patent offices in which the inventor is seeking protection.Filing a single PCT application offers numerous advantages. First, applying for the PCT patent buys the inventor the option to apply to multiple nations later without com-mitting the inventor to the expense of those multiple applications. With a PCT applica-tion, the inventor can establish a date of application in multiple countries (protecting the inventor’s priority over later claims), while paying only the single PCT applica-tion fee rather than the numerous national application fees. Though the inventor will eventually have to pay for national applications in the countries in which protection is sought, the inventor can delay those costs. Thus, the inventor has time to assess the likelihood of the patent being granted and the potential profitability of the invention. If the PCT process suggests that the patent will not be granted or if it appears the inven-tion has limited potential for earning returns, the inventor can forgo the expense of applying to the national offices.Another advantage of the PCT process is that it helps make the results of patent applications more uniform. Though individual countries are not required to grant a patent to those inventions that are granted a patent by the PCT governing office, the granting of the patent by the PCT provides persuasive evidence in favor of granting the patent in the individual national offices. As of August 2015, there were 148 member states of the Patent Cooperation Treaty.Patent StrategiesIt is typical to assume that an inventor seeks a patent because they desire to make and sell the invention themselves. However, inventors and firms may monetize patents in a range of different ways, including licensing the technology to others or selling the pat-ent rights to another firm that can better utilize the technology.5 Furthermore, whereas the conventional wisdom is that most inventors prefer to keep the details of their inven-tion secret before the patent is granted (to prevent rivals from having access to their proprietary knowledge), this turns out not to be the case. A study by Stuart Graham and Deepak Hegde found that the vast majority of patentees prefer to disclose their patent applications before they are granted. Both large and small inventors, across Final PDF to printer
sch87956_ch09_197-222.indd 207 11/09/18 11:21 AMChapter 9 Protecting Innovation 207all major technology fields exhibited this preference for early disclosure, presumably because it allows them to publicize their invention’s quality and scope to competi-tors, external investors, and potential licensees. Disclosure via patent application also establishes the date from which patentees can enjoy provisional patent rights.6Firms may also seek patents just to limit the options of competitors or to earn rev-enues through aggressive patent lawsuits. These actions are sometimes referred to as “patent trolling.” A patent troll’s primary purpose in owning patents is to extort money from other firms. For example, a patent troll might buy a patent from a bank-rupt firm to sue another company that it claims is infringing on the purchased pat-ent. Apple claims to be the number one target for patent trolls, having faced nearly 100 lawsuits between 2011 and 2014.7 According to RPX Corporation, a firm that helps companies resolve patent lawsuits through licensing, patent trolls filed more than 2900 infringement suits in the United States in 2012.8 This type of predatory pat-enting has sparked an effort by the U.S. Federal Government to make patent granting stricter and to impose penalties against spurious patent lawsuits.9In industries with complex technologies such as computers, software, and telecom-munications, a dense web of overlapping patents known as “patent thickets” can make it very difficult for firms to compete without falling prey to patent suits by other firms in that technology domain. This can seriously stifle innovation and has resulted in the rather peculiar strategy of firms buying bundles of patents to create war chests that they hope will deter the patent attacks of others. For example, in 2011, the bankrupt Nortel auctioned off its massive patent portfolio. The auction was won by a consortium called Rockstar Bidco that included Microsoft, Apple, RIM, Sony, and Ericsson, who paid $4.5 billion for the war chest, beating out Google which bid $4.4 billion. Google subsequently bought 1030 IBM patents that covered a range of technologies, from the fabrication of microprocessing chips, object- oriented programming, and other business processes. These patents were not necessary for Google’s business directly; rather they provided a retaliation threat to others that might attack them through patent suits.10 Google also bought Motorola Mobility for $12.5  billion the same year, and it was widely believed that the purchase was almost solely for Motorola’s patents, which would bolster Google’s position in the lawsuit they expected would arise from the Nortel patents.11 In October of 2013, confirming Google’s fears, Rockstar Bidco filed suit against Google and seven companies that make phones for Google’s Android operating system.12 Google countersued based on its own patents, and in November 2014, it was reported that Google and Rockstar had reached a settlement.13Trademarks and Service MarksA trademark is a word, phrase, symbol, design, or other indicator that is used to dis-tinguish the source of goods from one party from the goods of others. The “Intel Inside” logo on many computers is one example of a trademark, as is the familiar Nike “swoosh” symbol. A service mark is basically the same as a trademark, but dis-tinguishes the provider of a service rather than a product. Often the term trademark is used to refer to both trademarks and service marks.Trademarks and service marks can be embodied in any indicator that can be per-ceived through one of the five senses. Most marks are embodied in visual indicators, patent trollingA pejorative term for when an indi-vidual or firm misuses patents against other individuals or firms in attempt to extract money from them.patent thicketsA dense web of overlapping patents that can make it difficult for firms to com-pete or innovate.Final PDF to printer
sch87956_ch09_197-222.indd 208 11/09/18 11:21 AM208 Part Two Formulating Technological Innovation Strategysuch as words, pictures, and slogans. However, marks are also registered that use other senses such as sound (e.g., tones that are associated with a particular company or brand) or smells (as in fragrance). Trademark rights may be used to prevent others from using a mark that is similar enough to be confusing, but they may not be used to prevent others from producing or selling the same goods or services under a clearly different mark.In most countries, the rights to a trademark or service mark are established in the legitimate use of the mark and do not require registration; however, registration pro-vides several advantages. First, registering the mark provides public notice of the reg-istrant’s claim of ownership over the mark. Second, marks must be registered before a suit can be brought in federal court against an infringement of the mark. Third, registration can be used to establish international rights over the trademark, as when the U.S. registration is used to establish registration in other countries, and to protect the mark against infringement from imported products. As of April 2018, the U.S. Patent and Trademark Office charged between $275 and $375 application fee to reg-ister a trademark. It normally took 10 to 16 months to receive certification from the U.S. Patent and Trademark Office, but the protection offered by the registration of the trademark begins from the date of filing. Unlike patents and copyrights, trademark protection can last as long as the trademark is in use, but the registration requires periodic renewal.Major International Trademark TreatiesNearly all countries offer some form of trademark registration and protection. National or regional offices maintain a Register of Trademarks that contains infor-mation on all trademark registrations and renewals. To eliminate the need to register separately in each country (or region), the World Intellectual Property Organization administers a System of International Registration of Marks governed by two treaties: the Madrid Agreement Concerning the International Registration of Marks and the Madrid Protocol. Countries that adhere to either (or both) the Madrid Agreement or Madrid Protocol are part of the Madrid Union. Any individual that lives in, is a citizen of, or maintains an establishment in a Madrid Union country can register with the trademark office of that country and obtain an international registration that provides protection in as many other Madrid Union countries as the applicant chooses. As of April 2014, there were 91 member countries of the Madrid Union.CopyrightCopyright is a form of protection granted to works of authorship. In the United States, the authors of original literary, dramatic, musical, artistic, and certain other intellec-tual works can obtain copyright protection.14 Like trademarks, the rights of copyright protection are established by legitimate use of the work. This protection is available whether or not the work is published and prevents others from producing or distribut-ing that work. Under section 106 of the 1976 Copyright Act, the owner of the copy-right has the exclusive right to do (or authorize others to do) the following: ∙ Reproduce the work in copies or phonorecords. ∙ Prepare derivative works based upon the work.Final PDF to printer
sch87956_ch09_197-222.indd 209 11/09/18 11:21 AMChapter 9 Protecting Innovation 209 ∙ Distribute copies or phonorecords of the work to the public by sale or other transfer of ownership, or by rental, lease, or lending. ∙ Perform the work publicly, in the case of literary, musical, dramatic, and choreo-graphic works, pantomimes, and motion pictures and other audiovisual works. ∙ Display the copyrighted work publicly, in the case of literary, musical, dramatic, and choreographic works, pantomimes, and pictorial, graphic, or sculptural works, including the individual images of a motion picture or other audiovisual work. ∙ Perform the work publicly by means of a digital audio transmission (in the case of sound recordings).There are, however, limitations to these rights. In particular, in the United States, the doctrine of fair use stipulates that in most circumstances it is not a violation of copyright for others to use copyrighted material for purposes such as criticism, com-ment, news reporting, teaching, scholarship, or research. Furthermore, some types of work cannot be protected by copyright. For example, work that has not been fixed in a tangible form of expression (e.g., a choreographed dance or improvisational speech that was not notated or recorded) is not eligible for copyright protection. Titles, names, short phrases, slogans, familiar symbols, and lists of ingredients also cannot be copyrighted.Unlike patent protection, copyright protection is secured automatically when an eligible work is created and fixed in a copy or phonorecord for the first time. No publication or registration with the Copyright Office is necessary to establish this copyright, though registering the copyright is advantageous in that it establishes a public record of the copyright claim and is required before filing an infringement suit in court. As of April 2018, basic online registration of copyright with the U.S. Copyright Office costs $35, and it took about 3 to 10 months to receive a certificate of registration.Before 1978, copyright protection lasted only 28 years from the time it was secured (though during the last year the author could opt to renew the protection for an addi-tional term). Revisions to U.S. copyright law, however, give copyright protection to works created after 1978 that lasts for the author’s life plus an additional 70 years.Copyright Protection around the WorldAs with patents and trademarks, no international copyright law automatically protects an author’s work throughout the world. Copyright protection varies from country to country. However, most countries do offer copyright protection to both domestic and foreign works, and there are international copyright treaties for simplifying the pro-cess of securing such protection. One of the most significant is the Berne Union for the Protection of Literary and Artistic Property (known as the Berne Convention). The Berne Convention specifies a minimum level of copyright protection for all mem-ber countries, and it requires member countries to offer the same protection to both its own citizens and foreign nationals. Other treaties include the Universal Copyright Convention (UCC); the Rome Convention for the Protection of Performers, Producers of Phonograms and Broadcasting Organizations; the Brussels Convention Relating to the Distribution of Program-Carrying Signals Transmitted by Satellite; and the World Intellectual Property Organization Copyright Treaty.Final PDF to printer
sch87956_ch09_197-222.indd 210 11/09/18 11:21 AM210 Part Two Formulating Technological Innovation StrategyTRADE SECRETSRather than disclose detailed information about a proprietary product or process in exchange for the grant of a patent, inventors or firms often will choose to protect their intellectual property by holding it as a trade secret. A trade secret is information that belongs to a business that is generally unknown to others. Trade secrets need not meet many of the stringent requirements of patent law, enabling a broader class of assets and activities to be protectable. For example, while the formula for a beverage is not patentable, it can be considered a trade secret. Trade secret law traces its history back to Roman law punishing individuals who induced someone to reveal the details of their employer’s commercial affairs.15Information is typically considered to be a trade secret only if it (a) offers a distinc-tive advantage to the company in the form of economic rents, and (b) remains valu-able only as long as the information remains private. Examples of trade secrets might include information about a firm’s customers, its marketing strategies, or its manufac-turing processes. Trade secret law protects such information from being wrongfully taken by another party. In the United States, trade secret law is implemented at the state level, but the Uniform Trade Secret Act attempts to make these laws consistent from state to state.For information to qualify as a trade secret under the Uniform Trade Secret Act, the information must meet the following three criteria: ∙ The information must not be generally known or readily ascertainable through legitimate means. ∙ The information must have economic importance that is contingent upon its secrecy. ∙ The trade secret holder must exercise reasonable measures to protect the secrecy of the information.If information meets these criteria, the Uniform Trade Secret Act stipulates that its owner can prevent others from benefiting from this information without the owner’s permission. In particular, the act states that no individual or group can copy, use, or otherwise benefit from a trade secret without the owner’s authorization if they meet any of the following conditions: 1. They are bound by a duty of confidentiality (e.g., employees, lawyers). 2. They have signed a nondisclosure agreement. 3. They acquire the secret through improper means such as theft or bribery. 4. They acquire the information from someone who did not have the right to disclose it. 5. They learn about the secret by mistake but have reason to know that the informa-tion was a protected trade secret.In most regions, if owners of a trade secret believe that another party has stolen or improperly disclosed their trade secret, they can ask a court to issue an injunction against further use of the secrets, and they may also be able to collect damages for any economic harm suffered by the improper use of the trade secret. For example, in November 2002, Procter & Gamble sued Potlatch Corporation, claiming that Potlatch had stolen trade secret methods used to produce Bounty paper towels and Charmin trade secretInformation that belongs to a business that is held private.Final PDF to printer
sch87956_ch09_197-222.indd 211 11/09/18 11:21 AMChapter 9 Protecting Innovation 211bath tissue by hiring away two of Procter & Gamble’s paper manufacturing experts. Potlatch is a large, private-label tissue manufacturer that produces toilet paper, facial tissues, napkins, and paper towels for grocery store chains such as Albertsons and Safeway. By March 2003, the two companies had reached an agreement to settle out of court, keeping the terms of the settlement confidential.16THE EFFECTIVENESS AND USE OF PROTECTION MECHANISMSThe methods used to protect innovation—and their effectiveness—vary significantly both within and across industries.17 In some industries, such as pharmaceuticals, legal protection mechanisms such as patents are very effective. In other industries, such as electronics, patents and copyright provide relatively little protection because other firms can often invent around the patent without infringing on it (as IBM discovered when Compaq was able to produce a computer nearly identical to its personal com-puter design). It is also notoriously difficult to enforce patents protecting industrial processes such as manufacturing techniques. If patents provide little protection, the firm may rely more heavily on trade secrets; however, the ability to protect trade secrets also varies with the nature of the technology and the industry context. To protect a trade secret, a firm must be able to expose its product to the public without revealing the underlying technology, but in many cases, revealing the product reveals all.For some competitive situations, protecting a technology may not be as desirable as liberally diffusing it. In industries characterized by increasing returns, firms some-times choose to liberally diffuse their technologies to increase their likelihood of ris-ing to the position of dominant design. As discussed in Chapter Four, learning-curve effects and network externalities can cause some industries to demonstrate increasing returns to adoption: The more a technology is adopted, the more valuable it becomes.18 This dynamic can lead to winner-take-all markets that create natural monopolies. A firm that controls the standard can reap monopoly rents and can exert significant architectural control over both its own industry and related industries.19This enviable position can be so lucrative that firms may be willing to lose money in the short term to improve their technology’s chance of rising to the position of dominant design. Thus, firms may liberally diffuse their technologies (through, e.g., open source software or liberal licensing arrangements) to accelerate the technol-ogy’s proliferation and thereby jump-start the self-reinforcing feedback effect that can lead to the technology’s dominance. However, the firm often faces a dilemma: If it liberally diffuses the technology to would-be competitors, it relinquishes the oppor-tunity to capture monopoly rents when and if the technology emerges as a dominant design. Furthermore, once control of a technology is relinquished, it can be very hard to regain; thus, such diffusion may result in the firm losing all hope of controlling the technology. Finally, liberal diffusion of the technology can result in the fragmentation of the technology platform: As different producers add improvements to the technol-ogy that make it better fit their needs, the “standard” may be split into many nonstan-dardized versions (as with UNIX, as described in more detail later in the chapter). To resolve these trade-offs, firms often adopt a strategy of partial protection for their innovations, falling somewhere on the continuum between wholly proprietary systems and wholly open source softwareSoftware whose code is made freely available to others for use, augmentation, and resale.Final PDF to printer
sch87956_ch09_197-222.indd 212 11/09/18 11:21 AM212 Part Two Formulating Technological Innovation StrategyWholly Proprietary Systems versus Wholly Open SystemsWholly proprietary systems are those based on technology that is company-owned and protected through patents, copyrights, secrecy, or other mechanisms. Such tech-nologies may be legally produced or augmented only by their developers. Wholly proprietary systems are often not compatible with the products offered by other manu-facturers. Because their operation is based on protected technology, other manufac-turers are often unable to develop components that may interact with the proprietary system. Proprietary systems typically provide their developers with the opportunity to appropriate rents from the technology. However, they might also be less likely to be adopted readily by customers as a result of their higher costs and the inability to mix and match components.In wholly open systems, the technology used in a product or process is not protected by secrecy or patents; it may be based on available standards or it may be new technology that is openly diffused to other producers. Wholly open technolo-gies may be freely accessed, augmented, and distributed by anyone. Such technologies are usually quickly commoditized and provide little appropriability of rents to their developers.Many technologies are neither wholly proprietary nor wholly open—they are par-tially open, utilizing varying degrees of control mechanisms to protect their technolo-gies. It is useful to think of a control continuum that stretches from wholly proprietary to wholly open (see Figure 9.2). For instance, most of the major video game console producers (Nintendo, Sony, and Microsoft) utilize a wholly proprietary strategy for their consoles, but a limited licensing policy for their games. The licensing policies are designed to encourage developers to produce games for the systems, while enabling the console producers to retain a great deal of control over the games produced. All games developed for the consoles must be approved by the console producer before they can be made commercially available. For example, in the case of Microsoft, would-be Xbox games developers must first apply to the Xbox Registered Developer wholly propri-etary systemsGoods based on technology that is owned and vigorously protected through patents, copy-rights, secrecy, or other mecha-nisms. Wholly proprietary tech-nologies may be legally produced and augmented only by their developers.wholly open systemsGoods based on technology that is not protected and that is freely available for production or augmentation by other producers.FIGURE 9.2Examples on the Continuum from Wholly Proprietary to Wholly OpenWhollyProprietaryLimited LicensingModerateLicensingLiberalLicensingWholly OpenMicrosoft’sXbox video gameconsole;Monsanto’sRoundup before1999Videogames forthe Microsoft Xbox console;Monsanto’sRoundup fromJanuary 1999 to September 2000MicrosoftWindowsSun’s JavaGlyphosate(the baseingredient ofMonsanto’sRoundup) afterSeptember 2000Final PDF to printer
sch87956_ch09_197-222.indd 213 11/09/18 11:21 AMChapter 9 Protecting Innovation 213Program (for established games developers) or the Xbox Incubator Program (for smaller or newer games developers). If accepted into one of these two programs, the developer will receive access to development tools, but this does not guarantee the approval of any resulting game titles. The games are subjected to a separate, rigorous approval process.By contrast, the licensing policies for Microsoft’s Windows are more open. Win-dows is protected by copyright, and Microsoft defends its exclusive right to augment the software; however, it also permits complementary goods providers to access por-tions of the source code to facilitate development of complementary goods, licenses the rights to such providers to produce complementary applications, and licenses original equipment manufacturers (OEMs) to distribute the software by bundling it with hardware. Those who purchase a license for the software can execute and bun-dle the software with other goods but may not augment the software. For example, software applications developers may produce and distribute value-added applications for use with Windows as long as those applications do not affect the functionality of the Windows program itself.As described in the Theory in Action section later in the chapter, Sun’s “community source” (as opposed to “open source”) policy for Java is even more open. This policy grants anyone immediate access to the complete source code for Java and allows users to develop commercial applications based on the code, or to augment the code for their own implementations. These developers pay no license fee to Sun. However, any augmentation to the core structure of Java must be approved by the Java Community Process, which is managed by Sun. Sun’s “community source” principle is meant to encourage the broader software community to improve Java and develop complemen-tary applications, but it allows Sun to retain some control over the core platform to ensure that the platform does not become fragmented through unmanaged develop-ment by the software community.Many technologies that were once wholly proprietary or partially open become wholly open once their patents or copyrights expire. For instance, Monsanto’s highly profitable Roundup herbicide is based on a patented chemical ingredient called glypho-sate. This extremely potent herbicide was adopted by farmers in more than 100 coun-tries and accounted for a substantial portion of Monsanto’s sales.20 However, facing impending expiration of its patents, Monsanto began to license the rights to glypho-sate production to a few other companies (including Dow Agrosciences, DuPont, and Novartis) in 1999. In September 2000, the U.S. patent on glyphosate expired, and any chemical company was free to produce and sell glyphosate-based herbicides in the United States, making glyphosate a wholly open technology.Advantages of ProtectionBecause proprietary systems offer greater rent appropriability, their developers often have more money and incentive to invest in technological development, promotion, and distribution. If a single firm is the primary beneficiary of its technology’s suc-cess, it has much greater incentive to invest in further developing the technology. The profits from the technology may be directly reinvested in further improvements in the technology. The sponsor of a proprietary technology might also adopt a penetration pricing strategy (i.e., it may offer the technology at a low price or free) to rapidly build original equipment manufacturers (OEMs)Firms that assemble goods using compo-nents made by other manufac-turers, also called value-added resellers (VARs).Final PDF to printer
214sch87956_ch09_197-222.indd 214 11/09/18 11:21 AMTheory in Action IBM and the Attack of the ClonesIn 1980, IBM was in a hurry to introduce a personal com-puter. When personal computers first began to emerge at the end of the 1970s, most of the major computer manufacturers considered it no more than a peculiar product for a hobbyist market. The idea that individuals would want personal computers on their desks seemed ludicrous. However, as total U.S. personal computer sales reached $1 billion, IBM began to worry that the personal computer market could actually turn out to be a significant computer market in which IBM had no share. To bring a personal computer to market quickly, IBM decided to use many off-the-shelf components from other vendors, including Intel’s 8088 microprocessor and Microsoft’s software. However, IBM was not worried about imitators because IBM’s proprietary basic input/output system (BIOS), the computer code that linked the computer’s hardware to its software, was protected by copyright. While other firms could copy the BIOS code, doing so would violate IBM’s copyright and incur the legendary wrath of IBM’s legal team.However, getting around IBM’s copyright turned out not to be difficult. Copyright protected the written lines of code, but not the functions those codes produced. Compaq was able to reverse-engineer the BIOS in a mat-ter of months without violating IBM’s copyright. First, a team of Compaq programmers documented every func-tion the IBM computer would perform in response to a given command, without recording the code that per-formed the function. This list of functions was then given to another team of “virgin” programmers (programmers who were able to prove that they had never been exposed to IBM’s BIOS code).a These programmers went through the list of functions and wrote code to create identical func-tions. The result was a new BIOS that acted just like an IBM BIOS but did not violate its copyright. Compaq sold a record-breaking 47,000 IBM-compatible computers in its first year, and other clones were quick to follow.a R. Cringely, Accidental Empires (New York: HarperCollins, 1992).its installed base, it may spend aggressively on advertising to increase awareness of the technology, and it may even subsidize the production of complementary goods to increase the desirability of its technology to customers. A firm may be willing to lose money in the short term to secure the technology’s position as the standard, because once the technology has emerged as a standard, the payoff can be substantial and enduring. By contrast, when multiple firms can produce a technology, losing money on the technology in the short term to promote it as a standard is highly risky because the long-term distribution of the payoffs is uncertain. While the technology’s devel-oper may have borne the bulk of the cost in developing the technology, multiple firms may vie for the profits to be made on the technology.Protecting the technology also gives the developing firm architectural control over the technology. Architectural control refers to the firm’s ability to determine the structure and operation of the technology, and its compatibility with other goods and services. It also refers to the firm’s ability to direct the future development path of the technology. Architectural control can be very valuable, especially for technolo-gies in which compatibility with other goods and services is important. By controlling the technology’s architecture, the firm can ensure that the technology is compatible with its own complements, while also restricting its compatibility with the comple-ments produced by others.21 The firm can also control the rate at which the technol-ogy is upgraded or refined, the path it follows in its evolution, and its compatibility with previous generations. If the technology is chosen as a dominant design, the firm architectural controlThe ability of a firm (or group of firms) to deter-mine the struc-ture, operation, compatibility, and development of a technology.Final PDF to printer
sch87956_ch09_197-222.indd 215 11/09/18 11:21 AMChapter 9 Protecting Innovation 215with architectural control over the technology can have great influence over the entire industry. Through selective compatibility, it can influence which other firms do well and which do not, and it can ensure that it has a number of different avenues from which to profit from the platform.Microsoft’s Windows is the quintessential embodiment of this strategy. Because Windows is the dominant operating system in the personal computing market and because it serves as the interface between a computer’s hardware and software, Micro-soft has considerable market power and architectural control over the evolution of the personal computer system. Among other things, Microsoft has been able to incorpo-rate ever more utility programs into the core program, thereby expanding and taking over the roles of many other software components. Once a user purchased an operating system, uninstaller programs, disk-compression programs, and memory management programs separately, but Windows 95 and 98 integrated all these products and more into the operating system. This “feature creep” had a major impact on competition in the industry; many utility producers such as Qualitas, Stac Electronics, Microhelp, Quarterdeck, and others were forced to abandon their once-profitable products.Advantages of DiffusionThe primary argument for diffusing a technology instead of protecting it is that open technologies may accrue more rapid adoptions. If multiple firms are producing, dis-tributing, and promoting the technology, the technology’s installed base may accu-mulate much more rapidly than if one firm alone is responsible for such activities. Competition among producers may drive the price of the technology down, making it more attractive to customers. Both customers and complementary goods providers may also perceive the technology as better (or its future more certain) if there are multiple companies backing the technology. This perception can lead to much more rapid adoption of the technology by customers and complementary goods provid-ers, which further stimulates more companies to back the technology. Thus, a liberal diffusion strategy can stimulate the growth of the installed base and availability of complementary goods.22Google used a liberal diffusion strategy to help its Android operating system for smartphones become widely adopted. Google’s liberal licensing policy for Android attracted many handset manufacturers and applications developers to the system, enabling its ecosystem to grow rapidly. A larger ecosystem with more phone models, price points, and applications, in turn, attracted a wider range of customers.Open technologies can also benefit from the collective development efforts of par-ties external to the sponsoring firm. For instance, Netscape Navigator, UNIX, and Linux are all technologies that have benefited significantly from external develop-ment. By making the source code freely available to the vast world of developers who could benefit from the technology, the technologies reaped the advantages of having a much larger pool of talent and resources directed at improving the technologies than could have been rallied by the original developers.External development, however, poses some costs and risks. First, external devel-opment efforts typically lack the coordination of internal development. External devel-opers may have very diverse objectives for the technology; rather than work together toward some unified vision of what the technology could achieve in the future, they Final PDF to printer
sch87956_ch09_197-222.indd 216 11/09/18 11:21 AM216 Part Two Formulating Technological Innovation Strategymight work in different, possibly even conflicting, directions.23 Much of their effort may be redundant, as different external developers work on solving the same problems without communicating with each other. Finally, whether and how these improvements get incorporated into the technology and disseminated to other users of the technology can prove very problematic. UNIX provides a stark example of this.UNIX was an operating system first developed by AT&T’s Bell Laboratories in 1969. Though a Department of Justice injunction forbade AT&T from selling soft-ware commercially, it made the source code for the product available through licens-ing arrangements. Early licensees (notably, University of California—Berkeley) began using and adapting the software for their purposes, causing many incompatible versions of the software to emerge. Though the software community made several attempts to standardize the UNIX operating language, their efforts failed. AT&T also challenged the commercialization of several UNIX variants, but to no avail. Ultimately, AT&T sold the division responsible for UNIX to Novell, and Novell handed over the rights to the UNIX trademark to the X/Open standards-setting body.24Given the range of advantages (and risks) of protecting versus diffusing a technol-ogy, a firm must carefully consider the following factors in deciding whether, and to what degree, it should protect its innovation.Production Capabilities, Marketing Capabilities, and CapitalIf the firm is unable to produce the technology at sufficient volume or quality levels (or market the technology with sufficient intensity), then protecting the technology so that the firm is its sole provider may significantly hinder its adoption. For example, when JVC was promoting its VHS standard for video recorders, its management knew JVC was at a disadvantage in both manufacturing and marketing capabilities compared to Sony (which was promoting the Beta technology). JVC chose to vigorously pursue both licensing and OEM agreements, lining up Hitachi, Matsushita, Mitsubishi, and Sharp to boost the technology’s production rate.Similarly, if complementary goods influence the value of the technology to users, then the firm must (a) be able to produce the complements in sufficient range and quan-tity, (b) sponsor their production by other firms, or (c) encourage collective production of the complements through a more open technology strategy. The only firms that have been successful in the U.S. video game industry were those that were able to produce games in-house (ensuring that a wide range of games would be available at the con-sole’s launch) and that encouraged third-party development of games (to ensure that the number of game titles grew quickly). Both Nintendo and Sega had previous arcade experience, and thus possessed considerable game development expertise. Microsoft had long been a producer of PC-based video games, so it had some game developing experience, and it also acquired a few small game developers (e.g., Bungie) to expand its expertise in developing console-type games.25 Sony had no prior game experience, but aggressively acquired in-house developers, licensed external developers, and set up a program with Metrowerks to provide developer tools that would make it easier for external developers to produce PlayStation games. If a firm lacks the production capa-bility or expertise to produce a sufficient range of complementary goods, or the capital to acquire such capabilities quickly, it should encourage collective production of com-plements through a more open technology strategy and utilize forms of sponsorship.Final PDF to printer
sch87956_ch09_197-222.indd 217 11/09/18 11:21 AMChapter 9 Protecting Innovation 217Industry Opposition against Sole-Source TechnologySometimes other industry members are able to exert strong pressure against the adop-tion of a technology that would give one (or a few) producer(s) undue control and power, causing a technology that is restricted to such production to be rejected or more hotly contested than a more open technology. This was the case with Sony and Philips’ Super Audio CD (SACD) audio format. Sony and Philips had jointly created the origi-nal compact disc (CD) format and split the royalties on every CD player sold, totaling hundreds of millions of dollars. The rest of the world’s leading consumer electronics producers (including Hitachi, JVC, Matsushita, Mitsubishi, and Toshiba) and record producers (including Time Warner and Seagram’s Universal Music group) banded together to form the Digital Video Disk (DVD) Audio consortium. This consortium’s purpose is to promote the DVD Audio standard that is intended to displace the CD and enable royalties to be split among the 10 companies that control the patents.26 Industry observers note that a driving force underlying the formation of the consortium was to prevent Sony and Philips from controlling yet another generation of audio formats. The degree of industry opposition to a sole-source technology needs to be considered when the firm formulates its technology strategy. If the industry is able to pose sig-nificant opposition, the firm may need to consider a more open technology strategy to improve the technology’s likelihood of being chosen as a dominant design.Resources for Internal DevelopmentIf a firm does not have significant resources (capital, technological expertise) to invest in the technology’s functionality, it may have difficulty producing a technology that has an initial performance level, and rate of improvement, that the market finds attractive. In such instances, it can be valuable to tap the external development efforts of other firms (or individuals) through utilizing a more open technology strategy. For example, when Netscape found itself in a race to match browser capabilities with Microsoft, it was at a tremendous disadvantage in both human resources and capital. Microsoft had legions of internal developers and a lot of money to invest in Explorer; there was no way that Netscape could match those resources internally. Instead, Netscape tapped the external development community by giving them access to its source code and incorporating their improvements into the Navigator product.Control over FragmentationFor technologies in which standardization and compatibility are important, maintain-ing the integrity of the core product is absolutely essential, and external development can put it at risk. As the UNIX example illustrates, if the developing firm relinquishes all control over the development of the technology, the technology will have no shep-herd with the ability and authority to direct its trajectory and ensure that a single stan-dard remains intact. This suggests that the developer of any technology that requires standardization and compatibility should retain some degree of control over the tech-nology, or find/establish another governing body with the authority to do so.Incentives for Architectural ControlArchitectural control over the evolution of a technology is always valuable; however, it becomes particularly valuable if a firm is a significant producer of complements to Final PDF to printer
sch87956_ch09_197-222.indd 218 11/09/18 11:21 AM218 Part Two Formulating Technological Innovation Strategythe technology in question. A firm with architectural control can typically design the technology to be compatible with its own complements and incompatible with those of competitors. If the technology is chosen as the dominant design, this architectural con-trol allows the firm to ensure that it reaps the lion’s share of the rewards in complements production. Furthermore, by making the technology selectively compatible with some competitors and not others, the firm can exert great influence over the competitive field.Architectural control can also enable the firm to direct the development efforts put into the technology so that it exploits the firm’s core competencies. Technology trajec-tories are path dependent; minor events in their evolution can set them careening off into unexpected directions. A firm that has a significant stake in a particular evolution path (because, e.g., it has technological competencies that are much more amenable to one path of evolution than other potential paths) may place a high value on architec-tural control, which can enable it to co-opt or destroy less favorable development paths by denying their progenitors access to the market. 1. The degree to which a firm can capture the rents from its innovation efforts is largely determined by the degree to which competitors can quickly and easily imi-tate the innovation. Some innovations are inherently difficult to copy; others are difficult to copy because of the mechanisms the firm uses to protect its innovation. 2. The three primary legal mechanisms used to protect innovation in most countries are patents, trademarks, and copyrights. Each mechanism is designed to protect a different type of work or good. 3. International treaties have helped to harmonize patent, trademark, and copyright laws around the world. Most countries now have patent, trademark, and copyright laws of some form, and in some instances protection can be applied for in multiple countries simultaneously. 4. Trade secrets provide another mechanism of protecting innovation. Firms that protect their intellectual property as a trade secret often have legal recourse if another party wrongfully takes and uses such property. 5. Legal mechanisms for protecting innovation are more effective in some industries than others; in some industries, inventing around a patent or copyright is relatively easy. Similarly, in some industries, it is nearly impossible to protect an innovation by using trade secrets because commercializing the innovation reveals its underly-ing technologies. 6. Sometimes the choice between protecting versus diffusing a technology is not obvious. Both strategies offer potential advantages. Many firms use neither a wholly open nor a wholly proprietary strategy, but rather a partially open strategy. 7. Protecting an innovation helps ensure that the firm earns the lion’s share of the returns from the innovation. These returns can then be reinvested in further developing the technology, promoting the technology, and producing comple-mentary goods. 8. Protecting an innovation also preserves the firm’s architectural control, enabling it to direct the technology’s development, determine its compatibility with other Summary of ChapterFinal PDF to printer
sch87956_ch09_197-222.indd 219 11/09/18 11:21 AMChapter 9 Protecting Innovation 219goods, and prevent multiple incompatible versions of the technology from being produced by other firms. 9. Diffusing a technological innovation can encourage multiple firms to produce, distribute, and promote the technology, possibly accelerating its development and diffusion. Diffusion can be particularly useful in industries that accrue increasing returns to adoption. It is also useful when the firm has inadequate resources to be the sole developer, producer, distributor, and marketer of a good. 1. What are the differences between patents, copyrights, and trademarks? 2. What factors should a firm considering marketing its innovation in multiple coun-tries use in formulating its protection strategy? 3. When are trade secrets more useful than patents, copyrights, or trademarks? 4. Identify a situation in which none of the legal protection mechanisms discussed (patents, copyrights, trademarks, trade secrets) will prove useful. 5. Describe a technological innovation not discussed in the chapter, and identify where you think it lies on the control continuum between wholly proprietary and wholly open. 6. What factors do you believe influenced the choice of protection strategy used for the innovation identified above? Do you think the strategy was a good choice?Discussion QuestionsClassicsLevin, R., A. Klevorick, R. Nelson, and S. Winter, “Appropriating the Returns from Industrial Research and Development,” Brookings Papers on Economic Activity, Microeconomics 3 (1987), pp. 783–820.Bound, J., C. Cummins, Z. Griliches, B. H. Hall, and A. Jaffe, “Who Does R&D and Who Patents?” in R&D, Patents, and Productivity, ed. Z. Griliches (Chicago: University of Chicago Press for the National Bureau of Economic Research, 1984).Jaffe, A. B., and J. Lerner, Innovation and Its Discontents: How Our Broken Patent System Is Endangering Innovation and Progress, and What to Do about It (Princeton, NJ: Princeton University Press, 2004).Schilling, M.A., “Protecting or Diffusing a Technology Platform: Tradeoffs in Appro-priability, Network Externalities, and Architectural Control,” in Platforms, Markets and Innovation, ed. A. Gawer (Cheltenham, UK: Edward Elgar Publishing, 2009).Teece, D. J., “Profiting from Technological Innovation—Implications for Integra-tion, Collaboration, Licensing and Public-Policy,” Research Policy 15, no. 6 (1986), pp. 285–305.Recent WorkFarre-Mensa, J., D. Hegde, and A. Ljungqvist, “What Is a Patent Worth? Evidence from the U.S. Patent ‘Lottery’ (March 14, 2017),” USPTO Economic Working Paper 2015-5. Available at SSRN: or 10.2139/ssrn.2704028Suggested Further ReadingFinal PDF to printer
sch87956_ch09_197-222.indd 220 11/09/18 11:21 AM220 Part Two Formulating Technological Innovation StrategyFisher, W.W., and F. Oberholzer-Gee, “Strategic Management of Intellectual Prop-erty,” California Management Review 55, no. 4 (Summer 2013), pp. 157–83.Graham, S., and D. Hegde, “Disclosing Patents’ Secrets,” Science 347 (2015), no. 6219, pp. 236–37.Holgersson, M., O. Granstrand, and M. Bogers, “The Evolution of Intellectual Prop-erty Strategy in Innovation Ecosystems: Uncovering Complementary and Substitute Appropriability Regimes,” Long Range Planning 51 (2018):303–19.Somaya, D. “Patent Strategy and Management: An Integrative Review and Research Agenda,” Journal of Management 38 (2012), pp. 1084–114. 1. J. B. Barney, “Firm Resources and Sustained Competitive Advantage,” Journal of Management 17 (1991), p. 990. 2. “Software Patent,” Bank Technology News 14, no. 3 (2001), p. 25. 3. A. B. Silverman, “Software Patents for Methods of Doing Business—A Second Class Citizen No More,” Journal of Management 52, no. 19 (2000), p. 64. 4. M. Carley, D. Hegde, and A. Marco, “What is the probability of receiving a US Patent?” Yale Journal of Law & Technology, 17 (2015), pp. 204–223. 5. D. Alderucci and W. Baumol, “Patents and the dissemination of inventions,” Journal of Eco-nomic Perspectives, 27 (2013), no. 4, pp. 223–26; D. Alderucci, “Monetization Strategies for Business Method Patents,” The Licensing Journal (2000), November. 6. S. Graham and D. Hegde, “Disclosing Patents’ Secrets,” Science 347 (2015), no. 6219, pp. 236–37. 7. “Apple Complains of “Patent Trolls,” LA Times (2014), February 8. 8. A. Jones, “Tech Firms Back Obama Patent Move,” Wall Street Journal, June 4. 9. W. New, “White House Takes Major Action Against “Patent Trolls,” Intellectual Property Watch, (2013), June 4; “Hatch Introduces Measure to Stop Patent Trolls,” The Ripon Advance (2013), November 4; E. Wyatt, “FTC Settles First Case Targeting ‘Patent Troll’,” New York Times (2014), November 6. 10. S. Decker and B. Womack, “Google Buys 1,023 IBM Patents to Bolster Defense of Android,” BloombergBusiness (2014): September 14. 11. Q. Hardy, “Google Buys Motorola for Patent Parts,” Forbes (2011), August 15. 12. J. Mullin, “Patent War Goes Nuclear: Microsoft, Apple-owned “Rockstar” Sues Google,” Arstechnica (2013), October 31. 13. J. Roberts, “Apple-backed Rockstar Ends Patent War on Android, Deal Suggests,” GigaOM (2014):November. 14. U.S. Copyright Office. 15. The Trade Secrets home page. 16. S. Decker, “Procter & Gamble, Potlatch Resolve Trade Secrets Suit,” Seattle Post Intelligencer, March 14, 2003. 17. R. Levin, A. Klevorick, R. Nelson, and S. Winter, “Appropriating the Returns from Indus-trial Research and Development,” Brookings Papers on Economic Activity, Microeconomics 3 (1987), pp. 783–820; and J. Bound, C. Cummins, Z. Griliches, B. H. Hall, and A. Jaffe, “Who Does R&D and Who Patents?” in R&D, Patents, and Productivity, ed. Z. Griliches (Chicago: University of Chicago Press for the National Bureau of Economic Research, 1984).EndnotesFinal PDF to printer
sch87956_ch09_197-222.indd 221 11/09/18 11:21 AMChapter 9 Protecting Innovation 221 18. W. B. Arthur, Increasing Returns and Path Dependency in the Economy (Ann Arbor: The University of Michigan Press, 1994). 19. C. H. Ferguson and C. R. Morris, Computer Wars (New York: Random House, 1993); and R. Henderson and K. Clark, “Architectural Innovation: The Reconfiguration of Existing Prod-uct Technologies and the Failure of Established Firms,” Administrative Science Quarterly 35 (1990), pp. 9–30. 20. S. Brooks, M. A. Schilling, and J. Scrofani, “Monsanto: Better Living through Genetic Engi-neering?” in Strategic Management, Competitiveness and Globalization, 5th ed., eds. M. Hitt, R. Hoskisson, and R. D. Ireland (Minneapolis/St. Paul: West Publishing, 2001). 21. M. A. Schilling, “Toward a General Modular Systems Theory and Its Application to Interfirm Product Modularity,” Academy of Management Review 25 (2000), pp. 312–34. 22. C. W. L. Hill, “Establishing a Standard: Competitive Strategy and Technological Standards in Winner-Take-All Industries,” Academy of Management Executive 11, no. 2 (1997), pp. 7–25; and M. A. Schilling, “Winning the Standards Race: Building Installed Base and the Availability of Complementary Goods,” European Management Journal 17 (1999), pp. 265–74. 23. R. Garud, S. Jain, and A. Kumaraswamy, “Institutional Entrepreneurship in the Sponsorship of Common Technological Standards: The Case of Sun Microsystems and Java,” Academy of Management Journal 45 (2002), pp. 196–214. 24. D. Essner, P. Liao, and M. A. Schilling, “Sun Microsystems: Establishing the Java Standard,” Boston University teaching case no. 2001–02, 2001. 25. J. Kittner, M. A. Schilling, and S. Karl, “Microsoft’s Xbox,” New York University teaching case, 2002. 45. 26. J. Brinkley, “Disk versus Disk: The Fight for the Ears of America,” New York Times, August 8, 1999.Final PDF to printer
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sch87956_ch10_223-248.indd 223 11/12/18 10:34 AMPart ThreeImplementing Technological Innovation StrategyIn this section, we will cover the key aspects of implementing a technological innovation strategy, including: ∙ Structuring the firm to improve its likelihood of innovating, its effectiveness at new product development, and its speed of new product development. ∙ Managing new product development processes to maximize fit with customer needs, while simultaneously minimizing development cycle time and control-ling development costs. ∙ Composing, structuring, and managing new product development teams to maximize new product development effectiveness. ∙ Crafting a strategy for effectively deploying the innovation into the market-place, including timing, licensing strategies, pricing strategies, distribution, and marketing.Final PDF to printer
sch87956_ch10_223-248.indd 224 11/12/18 10:34 AMImplementing Technological Innovation StrategyFinal PDF to printer
225sch87956_ch10_223-248.indd 225 11/12/18 10:34 AMChapter TenOrganizing for InnovationOrganizing for Innovation at GoogleGoogle was founded in 1998 by two Stanford Ph.D. students, Sergey Brin and Larry Page, who had developed a formula for rank ordering random search results by relevancy. Their formula gave rise to an incredibly powerful Internet search engine that rapidly attracted a loyal following. The search engine enabled users to quickly find information through a simple and intuitive user interface. It also enabled Google to sell highly targeted advertising space.The company grew rapidly. In 2001, Brin and Page hired Eric Schmidt, former CTO of Sun Microsystems and former CEO of Novell, to be Google’s CEO. In 2004, the company went public, raising $1.6 billion in one of the most highly anticipated IPOs ever. Under Schmidt, the company adhered to a broad yet dis-ciplined mission: “To organize the world’s information and make it universally accessible and useful.” This led the company to leverage its core search and advertising capabilities into blogging, online payments, social networks, and other information-driven businesses.By 2014, Google had sales of over $66 billion, and employed more than 57,000 people. Despite this size, however, the company eschewed hierarchy and bureaucracy and sought to maintain a small-company feel. As noted by Schmidt during an interview, “Innovation always has been driven by a person or a small team that has the luxury of thinking of a new idea and pursuing it. There are no counter examples. It was true 100 years ago and it’ll be true for the next 100 years. Innovation is something that comes when you’re not under the gun. So it’s important that, even if you don’t have balance in your life, you have some time for reflection. So that you could say, ‘Well, maybe I’m not working on the right thing.’ Or, ‘maybe I should have this new idea.’ The creative parts of one’s mind are not on schedule.”aIn accordance with this belief, Google’s engineers were organized into small technology teams with considerable decision-making authority. Every aspect of the headquarters, from the shared offices with couches, to the recreation facilities and the large communal cafe known as “Charlie’s Place,” was designed to foster Final PDF to printer
sch87956_ch10_223-248.indd 226 11/12/18 10:34 AM226 Part Three Implementing Technological Innovation Strategyinformal communication and collaboration.b Managers referred to Google as a flex-ible and flat “technocracy,” where resources and control were allocated based on the quality of people’s ideas rather than seniority or hierarchical status. Schmidt remarked, “One of the things that we’ve tried very hard to avoid at Google is the sort of divisional structure that prevents collaboration across units. It’s difficult. So I understand why people want to build business units, and have their presidents. But by doing that you cut down the informal ties that, in an open culture, drive so much collaboration. If people in the organization understand the values of the company, they should be able to self-organize to work on the most interesting problems.”cA key ingredient in Google’s organization is an incentive system that requires all technical personnel to spend 20 percent of their time on innovative proj-ects of their own choosing. This budget for innovation is not merely a device for creating slack in the organization for creative employees—it is an aggres-sive mandate that employees develop new product ideas. As noted by one Google engineer, “This isn’t a matter of doing something in your spare time, but more of actively making time for it. Heck, I don’t have a good 20% project yet and I need one. If I don’t come up with something I’m sure it could negatively impact my review.”d Managers face similar incentives. Each manager is required to spend 70  percent of his or her time on the core business, 20 percent on related-but- different projects, and 10 percent on entirely new products. Accord-ing to Marissa Mayer, Google’s head of search products and user experience, a significant portion of Google’s new products and features (including Gmail and AdSense) resulted from the 20 percent time investments of Google engineers.In 2015, the company was reorganized into Alphabet Inc., a holding com-pany, wherein Google and other divisions such as Access, Calico, CapitalG, Nest, and others were wholly owned subsidiaries. The divisions retained their flat and flexible reporting structures.e In a podcast interview at Stanford University, Andy Grove (former CEO of Intel) remarked that the company’s organization appeared chaotic, even noting “From the outside it looks like Google’s organizational structure is best described by . . . Brownian motion in an expanding model” and questioned whether Schmidt believed this model would continue to work forever. In his response, Schmidt responded, “There’s an important secret to tell, which is there are parts of the company that are not run chaotically. Our legal department, our finances. Our sales force has normal sales quotas. Our normal strategic planning activities, our normal investment activities, our M&A activities are run in a very traditional way. So the part of Google that gets all the attention is the creative side, the part where new products are being built and designed, and that is different. And it looks to us like that model will scale for quite some time . . . it looks like small teams can run ahead and that we can replicate that model for that part of the company.”fDiscussion Questions 1. What are the advantages and disadvantages of the creative side of Google being run as a flexible and flat “technocracy”? 2. How does Google’s culture influence the kind of employees it can attract and retain?Final PDF to printer
sch87956_ch10_223-248.indd 227 11/12/18 10:34 AMChapter 10 Organizing for Innovation 227OVERVIEWThe structure of an organization and the degree to which it uses formalized and stan-dardized procedures and controls can significantly influence its likelihood of inno-vating, the effectiveness of its innovation projects, and the speed of its new product development processes.1 For example, it is often argued that small, flexible organiza-tions with a minimum of rules and procedures will encourage creativity and experi-mentation, leading to more innovative ideas. At the same time, it is also frequently pointed out that well-developed procedures and standards can ensure that the organi-zation makes better development investment decisions and is able to implement proj-ects quickly and efficiently. How then do managers decide what structure and controls would make the most sense for their firm?A vast majority of firms use some type of product team structure to organize their new product development process, and we will look closely at how teams are com-posed and structured in Chapter Twelve, Managing New Product Development Teams. This chapter focuses on the organization-wide structural dimensions that shape the firm’s propensity and ability to innovate effectively and efficiently. We will review the research on how firm size and structural dimensions such as formalization, stan-dardization, and centralization affect a firm’s innovativeness. By focusing on these underlying structural dimensions, we will elucidate why some structures may be better for encouraging the creativity that leads to idea generation, while other structures may be better suited for efficient production of new products. We will also explore struc-tural forms that attempt to achieve the best of both worlds—the free-flowing organic and entrepreneurial structures and controls that foster innovation, plus the formalized and standardized forms that maximize efficiency while ensuring coherence across all of the corporation’s development activities. The chapter then turns to the challenge of managing innovation across borders. Multinational firms face particularly difficult 3. What do you believe the challenges are in having very different structure and controls for Google’s creative side versus the other parts of the company? 4. Some analysts have argued that Google’s free-form structure and the 20 percent time to work on personal projects is possible only because Google’s prior success has created financial slack in the company. Do you agree with this? Would Google be able to continue this management style if it had closer competitors? a J. Manyika, “Google’s View on the Future of Business: An Interview with CEO Eric Schmidt,” McKinsey Quarterly, November 2008. b From “The Google Culture,” c Manyika, “Google’s View on the Future of Business.” d B. Iyer and T. H. Davenport, “Reverse Engineering Google’s Innovation Machine,” Harvard Business Review, April 2008. e R. Price and M. Nudelman, “Google’s Parent Company, Alphabet, Explained in One Chart,” Business Insider, 2016. Available at: infographic-x-gv-2016-1. f Podcast retrieved on April 13, 2009, at PDF to printer
sch87956_ch10_223-248.indd 228 11/12/18 10:34 AM228 Part Three Implementing Technological Innovation Strategyquestions about where to locate—and how to manage—their development activities. We will review some of the work emerging on how multinational firms can balance the trade-offs inherent in these choices.SIZE AND STRUCTURAL DIMENSIONS OF THE FIRMSize: Is Bigger Better?In the 1940s, Joseph Schumpeter challenged supporters of antitrust law by propos-ing that large firms would be more effective innovators.2 Schumpeter pointed out that (1) capital markets are imperfect, and large firms are better able to obtain financing for R&D projects, and (2) firms with larger sales volume over which to spread the fixed costs of R&D would experience higher returns than firms with lower sales volume. Large firms are also likely to have better-developed complementary activities such as marketing or financial planning that enable them to be more effective innovators, and they are also likely to have greater global reach to obtain information or other resources.Another advantage of size may arise in scale and learning effects. If large firms spend more on R&D in an absolute sense, they might also reap economies of scale and learn-ing curve advantages in R&D—that is, they may get better and more efficient at it over time.3 Through investing in R&D, the firm develops competencies in the new product development process and thus may improve its development process. It may accumulate better research equipment and personnel. Furthermore, as a large firm gains experience in choosing and developing innovation projects, it may learn to make better selections of projects that fit the firm’s capabilities and have a higher likelihood of success.Large firms are also in a better position to take on large or risky innovation projects than smaller firms.4 For example, only a large company such as Boeing could develop and manufacture a 747, and only large pharmaceutical companies can plow millions of dollars into drug development in hopes that one or two drugs are successful.5 This suggests that in industries that have large development scale (i.e., the average develop-ment project is very big and costly), large firms will tend to outperform small firms at innovation. In theory a coalition of small firms ought to achieve the same scale advantages, but in practice, coordinating a coalition of firms tends to be very difficult. While a single large firm can exert hierarchical authority over all of the development activities to ensure cooperation and coordination, coalitions often do not have such a well-defined system of authority and control.On the other hand, as a firm grows, its R&D efficiency might decrease because of a loss of managerial control.6 That is, the bigger a firm gets the more difficult it can become to effectively monitor and motivate employees. Furthermore, as a firm grows, it becomes increasingly difficult for individual scientists or entrepreneurs to appropri-ate the returns of their efforts; therefore their incentives diminish.7 Thus, as the firm grows, the effectiveness of its governance systems may decrease.Large firms may also be less innovative because their size can make them less nim-ble and responsive to change. Large firms typically have more bureaucratic inertia due to many layers of authority and well-developed policies and procedures.8 For example, in the early 1980s, Xerox discovered that the administrative layers it had added to prevent errors in new product development had the unintended effect of blocking a Final PDF to printer
sch87956_ch10_223-248.indd 229 11/12/18 10:34 AMChapter 10 Organizing for Innovation 229project’s progress, making product development cycles unacceptably long and putting Xerox at a disadvantage to more nimble Japanese competitors.9High numbers of employees, large fixed-asset bases, and a large base of existing customers or supplier contracts can also be sources of inertia, making it difficult for the firm to change course quickly. As the number of employees grows, communi-cation and coordination may become more difficult and prone to decision-making delays. When large firms have large fixed-asset bases and/or significant fixed costs, they often prefer to stick with existing sources of cash flow rather than gambling on big changes. Strategic commitments to customers and suppliers can also tie the firm to its existing businesses and technologies, making it more difficult to respond to technological change. Strategic commitments can thus lead to an Icarus Paradox—a firm’s prior success in the market can hinder its ability to respond to new technologi-cal generations.Small firms are often considered more flexible and entrepreneurial than large firms. They are unencumbered by multiple layers of administration, large fixed-asset bases, or strategic commitments to large numbers of employees, customers, and suppliers. Small firms may also find it much simpler to monitor employees and reward them for their effort or success at innovation.10 Because resources are less abundant, small firms may also be more motivated to choose projects more carefully, leading to higher rates of new product success.A number of empirical studies have attempted to test whether large size improves or hampers innovation productivity. Several studies of patent counts, new drug introduc-tions, and technological innovations that improve product performance have indicated that small firms often outperform large firms in innovation.11 For example, a few stud-ies of patenting output have concluded that small firms appear to spend their R&D dollars more carefully and are more efficient, receiving a larger number of patents per R&D dollar.12 One study of 116 firms developing new business-to-business prod-ucts also found that small firms (those with annual sales less than $100 million) had significantly shorter development cycles than large firms (those with $100 million and more in sales), even when considering the relative magnitude of the innovation.13 However, a few studies have indicated that large firms may still outperform small firms in innovation in some industries.14While the firm’s overall size is not an easy-to-manipulate attribute of the firm, many firms have found ways of making even large firms feel small. One primary method is to break the overall firm into several smaller subunits, and then encourage an entrepreneur-ial culture within these subunits. Multiple studies have observed that in industries char-acterized by high-speed technological change, many large and hierarchical firms have been disaggregated (or “unbundled”) into networks of smaller, often more specialized, autonomous divisions or independent firms.15 In such industries, many firms have under-gone large-scale downsizing, with many functions and layers of management eliminated. The giant multidivisional firms of the twentieth century were replaced by leaner firms that were more focused and flexible, loosely coupled in a network of alliances, supplier relationships, and distribution agreements.16 This phenomenon led to the rise of terms such as virtual organization,17 network organization,18 and modular organization.19Since firms also use big company–small company hybrids to vary other structural dimensions of the firm (including formalization, standardization, and centralization), disaggregatedWhen something is separated into its constituent parts.Final PDF to printer
sch87956_ch10_223-248.indd 230 11/12/18 10:34 AM230 Part Three Implementing Technological Innovation Strategythese ambidextrous approaches to organizing will be covered in more depth after the structural dimensions of the firm are reviewed.STRUCTURAL DIMENSIONS OF THE FIRMFirms vary on a number of structural dimensions that can influence the amount, type, and effectiveness of their innovation. Key structural dimensions include centraliza-tion, formalization, and standardization.CentralizationCentralization is the degree to which decision-making authority is kept at top levels of the firm, while decentralization is the degree to which decision-making authority is pushed down to lower levels of the firm. Centralization can refer both to the geographi-cal location of activities (that is, the degree to which activities are performed in a cen-tral location for the firm) and to where power and authority over activities are located. That is, activities might occur in locations far from the corporate headquarters, but the authority and decision making over those activities may be retained at headquarters—leading to greater centralization than their physical location would suggest.For firms that have multiple R&D projects ongoing, whether to centralize or decen-tralize R&D activities is a complex issue. Decentralizing R&D activities to the divi-sions of the firm enables those divisions to develop new products or processes that closely meet their particular division’s needs (see Figure 10.1). The solutions they develop are more likely to fit well within the operating structure of the division, and be closely matched to the requirements of the customers served by that division. The decentralization of development projects also enables the firm to take advantage of the centralization/decentraliza-tionCentraliza-tion is the degree to which decision-making authority is kept at top levels of management. Decentralization is the degree to which decision-making authority is pushed down to lower levels of the firm.FIGURE 10.1Centralized and Decentralized R&D ActivitiesCentralized R&DR&DCorporateHeadquartersDivisionDivisionDivisionDivisionDivision(a)Decentralized R&DR&DCorporateHeadquartersR&DR&DR&DR&D(b)Final PDF to printer
sch87956_ch10_223-248.indd 231 11/12/18 10:34 AMChapter 10 Organizing for Innovation 231diversity of knowledge and market contacts that may exist in different divisions. Con-sistent with this, studies by Felipe Csaszar show that when decision-making about new projects is pushed down to the lowest levels of the firm, the firm ends up taking on both a greater quantity and variety of projects. Though there will be more failed projects, the firm makes fewer “errors of omission.”20 However, there is much risk of reinventing the wheel when R&D activities are decentralized. Many redundant R&D activities may be performed in multiple divisions, and the full potential of the technology to create value in other parts of the firm may not be realized. Furthermore, having multiple R&D departments may cause each to forgo economies of scale and learning-curve effects.By contrast, if the firm centralizes R&D in a single department, it may maximize economies of scale in R&D, enabling greater division of labor among the R&D special-ists and maximizing the potential for learning-curve effects through the development of multiple projects. It also enables the central R&D department to manage the deploy-ment of new technologies throughout the firm, improving the coherence of the firm’s new product development efforts and avoiding the possibility that valuable new tech-nologies are underutilized throughout the organization. For example, in the late 1980s, Intel realized that, as a result of the rising complexity and information processing demands in the semiconductor industry, its decentralized process development (which was scattered across diverse business groups) was resulting in serious delays and cost overruns. In the 1990s Intel thus centralized all process development, giving a single fabrication facility full responsibility for all new process generation. This development group would have maximum development resources (the highest in the industry). Once a new development process was completed and tested, it was replicated (in a process known in Intel as “copy exactly”) in all of the company’s other fabrication facilities.The use of a centralized versus decentralized development process varies by type of firm and industry. For example, a study by Laura Cardinal and Tim Opler found that research-intensive firms that were highly diversified were more likely to establish separate research and development centers to facilitate communication and transfer of innovation across divisions.21 A study by Peter Golder, on the other hand, found that consumer products companies tend to utilize more decentralized R&D, tailoring proj-ects to local markets, while firms in electronics industries tend to centralize R&D in centers of excellence that are devoted to leveraging particular competencies.22There is some disagreement about whether centralization enhances or impedes a firm’s flexibility and responsiveness to technological change (or other environmen-tal shifts). A highly centralized firm may be better able to make a bold change in its overall direction because its tight command-and-control structure enables it to impose such change on lower levels of the firm in a decisive manner. Decentralized firms may struggle to get the cooperation from all the divisions necessary to undergo a signifi-cant change. But decentralized firms may be better able to respond to some types of technological or environmental change because not all decisions need to be passed up the hierarchy to top management; employees at lower levels are empowered to make decisions and changes independently and thus may be able to act more quickly.Formalization and StandardizationFormalization and standardization are closely related structural dimensions of orga-nizations. The formalization of the firm is the degree to which the firm utilizes formalizationThe degree to which the firm utilizes rules, procedures, and written documentation to structure the behavior of individuals or groups within the organization.Final PDF to printer
sch87956_ch10_223-248.indd 232 11/12/18 10:34 AM232 Part Three Implementing Technological Innovation Strategyrules, procedures, and written documentation to structure the behavior of indi-viduals or groups within the organization. Standardization is the degree to which activities in a firm are performed in a uniform manner. The rules and procedures employed in formalization can facilitate the standardization of firm activities and help to regulate employee behavior by providing clear expectations of behavior and decision- making criteria. Formalization can substitute for some degree of managerial oversight, and thereby help large companies run smoothly with fewer managers. This is demonstrated in the accompanying Theory in Action about 3M, where both Lehr and Jacobson responded to the difficulty of managing the growing firm by imposing more discipline and rules. By creating formal processes for choosing and managing development projects, Lehr and Jacobsen hoped to improve the overall efficiency and coherence of the firm’s many decentralized development activities. However, high degrees of formalization can also make a firm rigid.23 If a firm codifies all of its activities with detailed procedures, it may stifle employee creativity. Employees may not feel empowered or motivated to implement new solutions. This is also noted in the 3M example, when employee resentment of the new planning methods led to morale and motivation problems.Similarly, while standardization can ensure that activities within the firm run smoothly and yield predictable outcomes, standardization can also stifle innovation. Standardiza-tion may be used to ensure quality levels are met and that customers and suppliers are responded to consistently and equitably. However, by minimizing variation, standardiza-tion can limit the creativity and experimentation that leads to innovative ideas.Mechanistic versus Organic StructuresThe combination of formalization and standardization results in what is often termed a mechanistic structure. Mechanistic structures are often associated with greater operational efficiency, particularly in large-volume production settings. The careful adherence to policies and procedures combined with standardization of most activities results in a well-oiled machine that operates with great consistency and reliability.24 For example, Dell Computer achieves its operational excellence, delivering products cost-effectively and with minimal inconvenience, by being highly standardized, disci-plined, and streamlined.25 While mechanistic structures are often associated with high centralization, it is also possible to have a highly decentralized mechanistic structure by using formalization as a substitute for direct oversight. By establishing detailed rules, procedures, and standards, top management can push decision-making authority to lower levels of the firm while still ensuring that decisions are consistent with top management’s objectives.Mechanistic structures, however, are often deemed unsuitable for fostering inno-vation. Mechanistic structures achieve efficiency by ensuring rigid adherence to standards and minimizing variation, potentially stifling creativity within the firm. Organic structures that are more free-flowing, and characterized by low levels of for-malization and standardization, are often considered better for innovation and dynamic environments.26 In the organic structure, employees are given far more latitude in their job responsibilities and operating procedures. Because much innovation arises from experimentation and improvisation, organic structures are often thought to be better for innovation despite their possible detriment to efficiency.27standardiza-tionThe degree to which activities are performed in a uniform manner.mechanisticAn organiza-tion structure characterized by a high degree of formalization and standardiza-tion, causing operations to be almost automatic or mechanical.organicAn organiza-tion structure characterized by a low degree of formalization and standardiza-tion. Employees may not have well-defined job responsibilities and operations may be char-acterized by a high degree of variation.Final PDF to printer
233sch87956_ch10_223-248.indd 233 11/12/18 10:34 AMIn 1916, William McKnight, the then general manager of sales and production for 3M, authorized the creation of the company’s first research laboratory to improve 3M’s sandpaper. McKnight had a strong belief in the power of individual entrepreneurship and innovation. He encouraged innovation through a combination of setting ambitious goals for new product development and giving individuals considerable freedom in how they pursued those goals. For example, McKnight established a companywide objective that 25 percent of sales should come from products created in the last five years. He also endorsed a “bootlegging” program whereby researchers could spend up to 15 percent of their time on whatever projects they were interested in pursuing.As the firm grew, McKnight continued to support a centralized R&D lab while also encouraging divisions to pursue their own development initiatives in response to market needs they encountered. However, as 3M’s product portfolio grew, it became increasingly difficult for 3M to manage functions such as production and sales. In 1944, McKnight began to experiment with an even more decentralized organizational form wherein divisions would have not only their own R&D labs, but also their own production operations and sales force. McKnight believed that small independent businesses would grow faster than a large company, leading to his “grow and divide” philosophy: Each division would be independent, and as its development projects grew into successful departments, they too would be spun off into new divisions.By 1980, when Lou Lehr took the helm, 3M had grown to have 85 basic technologies and competed in about 40 major product markets. Lehr feared that 3M’s greatest strength had become its weakness—the pro-liferation of independent businesses had led to a frag-mentation of effort. Lehr worried that divisions might be wasting too much time on redundant activities and not taking advantage of the opportunity to leverage tech-nologies across multiple divisions where they might be valuable. He wanted to ensure that divisions with related technologies would cooperate on development projects, and that new technologies would be diffused across the company. So he consolidated the company’s 42 divisions and 10 groups into four business sectors based on their relatedness of technology. He also cre-ated a three-tiered R&D system: central research lab-oratories that concentrated on basic research with long-term potential, sector labs that would serve groups of related divisions and develop core technologies to drive medium-term (5 to 10 years) growth, and divi-sion labs that would continue to work on projects with immediate applications. Lehr also imposed much more formal planning on the development process—some of 3M’s managers began to refer to it as “planning by the pound.” He also eliminated many projects that had been struggling for years.The arrival of “Jake” Jacobson in 1986 as the new CEO led 3M into an era of even greater discipline. Jacobson increased the target of sales from products developed within the past five years to 35 percent. He increased the R&D funding rate to about twice that of other U.S. companies, but also directed the company to become more focused in its project selection and to shorten development cycle times. He also imple-mented a companywide move toward using teams for development rather than encouraging individual entre-preneurs. Though Jacobson’s initiatives improved effi-ciency, many researchers began to resent some of the changes. They believed that the move to manage all development projects with teams was destroying the individualistic culture of entrepreneurship at 3M and that the focus on discipline came at the expense of cre-ativity and excitement. Motivation and morale problems began to emerge.Thus, when “Desi” Desimone became the CEO in 1991, he eased the company back toward a slightly looser, more entrepreneurial focus. He believed his predecessors had established a good architecture for ensuring that innovation did not run away in an uncon-trolled fashion, but he also believed the company needed more balance between freedom and control, as reflected in the following quote:Senior management’s role is to create an internal envi-ronment in which people understand and value 3M’s way of operating. It’s a culture in which innovation and respect for the individual are still central. If you have senior management who have internalized the prin-ciples, you create a trust relationship in the company. Theory in Action Shifting Structures at 3McontinuedFinal PDF to printer
234sch87956_ch10_223-248.indd 234 11/12/18 10:34 AMThe top knows it should trust the process of bottom-up innovation by leaving a crack open when someone is insistent that a blocked project has potential. And the lower levels have to trust the top when we intervene or control their activities.Source: Adapted from C. Bartlett and A. Mohammed, “3M: Profile of an Innovating Company,” Harvard Business School case no. 9-395-016, 1995.concludedSize versus StructureMany of the advantages and disadvantages of firm size that were discussed at the beginning of the chapter are related to the structural dimensions of formalization, stan-dardization, and centralization. Large firms often make greater use of formalization and standardization because as the firm grows it becomes more difficult to exercise direct managerial oversight. Formalization and standardization ease coordination costs, at the expense of making the firm more mechanistic. Many large firms attempt to overcome some of this rigidity and inertia by decentralizing authority, enabling divisions of the firm to behave more like small companies. For example, firms such as General Electric, Hewlett-Packard, Johnson and Johnson, and General Motors have attempted to take advantage of both bigness and smallness by organizing their compa-nies into groups of small companies that can access the large corporation’s resources and reach while retaining a small company’s simplicity and flexibility.28 The next sec-tion examines several methods by which firms can achieve some of the advantages of large size, and the efficiency and speed of implementation afforded by mechanistic structures, while simultaneously harnessing the creativity and entrepreneurial spirit of small firms and organic structures.The Ambidextrous Organization: The Best of Both Worlds?Most firms must simultaneously manage their existing product lines with efficiency, consistency, and incremental innovation, while still encouraging the development of new product lines and responding to technological change through more radical innova-tion. Tushman and O’Reilly argue that the solution is to create an ambidextrous organi-zation.29 An ambidextrous organization is a firm with a complex organizational form that is composed of multiple internally inconsistent architectures that can collectively achieve both short-term efficiency and long-term innovation.30 Such firms might utilize mechanistic structures in some portions of the firm and organic structures in others. This is one of the rationales for setting up an R&D division that is highly distinct (either geographically or structurally) from the rest of the organization; a firm can use high lev-els of formalization and standardization in its manufacturing and distribution divisions, while using almost no formalization or standardization in its R&D division. Incentives in each of the divisions can be designed around different objectives, encouraging very different sets of behavior from employees. A firm can also centralize and tightly coor-dinate activities in divisions that reap great economies of scale such as manufacturing, while decentralizing activities such as R&D into many small units so that they behave like small, independent ventures. Whereas traditionally research emphasized the impor-tance of diffusing information across the firm and ensuring cross-fertilization of ideas across new product development efforts, recent research suggests that some amount of isolation of teams, at least in early development stages, can be valuable. When multiple ambidextrous organizationThe ability of an organization to behave almost as two different kinds of compa-nies at once. Dif-ferent divisions of the firm may have different structures and control systems, enabling them to have differ-ent cultures and patterns of operations.Final PDF to printer
sch87956_ch10_223-248.indd 235 11/12/18 10:34 AMChapter 10 Organizing for Innovation 235teams interact closely, there is a risk that a solution that appears to have an advantage (at least at the outset) will be too rapidly adopted by other teams. This can cause all of the teams to converge on the same ideas, thwarting the development of other creative approaches that might have advantages in the long run.31 Consistent with this, a signifi-cant body of research on “skunk works” has indicated that there can be significant gains from isolating new product development teams from the mainstream organiza-tion.32 Separating the teams from the rest of the organization permits them to explore new alternatives, unfettered by the demands of the rest of the organization.Similarly, firms that have multiple product divisions might find that one or more divisions need a more organic structure to encourage creativity and fluid responses to environmental change, while other divisions benefit from a more structured and standardized approach. For example, when USA Today decided to establish an online version of the popular newspaper, management discovered it would need more flexible procedures to respond to both rapid technological change and the real-time informa-tion updating requirements of the online paper. The paper would also require different incentive schemes to attract and retain technologically savvy employees. The company established the online paper as a separate division with a different reporting structure, less formalization, a different pay structure, and even different cultural norms about appropriate work attire and working hours.Apple provides another example. In 1980, Apple was churning out Apple II per-sonal computers at a fast clip. However, Steve Jobs was not content with the product design; he wanted a product that would revolutionize the world by dramatically chang-ing the way people interact with computers. He wanted to develop a computer so user-friendly and self-contained that it would appeal even to people who had no interest in the technological features of computers—it would become an extension of their everyday lives. Jobs began working with a team of engineers on a new project called Macintosh (originally developed by another Apple engineer, Jef Raskin). Jobs did not believe that the growing corporate environment at Apple was conducive to nurturing a revolution, so he created a separate division for the Macintosh that would have its own unique culture. He tried to instill a free-spirited entrepreneurial atmosphere remi-niscent of the company’s early beginnings in a garage, where individualistic and often eccentric software developers would flourish. The small group of team members was handpicked and sheltered from normal corporate commitments and distractions. He encouraged the Macintosh team members to consider themselves renegades, and even hung a pirate’s skull-and-crossbones flag over their building. Jobs would also take the team on regular retreats to isolated resorts and reaffirm the renegade culture with quotes like “It’s more fun to be a pirate than to join the Navy.”33If big firms can have internal structures with the incentives and behavior of small firms, then much of the logic of the impact of firm size on technological innova-tion rates becomes moot. A single organization may have multiple cultures, structures, and processes within it; large firms may have entrepreneurial divisions that can tap the greater resources of the larger corporation, yet have the incentive structures of small firms that foster the more careful choice of projects or enhance the motivation of R&D scientists. Such entrepreneurial units may be capable of developing discontinu-ous innovations within the large, efficiency-driven organizations that tend to foster incremental innovations.Skunk Works®Skunk Works® is a term that originated with a division of Lock-heed Martin that was formed in June of 1943 to quickly develop a jet fighter for the United States Army. It has evolved as skunk works to refer more generally to new product develop-ment teams that operate nearly autonomously from the parent organization, with considerable decentralization of authority and little bureaucracy.Final PDF to printer
sch87956_ch10_223-248.indd 236 11/12/18 10:34 AM236 Part Three Implementing Technological Innovation StrategyFirms can also achieve some of the advantages of mechanistic and organic structures by alternating through different structures over time.34 Schoonhoven and Jelinek studied Intel, Hewlett-Packard, Motorola, Texas Instruments, and National Semiconductor and found that these firms maintained a “dynamic tension” between formal reporting structures, quasifor-mal structures, and informal structures.35 While the organizations had very explicit reporting structures and formalized development processes, the organizations were also reorganized frequently to modify reporting relationships and responsibilities in response to a changing environment. Thus, while the organizations used seemingly mechanistic structures to ensure systematic and efficient production, frequent reorganizing enabled the firms to be flexible.These firms also used what Schoonhoven and Jelinek term quasiformal structures in the form of teams, task forces, and dotted-line relationships (that is, reporting relationships that were not formally indicated on the organizational chart). These quasiformal struc-tures were more problem-focused and could change faster than the rest of the company. They also provided a forum for interaction across divisions and thus played an important boundary-spanning role. One advantage of quasiformal structures is that they fostered interactions based on interests rather than on hierarchy. This can foster more employee motivation and cross-fertilization of ideas. As noted by one employee: “Sometimes [ innovation] happens in the men’s room. One guy’s talking to another guy, and another guy’s standing, eavesdropping on the conversation, scribbling on a napkin.”36 Some of the downsides to such quasiformal structures were that they required time to manage, and they could be hard to kill. Since the quasi structures were not part of the formal reporting struc-ture, it could sometimes be difficult to establish who had the authority to disband them.MODULARITY AND “LOOSELY COUPLED” ORGANIZATIONSAnother method firms use to strike a balance between efficiency and flexibility is to adopt standardized manufacturing platforms or components that can then be mixed and matched in a modular production system. This enables them to achieve standard-ization advantages (such as efficiency and reliability) at the component level, while achieving variety and flexibility at the end product level.Modular ProductsModularity refers to the degree to which a system’s components may be separated and recombined.37 Making products modular can exponentially increase the number of possible configurations achievable from a given set of inputs.38 For example, many of IKEA’s shelving systems are designed so that users can mix and match a number of components to meet their needs. The shelves and supports come in a range of stan-dardized sizes, and they can all be easily attached with standardized connectors. Simi-larly, some stoves now offer customers the ability to expand the range of the stove’s functionality by removing the burners and plugging in other cooking devices such as barbecue grills and pancake griddles. Publishers have even embraced modularity by offering digital content that enables instructors to assemble their own textbooks from book chapters, articles, cases, or their own materials.Many other products are produced in a modular way, even though the customer does not perceive the modularity. By standardizing a number of common components and using flexible manufacturing technologies that can quickly shift from one assembly Final PDF to printer
sch87956_ch10_223-248.indd 237 11/12/18 10:34 AMChapter 10 Organizing for Innovation 237configuration to another, companies can produce a wide variety of product models just by changing which components are combined, while still achieving economies of scale and efficiency in the individual components. For example, Chrysler achieves one of the fastest new product development cycles in the automobile industry while also keeping new product development costs low through its practice of using a few standard plat-forms upon which all of its new car models are built. Tata Motors, the Indian company that introduced a $2500 car in 2008, used modularity even more dramatically. The Nano is built in components that can be sold and shipped in kits to be assembled and serviced by local entrepreneurs. This both enables the distribution of the Nano to be fast and streamlined and enables better penetration of remote rural markets.39Modularity is achieved in product design through the specification of standard inter-faces. For example, by designing all of its shelving components to work with its stan-dardized connectors, IKEA ensures that components can be freely mixed and matched. Individual components can be changed without requiring any design changes in the other components. Because modularity enables a wider range of end configurations to be achieved from a given set of inputs, it provides a relatively cost-effective way for firms to meet heterogeneous customer demands. Furthermore, since modularity can enable one component to be upgraded without changing other components, modular-ity can enable firms and customers to upgrade their products without replacing their entire system. The personal computer is an excellent example of a modular system that enables upgrading. For example, if users want their personal computer to have more memory or a better monitor, they do not need to replace their entire computer system—they can simply purchase and install additional memory or a new monitor.Modular products become more valuable when customers have heterogeneous demands and there are diverse options for meeting them. For example, suppose a car may be assembled from a range of components. The wider the range of components that may be recombined into a car, the wider is the range of possible car configura-tions achievable through modularity, and the greater is the potential opportunity cost of being “locked in” to a single configuration. Furthermore, the more heterogeneous customers are in their demand for car features, the less likely they are to agree on a single configuration. By employing modularity, heterogeneous customers can choose a car configuration that more closely meets their preferences.40 By contrast, if custom-ers all want the same thing, then there is little to be gained through offering a modular system—it will be a simple matter to determine the best combination of components to meet customer demands and integrate them into a nonmodular system.When products are made more modular, it enables the entire production system to be made more modular. The standard interfaces reduce the amount of coordination that must take place between the developers of different components, freeing them to pursue more flexible arrangements than the typical organizational hierarchy.41 Thus more modular products are often associated with more modular organizations with less centralization.42 Such flexible arrangements are referred to as “loosely coupled organizational structures,” as described in the next section.Loosely Coupled Organizational StructuresOrganizations can also be made modular through the adoption of structures that enable “loose coupling.”43 In a loosely coupled structure, development and production Final PDF to printer
sch87956_ch10_223-248.indd 238 11/12/18 10:34 AM238 Part Three Implementing Technological Innovation Strategyactivities are not tightly integrated but rather achieve coordination through their adher-ence to shared objectives and common standards. If, for example, each development group agrees to a development plan and standardized interfaces that enable the com-ponents they develop to connect and interact effectively, there may be little need for close coordination between the groups. The standard interface provides “embedded coordination” among all the development and production participants.44 This can enable components of a product to be produced by highly autonomous divisions of the firm, or even by multiple independent firms.Advances in information technology have also enabled loosely coupled organiza-tional structures to become more common.45 Information technology can enable a firm to access and process more information at a lower cost, vastly increasing the firm’s options for development configurations.46 For example, information technology low-ers a firm’s search costs for locating suitable development partners, as well as the costs of monitoring the partner’s performance. This was clearly demonstrated in a study by Nick Argyres of the development of the B-2 “Stealth” bomber, a highly advanced mili-tary aircraft, developed jointly by Northrop, Boeing, Vaught, and General Electric.47 Argyres found that enhanced information technology limited the need for coordination of activities through hierarchical control. By using information technology and devel-oping a standard interface—a shared “technical grammar” that facilitated communica-tion across firms—the firms involved in the development of the bomber could work autonomously, yet cooperatively.Less need for integration frees firms to pursue more flexible research and develop-ment and production configurations. For instance, firms can become more special-ized by focusing on a few key aspects of technological innovation that relate closely to the firm’s core competencies, while obtaining other activities through outsourc-ing or alliances. By focusing on those activities in which the firm has a competitive advantage, the firm can improve its chance of developing a product that has a price-to-value ratio that attracts customers while reducing the overhead and administrative complexity of maintaining a wide scope of activities. This can cause whole industries to be transformed as large vertically integrated firms are displaced by nimbler, more specialized producers.48 For example, when computer workstations displaced their more integrated predecessors, minicomputers (which were traditionally built using a proprietary central processor, combined with a proprietary system bus, and run with a proprietary operating system), the entire computer industry began to become more modular as integrated producers like Prime, Wang, and Data General were dis-placed by a network of producers (including Sun Microsystems, Silicon Graphics, and Motorola), whose components could be combined in numerous end product configu-rations. The platform ecosystems described in Chapter Four are another example of loosely coupled organizations, as are distributed innovation systems that use crowd-sourcing like Linux and Wikipedia.49There are, however, disadvantages of loose coupling. Many activities reap signifi-cant synergies by being integrated.50 In particular, activities that require the frequent exchange of complex or tacit knowledge are likely to need closer integration than a loosely coupled development configuration can offer. For example, suppose the design of a delivery mechanism for a drug will require intensive coordination with the design of the drug itself. It may be that the strength and dosage of the drug must be carefully Final PDF to printer
239sch87956_ch10_223-248.indd 239 11/12/18 10:34 AMWhen Boeing launched its sales program for the yet- to-be-built 787 Dreamliner in late 2003, it rapidly became the fastest-selling commercial jet liner in his-tory. By 2011, Boeing had received more than 800 advance orders for the aircraft—more than any other plane in history.b The Dreamliner marked an important turning point for the company. Boeing had not built an all-new airliner since 1994, when the 777 took to the sky. Since that time, Airbus had led the way in aero-space innovation, while Boeing had been content to stretch and refine its existing families of airplanes such as the 737 and 747. Many had begun to believe that Boeing no longer had what it took to build an entirely new aircraft.c The Dreamliner’s success or failure would thus send strong signals to the market about the com-pany’s prospects for the future.The Dreamliner was a super-efficient long-range mid-sized airliner. It would be the first commercial jet manufactured primarily from carbon fiber composites, enabling it to be significantly lighter and thus more fuel efficient than traditional commercial jets. Because the composite material could be more easily sculpted than aluminum, the wings of the jet would have grace-ful curves like a bird’s wings. Furthermore, since the composite material was exceptionally strong and resistant to corrosion, the cabin could be both more pressurized and more humidified, making air travel more comfortable.d Composites also allowed Boeing to easily assemble the forward, center, and rear sec-tions of the fuselage, the wings, the horizontal stabiliz-ers, and the vertical fins as large individual modules that could be quickly snapped together to form the airplane, instead of constructing the aircraft piece by piece using aluminum sheets as prior aircraft had been constructed.eThe innovations of the Boeing 787 program extended well past the actual composition of the air-craft. For the 787 project, Boeing also revolutionized the structure of the production processes involved in building a commercial aircraft. The production of the 787 would be significantly more loosely coupled than any commercial aircraft to date. Dozens of partners from around the world built and preassembled large pieces of the plane which were then delivered to the Boeing plant for final assembly.f For example, Mitsubishi, Kawasaki, and Fuji, all of Japan, were contracted to pro-duce the wings, forward fuselage, and center wing box, respectively. Saab makes the cargo doors, and Alenia Aeronautica of Italy produces a horizontal stabilizer and central fuselage. Dozens of companies from other coun-tries contribute other parts.g Roughly 70 percent of the Dreamliner would be built outside of the United States. The dramatic increase in outsourcing was expected to provide a range of benefits that included spreading the risk of developing the aircraft, containing costs, and improving the prospects for foreign sales since purchas-ers and their governments often like to see work done on the aircraft in their countries.hThough Boeing had outsourced a portion of the work on its planes for decades, the 787 ushered in a new era of outsourcing, Boeing’s role would shift from being the traditional designer and manufacturer to becoming “an essential elements company, reserving for itself optimum design and integration tasks and relying on a select group of outsiders for everything else.”i The rev-olutionary new production process was not without its challenges, however. The sheer complexity of the proj-ect and the large number of suppliers involved made coordination much more complicated. Breakdowns in this coordination had led to several delays. Though the first Dreamliner had been slated to take flight in August of 2007, customers did not actually take deliv-ery of the first Dreamliners until late 2011. The chal-lenges of coordinating suppliers around the globe had led to numerous production delays and design adjust-ments. Boeing’s managers indicated that the com-pany would make little profit on the first several dozen planes because even after they rolled off the assem-bly line, they would require corrective work, includ-ing the repair of parts and design changes.j Boeing’s management acknowledged that some mistakes had been made in the supply chain, and Engineering Vice President Mike Denton indicated that the company was considering bringing more of the work back in-house. Theory in Action The Loosely Coupled Production of Boeing’s 787 DreamlineracontinuedFinal PDF to printer
240sch87956_ch10_223-248.indd 240 11/12/18 10:34 AMHe noted, “We will probably do more of the design and even some of the major production for the next new airplanes ourselves as opposed to having it all out with the partners.”ka Adapted from “The Loosely Coupled Production of Boeing’s 787 Dreamliner” by Jaspal Singh and Melissa A. Schilling, New York University teaching case.b C. Drew, “Boeing Posts 20% Profit Gain But Cuts Forecast For 2012 As Jet Completion Slows,” New York Times, January 25, 2012.c M. V. Copeland, “Boeing’s Big Dream,” Fortune 157, no. 9 (2008), pp. 180–91. d S. Holmes, “Better Living at 30,000 Feet,” BusinessWeek, August 2, 2007.e R. Renstrom, “Boeing’s Big Gamble: Half-Plastic Dreamliner,” Plastics News, July 2, 2007.f P. Hise, “How Many Small Businesses Does It Take to Build a Jet?” Fortune Small Business 17, no. 6 (2007), pp. 42–45.g J. Weber, “Boeing to Rein in Dreamliner Outsourcing,” BusinessWeek Online, January 19, 2009, p. 10.h Ibid., and M. Mecham, “The Flat-Earth Airplane,” Aviation Week & Space Technology, July 3, 2006, p. 43.i Mecham, “The Flat-Earth Airplane.”j C. Drew, “Boeing Posts 20% Profit Gain But Cuts Forecast For 2012 As Jet Completion Slows.” New York Times, January 25, 2012.k Weber, “Boeing to Rein in Dreamliner Outsourcing.”concludedcalibrated and adjusted in accordance to the speed at which the delivery mechanism releases the drug. Alternative materials considered for the delivery mechanism may also have to be evaluated for their risk of potential interaction with chemicals used in the drug solution. If ongoing intensive coordination is required, the development activities might be better carried out through close integration of all parties.An integrated firm also has mechanisms for resolving conflict that may be more effective or less expensive than those available in the market.51 For example, if a dis-pute should arise over the development of a new product among development groups that are within the same firm, top managers can decide what action to take and exer-cise their authority over the development groups. But if the development groups are in separate companies, developing a new product in a collaboration agreement, neither firm may possess the authority to resolve the dispute and enforce a particular outcome. If the firms are unable to resolve the dispute themselves, they may face going to court or arbitration to resolve the dispute, an expensive and time-consuming option.MANAGING INNOVATION ACROSS BORDERSThe organization of innovation activities becomes particularly interesting for multina-tional firms. Many of the same issues that shape the centralization-versus- decentralization decision discussed earlier become highly amplified in the multinational firm. Foreign markets offer highly diverse sources of information and other resources. They may also have highly diverse product needs and different operating norms. This prompts many firms to consider decentralizing R&D to take advantage of local information and tailor innovation activities to the local market. However, innovations developed in this decentralized manner might never be diffused to the other divisions. The customiza-tion of products and processes to the local markets makes them particularly difficult to transfer to divisions serving different markets. Divisions that are accustomed to developing their own innovations may be reluctant to share them with others for fear of giving away their proprietary knowledge. They may also be reluctant to adopt other Final PDF to printer
sch87956_ch10_223-248.indd 241 11/12/18 10:34 AMChapter 10 Organizing for Innovation 241divisions’ innovations because of the belief that innovations that are not developed locally will not suit their local market needs (a phenomenon known as not-invented-here syndrome). However, much of the value creation potential of a multinational is the opportunity to leverage technological innovation (and other core competencies) into multiple markets. Allowing innovation activities to become completely autonomous and disconnected risks forfeiting this opportunity. How does the multinational resolve this dilemma? A series of studies by Christopher Bartlett and Sumantra Ghoshal high-light some advantages and disadvantages of various approaches to the management of multinational innovation. They identify four primary strategies used by firms: center-for-global, local-for-local, locally leveraged, and globally linked.52The center-for-global strategy entails conducting all innovation activities at a centralized hub. These innovations are then deployed globally throughout the com-pany. The centralization of innovation activities enables management to: ∙ Tightly coordinate all R&D activities (across both functions and projects). ∙ Achieve greater specialization and economies of scale in R&D activities while avoiding duplication of activities in multiple divisions. ∙ Develop and protect core competencies. ∙ Ensure that innovations are standardized and implemented throughout the company.Managers are likely to choose a center-for-global approach to innovation when they have a strong desire to control the evolution of a technology, when they have strong concerns about the protection of proprietary technologies, when development activi-ties require close coordination, or when there is a need to respond quickly to tech-nological change and dispersed efforts are likely to create inefficiencies.53 However, a center-for-global approach tends to not be very responsive to the diverse demands of different markets. Furthermore, the divisions that serve these markets might resist adopting or promoting centrally developed innovations. As a result, innovations devel-oped centrally may not closely fit the needs of foreign markets and may also not be deployed quickly or effectively.A local-for-local strategy is the opposite of the center-for-global strategy. Each national subsidiary uses its own resources to create innovations that respond to the needs of its local market. A local-for-local strategy takes advantage of access to diverse information and resources, and it customizes innovation for the needs and tastes of the local market. Managers are likely to choose a local-for-local strategy when divisions are very autonomous and when markets are highly differentiated.There are several downsides to the local-for-local strategy, however. It can result in significant redundancy in activities as each division reinvents the wheel. Furthermore, each division may suffer from a lack of scale in R&D activities, and there is a risk that valuable innovations will not be diffused across the firm.Over time, firms have developed variants of these strategies that attempt to reap advantages of both the center-for-global and local-for-local strategies. Bartlett and Ghoshal identify one such strategy as the locally leveraged strategy. A firm imple-menting a locally leveraged strategy attempts to take the most creative resources and innovative developments from the divisions and deploy them across the company. This strategy enables the firm to take advantage of the diverse ideas and resources created in local markets, while leveraging these innovations across the company. One way this center-for-global strategyWhen all innova-tion activities are conducted at a central hub and innovations are then diffused throughout the company.local-for-local strategyWhen each divi-sion or subsid-iary of the firm conducts its own R&D activities, tailored for the needs of the local market.locally leveraged strategyWhen each division or subsidiary of the firm conducts its own R&D activities, but the firm attempts to leverage result-ing innovations throughout the company.Final PDF to printer
sch87956_ch10_223-248.indd 242 11/12/18 10:34 AM242 Part Three Implementing Technological Innovation Strategystrategy is employed in consumer markets is to assign an individual the role of interna-tional brand custodian. This person is responsible for ensuring that a successful brand is deployed into the firm’s multiple markets while also maintaining consistency in the product’s image and positioning.54 Such a strategy can be very effective if different markets the company serves have similar needs.Another approach, the globally linked strategy, entails creating a system of decentralized R&D divisions that are connected to each other. Each geographically decentralized division might be charged with a different innovation task that serves the global company’s needs. For example, a multinational auto manufacturer may empower one of its European divisions with the responsibility for developing new subcompact models that most closely fit the European markets but that may ultimately also be sold in the United States, Canada, and South America. In the meantime, its American divi-sion might bear the bulk of the responsibility for collaborating with other manufactur-ers to develop more efficient manufacturing processes that will ultimately be deployed corporatewide. Thus, while innovation is decentralized to take advantage of resources and talent pools offered in different geographic markets, it is also globally coordinated to meet companywide objectives. This approach also attempts to enable the learning accrued through innovation activities to be diffused throughout the firm. This strategy can be quite powerful in its ability to tap and integrate global resources, but it is also expensive in both time and money as it requires intensive coordination.In both the locally leveraged and globally linked strategies, R&D divisions are decentralized and linked to each other. The difference lies in the missions of the R&D divisions. In the locally leveraged strategy, the decentralized R&D divisions are largely independent of each other and work on the full scope of development activities relevant to the regional business unit in which they operate. This means, for example, that if their regional business unit produces and sells health care items, beauty care products, and paper products, the R&D division is likely to work on development projects related to all of these products. However, to ensure that the best innovations are leveraged across the company, the company sets up integrat-ing mechanisms (such as holding regular cross-regional meetings, or establishing a liaison such as an international brand custodian) to encourage the divisions to share their best developments with each other. By contrast, in the globally linked strat-egy, the R&D divisions are decentralized, but they each play a different role in the global R&D strategy. Instead of working on all development activities relevant to the region in which they operate, they specialize in a particular development activ-ity. For example, an R&D division may be in a regional business unit that produces and sells health care, beauty care, and paper products, but its role may be to focus on developing paper innovations, while other R&D divisions in the firm work on health care items or beauty care products. Or it might focus on basic chemistry applications relevant to all of the products, while another division explores packaging innova-tions, and so on. The role of the division should exploit some local market resource advantage (such as abundant timber or a cluster of chemical technology firms). This strategy attempts to take advantage of the diversity of resources and knowledge in foreign markets, while still linking each division through well-defined roles in the company’s overall R&D strategy.globally linked strategyInnovation activities are decentralized, but also centrally coordinated for the global needs of the corporation.Final PDF to printer
sch87956_ch10_223-248.indd 243 11/12/18 10:34 AMChapter 10 Organizing for Innovation 243Bartlett and Ghoshal argue that, overall, the multinational firm’s objective is to make centralized innovation activities more effective (that is, better able to serve the various local markets) while making decentralized innovation activities more effi-cient (that is, eliminating redundancies and exploiting synergies across divisions). Bartlett and Ghoshal propose that firms should take a transnational approach wherein resources and capabilities that exist anywhere within the firm can be leveraged and deployed to exploit any opportunity that arises in any geographic market. They argue that this can be achieved by: ∙ Encouraging reciprocal interdependence among the divisions of the firm (that is, each division must recognize its dependency on the other divisions of the firm). ∙ Utilizing integration mechanisms across the divisions, such as division-spanning teams, rotating personnel across divisions, and so on. ∙ Balancing the organization’s identity between its national brands and its global image.Ericsson provides an excellent example of this approach. Instead of using a strictly centralized or decentralized structure for its innovation activities, Ericsson’s struc-ture ebbs and flows between centralization and decentralization. Sometimes Ericsson increases levels of centralization and global integration for particular projects, while other times it decentralizes much more authority over innovation activities to its geo-graphically dispersed divisions. Similar to the dynamic tension approach described by Jelinek and Schoonhoven, Ericsson regularly modifies its structure to adjust the bal-ance between integration and autonomy. To encourage interunit integration, Ericsson also sends teams of 50 to 100 engineers to a different subsidiary for a year or two. Such member rotation programs facilitate the diffusion of knowledge throughout the firm.55 Furthermore, encouraging engineers to become integrated into multiple areas of the company helped the engineers identify with both the global company and par-ticular divisions. 1. The impact of firm size on innovation has been debated for more than 50 years. Size is thought to confer advantages such as economies of scale in R&D, greater access to complementary resources (like capital and market access), and learning benefits. However, size may also be associated with disadvantages such as inertia and governance problems. 2. Many firms attempt to make big companies feel small by breaking them into net-works of more specialized divisions. These divisions can behave like smaller, more entrepreneurial firms. 3. Structural dimensions of the firm, including formalization, standardization, and centralization, also affect the firm’s propensity to innovate and its effectiveness at innovation. Formalization and standardization tend to improve efficiency, but can stifle experimentation and creativity. Centralization has a more ambiguous effect Summary of ChapterFinal PDF to printer
sch87956_ch10_223-248.indd 244 11/12/18 10:34 AM244 Part Three Implementing Technological Innovation Strategyon innovation; in some cases, centralization can enable significant innovation to occur more rapidly, and in other situations, decentralization fosters more innova-tion by enabling managers to respond quickly to local needs. 4. Traditionally, scholars have divided organization structures into two major types: mechanistic structures, which are highly formalized and standardized, and are good for efficient production, and organic structures, which are loose and free flowing and are good for creativity and experimentation. 5. Ambidextrous organizations attempt to achieve both the efficiency advantages of large mechanistic firms and the creativity and entrepreneurial spirit of small organic firms. These firms may have divisions with different structures and con-trol schemes, or they may alternate between different structures. 6. Recently, many firms have begun forming loosely coupled networks both within and between firms to conduct development activities. Part of this transition is attributed to the rise in information technology and the resultant decrease in coor-dination costs. 7. Multinational firms face significant challenges in determining where and how to conduct their R&D activities. One primary challenge is to balance the need to tap the knowledge and resources of local markets while also achieving coherence across the corporation and ensure that technological innovations are diffused and leveraged throughout the organization. 1. Are there particular types of innovation activities for which large firms are likely to outperform small firms? Are there types for which small firms are likely to outperform large firms? 2. What are some advantages and disadvantages of having formalized procedures for improving the effectiveness or efficiency of innovation? 3. What factors should a firm consider when deciding how centralized its R&D activities should be? Should firms employ both centralized and decentralized R&D activities? 4. Why is the tension between centralization and decentralization of R&D activities likely to be even greater for multinational firms than for firms that compete in one national market? 5. What are some of the advantages and disadvantages of the transnational approach advocated by Bartlett and Ghoshal?Discussion QuestionsClassicsBurns, T., and G. M. Stalker, The Management of Innovation (London: Tavistock Publications, 1961).Chandler, A., Strategy and Structure: Chapter in the History of the American Indus-trial Enterprise (Cambridge, MA: Harvard University Press, 1962).Suggested Further ReadingFinal PDF to printer
sch87956_ch10_223-248.indd 245 11/12/18 10:34 AMChapter 10 Organizing for Innovation 245Ettlie, J. E., W. P. Bridges., and R. D. O’Keefe, “Organization Strategy and Struc-tural Differences for Radical versus Incremental Innovation,” Management Science 30 (1984), pp. 682–95.Schilling, M. A., “Towards a General Modular Systems Theory and Its Application to Inter-firm Product Modularity,” Academy of Management Review 25 (2000), 312–34.Schumpeter, J. A., Capitalism, Socialism and Democracy (New York: Harper & Brothers Publishers, 1942).Thompson, J. D., Organizations in Action (New York: McGraw-Hill, 1967).Recent WorkArora, A., S. Belenzon, and L. A. Rios, “The Organization of R&D in American Cor-porations: The Determinants and Consequences of Decentralization,” NBER Working Paper No. 17013 (2011), May.Kafouros, M., C. Wang, E. Mavroudi, J. Hong, and C. S. Katsikeas, “Geographic Dis-persion and Co-Location in Global R&D Portfolios: Consequences for Firm Perfor-mance,” Research Policy 47 (2018):1243–55.Kornberger, M., “The Visible Hand and the Crowd: Analyzing Organization Design in Distributed Innovation Systems,” Strategic Organization 15 (2017):174–93.Tushman, M., W. K. Smith., R. C. Wood., G. Westerman., and C. O’Reilly, “Organiza-tional Designs and Innovation Streams,” Industrial and Corporate Change 19 (2010), pp. 1331–66. 1. D. Dougherty, “Reimagining the Differentiation and Integration of Work for Sustained Product Innovation,” Organization Science 12 (2001), pp. 612–31; A. Griffin, “The Effect of Project and Process Characteristics on Product Development Cycle Time,” Journal of Marketing Research 34 (1997), pp. 24–35; E. H. Kessler and A. K. Chakrabarti, “Innovation Speed: A Conceptual Model of Context, Antecedents, and Outcomes,” Academy of Management Review 21 (1996), pp. 1143–91; and A. Menon, J. Chowdhury, and B. Lukas, “Antecedents and Outcomes of New Product Development Speed: An Interdisciplinary Conceptual Framework,” Industrial Market-ing Management 31 (2002), pp. 317–28. 2. J. A. Schumpeter, Capitalism, Socialism and Democracy (New York: Harper & Brothers Publishers, 1942). 3. W. M. Cohen and D. A. Levinthal, “Absorptive Capacity: A New Perspective on Learning and Innovation,” Administrative Science Quarterly 35 (1990), pp. 128–52; and M. I. Kamien and N. L. Schwartz, “Market Structure and Innovation—A Survey,” Journal of Economic Litera-ture 13 (1975), pp. 1–37. 4. F. Damanpour, “Organizational Size and Innovation,” Organization Studies 13 (1992) pp. 375–402. 5. R. L. Daft, Organization Theory and Design (Minneapolis: West Publishing Company, 1995). 6. W. Cohen and R. Levin, “Empirical Studies of Innovation and Market Structure,” in Handbook of Industrial Organization, vol. II, eds. R. Schmalensee and R. D. Willig (Amsterdam: Elsevier Science Publishers B.V., 1989). 7. Ibid; and J. Rotemberg and G. Saloner, “Benefits of Narrow Business Strategies,” American Economic Review 84, no. 5 (1994), pp. 1330–49.EndnotesFinal PDF to printer
sch87956_ch10_223-248.indd 246 11/12/18 10:34 AM246 Part Three Implementing Technological Innovation Strategy 8. G. Gilder, “The Revitalization of Everything: The Law of the Microcosm,” Harvard Business Review 66, no. 2 (1988), pp. 49–61. 9. M. Kharbanda, “Xerox Corporation: A Case Study in Revitalizing Product Development,” in Time-Based Competition: The Next Battleground in American Manufacturing, ed. J. D. Black-burn (Homewood, IL: Business One Irwin, 1991), pp. 177–90. 10. A. Cotterel, The Encyclopedia of Mythology (London: Smithmark, 1996). 11. J. Bound, C. Cummins, Z. Griliches, B. H. Hall, and A. Jaffe, “Who Does R&D and Who Patents?” in R&D, Patents, and Productivity, ed. Z. Griliches (Chicago: University of Chi-cago, 1984); A. K. Chakrabarti and M. R. Halperin, “Technical Performance and Firm Size: Analysis of Patents and Publications of U.S. Firms,” in Innovation and Technological Change: An International Comparison, eds. A. J. Acs and D. B. Audretsch (Ann Arbor, MI: University of Michigan Press, 1991); S. B. Graves and N. S. Langowitz, “Innovative Productivity and Returns to Scale in the Pharmaceutical Industry,” Strategic Management Journal 14 (1993), pp.  593–605; and G. N. Stock, N. P. Greis, and W. A. Fischer, “Firm Size and Dynamic Techno-logical Innovation,” Technovation 22 (2002), pp. 537–49. 12. Z. Griliches, “Patent Statistics as Economic Indicators: A Survey,” Journal of Economics Lit-erature 28 (1990), pp. 1661–1707; and F. M. Scherer, “The Propensity to Patent,” International Journal of Industrial Organization 1 (1983), pp. 107–28. 13. A. Griffin, “Product Development Cycle Time for Business-to-Business Products,” Industrial Marketing Management 31 (2002), pp. 291–304. 14. W. M. Cohen and S. Klepper, “A Reprise of Firm Size and R&D,” Economic Journal 106 (1996), pp. 925–51; and R. Henderson and I. Cockburn, “Scale, Scope and Spillovers: The Determinants of Research Productivity in Drug Discovery,” Rand Journal of Economics 27 (1996), pp. 32–59. 15. R. Ashkenas, D. Ulrich, T. Jick, and S. Kerr, The Boundaryless Organization: Breaking the Chains of Organizational Structure (San Francisco: Jossey-Bass Publishers, 1995); J. Hagel and M. Singer, “Unbundling the Corporation,” Harvard Business Review, March–April 1999, pp. 133–41; M. A. Schilling and K. Steensma, “The Use of Modular Organizational Forms: An Industry Level Analysis,” Academy of Management Journal 44 (2001), pp. 1149–69; C. Snow, R. Miles, and H. J. Coleman, “Managing 21st Century Network Organizations,” Organizational Dynamics 20, no. 3 (1992), pp. 5–20; and T. R. Zenger and W. S. Hesterly, “The Disaggrega-tion of Corporations: Selective Intervention, High-Powered Incentives, and Molecular Units,” Organization Science 8 (1997), pp. 209–23. 16. R. S. Achrol, “Changes in the Theory of Interorganizational Relations in Marketing: Toward a Network Paradigm,” Academy of Marketing Science 25 (1997), pp. 56–71. 17. H. Chesbrough and D. Teece, “When Is Virtual Virtuous? Organizing for Innovation,” Harvard Business Review, January–February 1996, pp. 65–73; and D. Churbuck and J. S. Young, “The Virtual Workplace,” Forbes 150, no. 12 (1992), pp. 184–90. 18. C. Jones, W. Hesterly, and S. Borgatti, “A General Theory of Network Governance: Exchange Conditions and Social Mechanisms,” Academy of Management Review 22 (1997), pp. 911–45; R. E. Miles and C. C. Snow, “Organizations: New Concepts for New Forms,” California Man-agement Review 28, no. 3 (1986), pp. 62–73; and R. E. Miles and C. C. Snow, “Causes of Fail-ures in Network Organizations,” California Management Review 34, no. 4 (1992), pp. 53–72. 19. D. Lei, M. A. Hitt, and J. D. Goldhar, “Advanced Manufacturing Technology: Organizational Design and Strategic Flexibility,” Organization Studies 17 (1996), pp. 501–24; R. Sanchez, “ Strategic Flexibility in Product Competition,” Strategic Management Journal 16 (1995), pp.  135–60; R. Sanchez and J. Mahoney, “Modularity, Flexibility, and Knowledge Management in Product and Organization Design,” Strategic Management Journal 17 (1996), pp. 63–76; and Schilling and Steensma, “The Use of Modular Organizational Forms: An Industry Level Analysis.”Final PDF to printer
sch87956_ch10_223-248.indd 247 11/12/18 10:34 AMChapter 10 Organizing for Innovation 247 20. Csaszar, FA. “Organizational Structure as a Determinant of Performance: Evidence from Mutual Funds,” Strategic Management Journal 33 (2012):611–632; Csaszar, FA, “When Con-sensus Hurts the Company,” MIT Sloan Management Review, (2015), Spring: 17–20. 21. L. Cardinal and T. Opler, “Corporate Diversification and Innovative Efficiency: An Empirical Study,” Journal of Accounting & Economics 19 (1995), pp. 365–82. 22. P. N. Golder, “Insights from Senior Executives about Innovation in International Markets,” Journal of Product Innovation Management 17 (2000), pp. 326–40. 23. Menon, Chowdhury, and Lukas, “Antecedents and Outcomes of New Product Development Speed.” 24. P. S. Adler, “Building Better Bureaucracies,” Academy of Management Executive 13, no. 4 (1999), pp. 36–50. 25. M. Treacy and F. Wiersema, “Customer Intimacy and Other Value Disciplines,” Harvard Busi-ness Review 71, no. 1 (1993), pp. 84–94. 26. M. P. Miles, J. G. Covin, and M. B. Heeley, “The Relationship between Environmental Dyna-mism and Small Firm Structure, Strategy, and Performance,” Journal of Marketing Theory and Practice 8, no. 2 (2000), pp. 63–75. 27. D. Leonard, Well-Springs of Knowledge: Building and Sustaining the Sources of Innovation (Boston: Harvard Business School Press, 1996); C. Moorman and A. Miner, “Organizational Improvisation and Organizational Memory,” Academy of Management Review 23, no. 4 (1998), pp. 698–723; and D. Dougherty, “Reimagining the Differentiation and Integration of Work for Sustained Product Innovation,” Organization Science 12 (2001), pp. 612–31. 28. Daft, Organization Theory and Design; and Menon, Chowdhury, and Lukas, “Antecedents and Outcomes of New Product Development Speed.” 29. M. L. Tushman and C. A. O’Reilly, “Ambidextrous Organizations: Managing Evolutionary and Revolutionary Change,” California Management Review 38, no. 4 (1996), pp. 8–31. 30. M. L. Tushman and C. A. O’Reilly, Winning through Innovation: A Practical Guide to Lead-ing Organizational Change and Renewal (Boston: Harvard Business School, 1997); and M. L. Tushman and W. Smith, “Organizational Technology: Technological Change, Ambi-dextrous Organizations and Organizational Evolution,” in Companion to Organizations, ed. J. A. Baum (New York: Blackwell Publishers, 2002), pp. 386–414. 31. C. Fang, J. Lee, and M. A. Schilling, “Balancing Exploration and Exploitation through Struc-tural Design: Advantage of the Semi-isolated Subgroup Structure in Organizational Learning,” Organization Science 21 (2010), pp. 625–42. 32. J. M. Benner and M. Tushman, “Exploitation, Exploitation, and Process Management: The Pro-ductivity Dilemma Revisited,” Academy of Management Review 28 (2003), pp. 238–56; and J. L. Bower and C. M. Christensen, “Disruptive Technologies: Catching the Wave,” Harvard Business Review 73, no. 1 (1995), pp. 43–53. 33. M. Rogers, “It’s the Apple of His Eye,” Newsweek, March 1, 2003. 34. N. Siggelkow and D. Levinthal, “Temporarily Divide to Conquer: Centralized, Decentralized, and Reintegrated Organizational Approaches to Exploration and Adaptation,” Organization Science 14 (2003), pp. 650–69. 35. M. Jelinek and C. Schoonhoven, The Innovation Marathon: Lessons from High Technology Firms (Oxford, UK: Basil Blackwell, 1990); and C. B. Schoonhoven and M. Jelinek, “Dynamic Tension in Innovative, High Technology Firms: Managing Rapid Technological Change through Organizational Structure,” in Managing Strategic Innovation and Change, eds. M. L. Tushman and P. Anderson (Oxford: Oxford University Press, 1996). 36. Schoonhoven and Jelinek, “Dynamic Tension in Innovative, High Technology Firms.” 37. M. A. Schilling, “Toward a General Modular Systems Theory and Its Application to Interfirm Product Modularity,” Academy of Management Review 25 (2000), pp. 312–34.Final PDF to printer
sch87956_ch10_223-248.indd 248 11/12/18 10:34 AM248 Part Three Implementing Technological Innovation Strategy 38. C. Y. Baldwin and K. B. Clark, Design Rules, Volume 1: The Power of Modularity (Cambridge, MA: MIT Press, 2000); R. Garud and A. Kumaraswamy, “Technological and Organizational Designs for Realizing Economies of Substitution,” Strategic Management Journal 16 (1995), pp. 93–109; and Sanchez, “Strategic Flexibility in Product Competition.” 39. J. Hagel and J. S. Brown, “Learning from Tata’s Nano.” BusinessWeek, February 27, 2008. 40. M. A. Schilling, “Towards a General Modular Systems Theory and its Application to Inter-firm Product Modularity,” Academy of Management Review 25 (2000), pp. 312–34. 41. Hoetker, G. “Do Modular Products Lead to Modular Organizations?” Strategic Management Journal 27 (2006): 501–518; Cabigiosu, A and Camuffo, A. “Beyond the “mirroring” Hypoth-esis: Product Modularity and Interorganizational Relations in the Air Conditioning Indus-try,” Organization Science 23 (2012): 686–703; Colfer, L. and Baldwin, CY. “The Mirroring Hypothesis: Theory, Evidence and Exceptions,” Harvard Business School Finance Working Paper No. 10–058 (2010), June 4th. 42. Zeschky, M., et al., “Coordination in Global R&D Organizations: An Examination of the Role of Subsidiary Mandate and Modular Product Architecture in Dispersed R&D Organizations,” Technovation 34 (2014):594–604. 43. Sanchez and Mahoney, “Modularity, Flexibility, and Knowledge Management in Product and Organization Design.” 44. Schilling and Steensma, “The Use of Modular Organizational Forms”; and Sanchez and Mahoney, “Modularity, Flexibility, and Knowledge Management in Product and Organization Design.” 45. E. Brynjolfsson, T. W. Malone, V. Gurbaxani, and A. Kambil, “Does Information Technology Lead to Smaller Firms?” Management Science 40 (1994), pp. 1628–45; and T. R. Zenger and W. S. Hesterly, “The Disaggregation of Corporations: Selective Intervention, High-Powered Incentives, and Molecular Units,” Organization Science 8 (1997), pp. 209–23. 46. E. Brynjolfsson, “Information Assets, Technology, and Organization,” Management Science 40 (1994), pp. 1645–63; and L. M. Hitt, “Information Technology and Firm Boundaries: Evidence from Panel Data,” Information Systems Research 10, no. 2 (1999), pp. 134–50. 47. N. S. Argyres, “The Impact of Information Technology on Coordination: Evidence from the B-2 ‘Stealth’ Bomber,” Organization Science 10 (1999), pp. 162–81. 48. Schilling and Steensma, “The Use of Modular Organizational Forms.” 49. M. Kornberger, “The Visible Hand and the Crowd: Analyzing Organization Design in Distrib-uted Innovation Systems,” Strategic Organization 15 (2017):174–193. 50. Chesbrough and Teece, “When Is Virtual Virtuous?” and Schilling and Steensma, “The Use of Modular Organizational Forms.” 51. Chesbrough and Teece, “When Is Virtual Virtuous?” 52. C. A. Bartlett and S. Ghoshal, “Managing Innovation in the Transnational Corporation,” in Managing the Global Firm, eds. C. A. Bartlett, Y. Doz, and G. Hedlund (London and New York: Routledge, 1990). 53. Ibid; and A. M. Rugman, “Research and Development by Multinational and Domestic Firms in Canada,” Canadian Public Policy 7 (1981), pp. 604–16. 54. Golder, “Insights from Senior Executives about Innovation in International Markets.” 55. T. Madsen, E. Mosakowski, and S. Zaheer, “The Dynamics of Knowledge Flows: Human Capital Mobility, Knowledge Retention and Change,” Journal of Knowledge Management 6, no. 2 (2002), pp. 164–77.Final PDF to printer
249sch87956_ch11_249-276.indd 249 11/12/18 10:32 AMChapter ElevenManaging the New Product Development ProcessScrums, Sprints, and Burnouts: Agile Development at Cisco SystemsCisco Systems, founded in 1984 in San Francisco, had grown to become a global leader in networking technology such as routers, servers, switches, networking software, security software, and more. For most of the company’s existence, it had used the “waterfall” method to develop software.a The typical waterfall method began with analysis that would result in documents specify-ing the business case, product requirements, marketing requirements, and so on. Different teams would then be formed to sequentially design, build, test, and deploy the product. A team could begin working only when the previous team had completed its stage of the process, and the entire process could take 18 months or more.bThis approach was similar to “stage-gate” methods and consistent with how the company developed hardware products. But managers in the software divi-sions were unsatisfied; they worried that their development cycles were too long compared to other software companies, making it hard to compete. In 2014, they decided to try a new approach called agile development to make software development faster and more flexible at the firm.Agile development began as a set of principles laid out by a group of 17  software engineers at a three-day retreat at a ski resort in Snowbird Utah in 2001.c Their objective was to come to an agreement about how to make soft-ware development faster and leaner. They ended up developing a set of core values and practices that emphasize collaboration, self-organization, and cross-functional teams.d The key distinction between traditional waterfall methods and agile methods was that rather than designing a complete product upfront and moving through a sequential process that culminates in testing and release, the product is broken up into many smaller parts or features that are built and Final PDF to printer
sch87956_ch11_249-276.indd 250 11/12/18 10:32 AM250 Part Three Implementing Technological Innovation Strategyreleased quickly, enabling the developers to get feedback and fix bugs early (see Figure 1). The process also gave developers considerably more autonomy.The method rapidly grew in popularity, attracting companies such as Google, Spotify, Netflix, and Twitter. Furthermore, though it was designed for software development, it had also been adopted for managing other kinds of projects, and had even been adopted by companies such as Lockheed Martin, Walmart, and ExxonMobil.eThe Agile Development ProcessIn agile development, a manager deemed the product owner (a person at the orga-nization who represents the customer’s interests) assembles a complete list of func-tions to be developed for the product based on user stories—short descriptions of functions described by customers in their own words. This list is called the product backlog. Work on the product backlog is organized into a series of sprints, periods of roughly two weeks in which a small set of features from the product backlog are developed and tested. Work is conducted by scrum teams, small, self-organizing teams with no titles or team manager. There is no formal task assignment; each member just contributes in whatever way they can to complete the work and the team makes decisions as a whole. Sometimes agile development projects also have a scrum master who acts as a coach for multiple scrum teams. The scrum master does not provide day-to-day direction or impose any particular technical solution; rather, the scrum master’s job is to help guide the scrum process itself.The teams figure out what items they can commit to and create a sprint backlog—a list of tasks they will complete during the sprint. Each day of the sprint, all the team members and the product owner attend a quick scrum meeting of 15 minutes max where they share what they worked on the previous day, what they will work on that day, and any obstacles to their progress. During the sprint, the scrum team takes a small set of features from idea through coding and testing.At the end of each sprint, there should be work that can be demonstrated to a client—a minimum viable productFIGURE 1Waterfall versus Agile DevelopmentWaterfall DevelopmentAgile DevelopmentReleaseDesignBuildReleaseDesignBuildReleaseDesignBuildDesignBuildTestReleaseFinal PDF to printer
sch87956_ch11_249-276.indd 251 11/12/18 10:32 AMChapter 11 Managing the New Product Development Process 251feedback early and often, helping the scrum teams weed out or refine their ideas. A burndown chart shows the amount of work remaining in a sprint or a product release, and is used to determine whether a sprint or release is on schedule.“Release Early, Release Often”In agile development, rather than having grand comprehensive product rede-signs, the product is constantly, incrementally adapted. Introducing small changes one or a few at a time helps to reduce risk, and also improves transparency about what works and what does not work. By contrast, when many changes are intro-duced simultaneously, it is harder to tell why the overall product succeeds or fails.For this approach to work, a product has to be fairly modular. That is, it must be possible for a large product to be broken down into many smaller, relatively independent problems that can be worked on separately (something that is not possible with all products).f Furthermore, a potential downside of the agile approach is that it may be more difficult (or less likely) to make large-scale sys-temic changes to a product.In the right setting, however, agile development can accelerate product development, improve customer satisfaction, and even improve employee sat-isfaction because the process gives them much more autonomy and a sense of ownership in their jobs. As one team member at Cisco put it, “My boss used to come and tell me to get my team to do this or do that. Now, I tell him that I cannot tell my team to do this or that; I can suggest it to them, but they will discuss and decide if it’s the right thing to do.”gDiscussion Questions 1. What are some of the advantages and disadvantages of the agile develop-ment process? 2. How is agile development similar to or different from (a) the stage-gate pro-cess and (b) the parallel development process described in the chapter? 3. What are some of the likely changes agile development requires in manag-ing development personnel? 4. What kinds of projects do you think agile development is appropriate for? What kinds of projects do you think it might be inappropriate for? a b R. Chen, R. Ravichandar, and D. Proctor, “Managing the Transition to the New Agile Business and Product Development Model: Lessons from Cisco Systems,” Indiana University Kelley School of Business Teach-ing Case (2016). c d “Agile Manifesto”, 2001, Agile Alliance. e C. M. Nyce, “The Winter Getaway that Turned the Software World Upside Down,” The Atlantic, December 8, 2017 f M. A. Schilling, “Modularity in Multiple Disciplines,” in R. Garud, R. Langlois, and A. Kumaraswamy eds., Managing in the Modular Age: Architectures, Networks and Organizations (Oxford, England: Blackwell Publishers, 2002) pp. 203–214. g R. Chen, R. Ravichandar, and D. Proctor, “Managing the Transition to the New Agile Business and Product Development Model: Lessons from Cisco Systems,” Indiana University Kelley School of Business Teach-ing Case (2016).Final PDF to printer
sch87956_ch11_249-276.indd 252 11/12/18 10:32 AM252 Part Three Implementing Technological Innovation StrategyOVERVIEWIn many industries, the ability to develop new products quickly, effectively, and effi-ciently is now the single most important factor driving firm success. In industries such as computer hardware and software, telecommunications, automobiles, and consumer electronics, firms often depend on products introduced within the past five years for more than 50 percent of their sales. Yet despite the avid attention paid to new product development, the failure rates for new product development projects are still agoniz-ingly high. By many estimates, more than 95 percent of all new product development projects fail to result in an economic return.1 Many projects are never completed, and of those that are, many flounder in the marketplace. Thus, a considerable amount of research has been focused on how to make the new product development process more effective and more efficient. This chapter discusses some strategic imperatives for new product development processes that have emerged from the study of best—and worst—practices in new product development.We will begin by looking at the three key objectives of the new product develop-ment process: maximizing fit with customer requirements, minimizing cycle time, and controlling development costs. We then will turn to methods of achieving these objec-tives, including adopting parallel development processes, using project champions, and involving customers and suppliers in the development process. Next we will look at a number of tools firms can utilize to improve the effectiveness and efficiency of the development process, including creating go/kill decision points with stage-gate pro-cesses, defining design targets with quality function deployment, reducing costs and development time with design for manufacturing and CAD/CAM systems, and using metrics to assess the performance of the new product development process.OBJECTIVES OF THE NEW PRODUCT DEVELOPMENT PROCESSFor new product development to be successful, it must simultaneously achieve three sometimes-conflicting goals: (1) maximizing the product’s fit with customer require-ments, (2) minimizing the development cycle time, and (3) controlling development costs.Maximizing Fit with Customer RequirementsFor a new product to be successful in the marketplace, it must offer more compelling features, greater quality, or more attractive pricing than competing products. Despite the obvious importance of this imperative, many new product development projects fail to achieve it. This may occur for a number of reasons. First, the firm may not have a clear sense of which features customers value the most, resulting in the firm’s overinvesting in some features at the expense of features the customer values more. Firms may also overestimate the customer’s willingness to pay for particular features, leading them to produce feature-packed products that are too expensive to gain significant market pen-etration. Firms may also have difficulty resolving heterogeneity in customer demands; if some customer groups desire different features from other groups, the firm may end up producing a product that makes compromises between these conflicting demands, and the resulting product may fail to be attractive to any of the customer groups.Final PDF to printer
sch87956_ch11_249-276.indd 253 11/12/18 10:32 AMChapter 11 Managing the New Product Development Process 253Numerous new products have offered technologically advanced features compared to existing products but have failed to match customer requirements and were subse-quently rejected by the market. For example, consider Apple’s Newton MessagePad, a relatively early entrant into the personal digital assistant market. The Newton was exceptional on many dimensions. It had a highly advanced ARM610 RISC chip for superior processing performance. Its operating system was object oriented (a feature that software programmers had been clamoring for), and Apple openly licensed the architecture to encourage rapid and widespread adoption by other vendors. Also, its weight, size, and battery life were better than many of the other early competitors. However, the Newton MessagePad was still much too large to be kept in a pocket, limiting its usefulness as a handheld device. Many corporate users thought the screen was too small to make the product useful for their applications. Finally, early problems with the handwriting recognition software caused many people to believe the product was fatally flawed.Another example is Philips’ attempt to enter the video game industry. In 1989, Philips introduced its Compact Disc Interactive (CD-i). The CD-i was a 32-bit sys-tem (introduced well before Sega’s 32-bit Saturn or Sony’s 32-bit PlayStation), and in addition to being a game player, it offered a number of educational programs and played audio CDs. However, Philips had overestimated how much customers would value (and be willing to pay for) these features. The CD-i was priced at $799, more than double the cost of Nintendo or Sega video game systems. Furthermore, the prod-uct was very complex, requiring a half-hour demonstration by a skilled sales represen-tative. Ultimately, the product failed to attract many customers and Philips abandoned the product.Minimizing Development Cycle TimeEven products that achieve a very close fit with customer requirements can fail if they take too long to bring to market. As discussed in Chapter Five, bringing a product to market early can help a firm build brand loyalty, preemptively capture scarce assets, and build customer switching costs. A firm that brings a new product to market late may find that customers are already committed to other products. Also, a company that is able to bring its product to market early has more time to develop (or encour-age others to develop) complementary goods that enhance the value and attractiveness of the product.2 Other things being equal, products that are introduced to the market earlier are likely to have an installed base and availability of complementary goods advantage over later offerings.Another important consideration regarding development cycle time relates to the cost of development and the decreasing length of product life cycles. First, many development costs are directly related to time. Both the expense of paying employees involved in development and the firm’s cost of capital increase as the development cycle lengthens. Second, a company that is slow to market with a particular generation of technology is unlikely to be able to fully amortize the fixed costs of development before that generation becomes obsolete. This phenomenon is particularly vivid in dynamic industries such as electronics where life cycles can be as short as 12 months (e.g., personal computers, semiconductors). Compa-nies that are slow to market may find that by the time they have introduced their development cycle timeThe time elapsed from project ini-tiation to product launch, usually measured in months or years.Final PDF to printer
sch87956_ch11_249-276.indd 254 11/12/18 10:32 AM254 Part Three Implementing Technological Innovation Strategyproducts, market demand has already shifted to the products of a subsequent tech-nological generation.Finally, a company with a short development cycle can quickly revise or upgrade its offering as design flaws are revealed or technology advances. A firm with a short devel-opment cycle can take advantage of both first-mover and second-mover advantages.Some researchers have pointed out the costs of shortening the development cycle and rushing new products to market. For example, Dhebar points out that rapid prod-uct introductions may cause adverse consumer reactions; consumers may regret past purchases and be wary of new purchases for fear they should rapidly become obso-lete.3 Other researchers have suggested that speed of new product development may come at the expense of quality or result in sloppy market introductions.4 Compressing development cycle time can result in overburdening the development team, leading to problems being overlooked in the product design or manufacturing process. Adequate product testing may also be sacrificed to meet development schedules.5 However, despite these risks, most studies have found a strong positive relationship between speed and the commercial success of new products.6Controlling Development CostsSometimes a firm engages in an intense effort to develop a product that exceeds cus-tomer expectations and brings it to market early, only to find that its development costs have ballooned so much that it is impossible to recoup the development expenses even if the product is enthusiastically received by the market. This highlights the fact that development efforts must be not only effective, but also efficient. Later in the chapter, ways to monitor and control development costs are discussed.SEQUENTIAL VERSUS PARTLY PARALLEL DEVELOPMENT PROCESSESBefore the mid-1990s, most U.S. companies proceeded from one development stage to another in a sequential fashion (see Figure 11.1a). The process included a number of gates at which managers would decide whether to proceed to the next stage, send the project back to a previous stage for revision, or kill the project. Typically, R&D and marketing provided the bulk of the input in the opportunity identification and concept development stages, R&D took the lead in product design, and manufactur-ing took the lead in process design. According to critics, one problem with such a system emerges at the product design stage when R&D engineers fail to communicate directly with manufacturing engineers. As a result, product design proceeds without manufacturing requirements in mind. A sequential process has no early warning sys-tem to indicate that planned features are not manufacturable. Consequently, cycle time can lengthen as the project iterates back and forth between the product design and process design stages.7To shorten the development process and avoid time-consuming and costly iterations between stages of the development cycle, many firms have adopted a partly parallel development process, as shown in Figure 11.1b.8 Product design is initiated before partly parallel development processA development process in which some (or all) of the development activities at least partially overlap. That is, if activ-ity A would pre-cede activity B in a partly parallel development pro-cess, activity B might commence before activity A is completed.Final PDF to printer
sch87956_ch11_249-276.indd 255 11/12/18 10:32 AMChapter 11 Managing the New Product Development Process 255concept development is complete, and process design is begun long before product design is finalized, enabling much closer coordination between the different stages and minimizing the chance that R&D will design products that are difficult or costly to manufacture. This should eliminate the need for time-consuming iterations between design stages and shorten overall cycle time. One type of parallel development pro-cess, concurrent engineering, involves not only conducting the typical product development stages simultaneously but also takes into account downstream stages of a product’s lifecycle such as maintenance and disposal.Parallel development processes are not universally endorsed, however. In some situations, using a parallel development process can substantially increase the risks or costs of the development process. If, for example, variations in product design require significant changes to the process design, beginning process design before product design is finalized can result in costly rework of the production process. Such risks are especially high in markets characterized by rapid change and uncertainty.9 concurrent engineeringA design method in which stages of product devel-opment (e.g., concept develop-ment, product design, and process design) and planning for later stages of the product lifecycle (e.g., maintenance, disposal, and recycling) occur simultaneously.FIGURE 11.1Sequential versus Partly Parallel Development ProcessesSequential ProcessPartly Parallel Development ProcessOpportunityidentificationCommercialproductionProcessdesignProductdesignConceptdevelopmentCycletimeOpportunityidentificationCommercialproductionProcessdesignProductdesignConceptdevelopmentCycletime(a)(b)Final PDF to printer
256sch87956_ch11_249-276.indd 256 11/12/18 10:32 AMTheory in Action The Development of ZantacIn the 1970s, Glaxo Holdings PLC of Great Britain was one of the larger health care conglomerates in the world, known principally for its baby food, but it needed a new hit product to stimulate sales. While contemplat-ing research possibilities, the head of Glaxo’s research laboratory, David Jack, attended a lecture by James Black, a Nobel Prize–winning scientist and researcher for U.S.-based SmithKline Beecham. During the lecture, Black described a new possibility for treating ulcers that involved compounds called H2 blockers that would inhibit gastrointestinal cells from secreting acid. Jack was intrigued. Ulcers were a common problem, and thus represented a large market opportunity for an effec-tive solution. Jack began experimenting with different compounds in pursuit of a formula that would be safe and effective. Unfortunately, researchers at SmithKline Beecham beat Glaxo to the finish line, introducing Tagamet in 1977. Tagamet revolutionized ulcer treat-ment, and sales grew phenomenally.aDiscouraged but not thwarted, Jack’s team kept working. Other companies (including Merck and Eli Lilly) were also developing their own ulcer treatments, and Jack believed that beating them to market might still give the company a shot at a significant share. In that same year, the team came up with a compound based on ranitidine (Tagamet was based on a com-pound called cimetedine) that achieved the desired objectives. However, Jack realized that if Glaxo was going to beat Merck and Eli Lilly to market, it would need to radically shorten the typical 10-year testing period required to secure regulatory approval and bring the product to market. To achieve this, Jack pro-posed the first parallel development process used in the pharmaceutical industry. Instead of following the typical sequence of testing (e.g., from rats to monkeys, and from short-term toxicity to long-term toxicity), Jack proposed doing all of the tests concurrently.b This intensified development process could potentially cut the cycle time in half—to five years—however, it would also be expensive and risky. If the development efforts increased the research costs substantially, it would be much harder to recoup those expenses through sales of the drug.Fortunately for Jack’s team, Paul Girolami, Glaxo’s director of finance, chose to champion the project. Girolami argued that the company should be willing to risk its range of decently profitable products for one potentially sensational drug, stating, “Having all your eggs in one basket concentrates the mind because you had better make sure it is a good basket.”c Not only was he able to convince the company that it was worth investing in the shortened development process, but also insisted that the product be modified so that it could be taken once a day (Tagamet required twice-a-day use) and so that the product would have fewer side effects than Tagamet. These features would help differentiate Zantac as a superior product, and it was hoped they would enable Glaxo to take share away from SmithKline Beecham. The development process was successful, and the product was ready for launch in 1982. To recoup its development costs, Girolami chose a premium pricing strategy for the product (one-third higher than Tagamet), arguing that its advantages would warrant its additional cost. He also insisted that the product be launched globally in all major markets, and he set up a distribution alliance with Hoffman-LaRoche to speed up the product’s penetration of the U.S. market.Girolami’s strategies were successful, and by the end of the year, Zantac was stealing about 100,000 patients a month from Tagamet. By 1987, Zantac sales had exceeded Tagamet’s, and by 1991, Zantac became the world’s No. 1 selling prescription drug and the first drug ever to achieve $1 billion in U.S. sales.d Both David Jack and Paul Girolami were knighted, and Sir Paul Girolami was appointed chairman of Glaxo.ea A. Corsig, T. Soloway, and R. Stanaro, “Glaxo Holdings PLC: Zantac,” in New Product Success Stories, ed. R. Thomas (New York: John Wiley & Sons, Inc., 1995), pp. 242–52.b Ibid.c C. Kennedy, “Medicine Man to the World,” Director 46, no. 4 (1992), pp. 106–10.d “Anti-Ulcer Drugs: Too Much Acid,” The Economist 318, no. 7700 (1991), pp. 82–84.e Corsig, Soloway, and Stanaro, “Glaxo Holdings PLC: Zantac.”Final PDF to printer
sch87956_ch11_249-276.indd 257 11/12/18 10:32 AMChapter 11 Managing the New Product Development Process 257*Note: Stage-Gate® is a registered trademark of Stage-Gate International Inc. Furthermore, once process design has commenced, managers may be reluctant to alter the product design even if market testing reveals that the product design is suboptimal. It is precisely these risks that the stage-gate* process (discussed later in the chapter) attempts to minimize.PROJECT CHAMPIONSA number of studies on new product development have suggested that firms should assign (or encourage) a senior member of the company to champion a new product development project.10 Senior executives have the power and authority to support and fight for a project. They can facilitate the allocation of human and capital resources to the development effort, ensuring that cycle time is not extended by resource constraints, and help ensure that the project can sustain the necessary momentum to surmount the hurdles that inevitably will arise.11 A senior project champion also can stimulate communication and cooperation between the different functional groups involved in the development process. Given that interfunctional communication and cooperation are necessary both to compress cycle time and to achieve a good fit between product attributes and customer requirements, the use of executive sponsors can improve the effectiveness of the development process. As of 2001, 68 percent of North American firms, 58 percent of European firms, and 48 percent of Japanese firms reported using senior managers to champion new product development projects.12 An example of a successful use of project championing is described in the accompanying Theory in Action: The Development of Zantac.Risks of ChampioningVigorous project championing, however, also has its risks. A manager’s role as champion may cloud judgment about the true value of the project. Optimism is the norm in prod-uct development—surveys indicate a systematic upward bias in estimates of future cash flows from a project.13 In the role of champion, this optimism is often taken to extreme levels. Managers may fall victim to escalating commitment and be unable (or unwilling) to admit that a project should be killed even when it is clear to many others in the orga-nization that the project has gone sour, or the factors driving the project’s original value are no longer relevant. While it is common to read stories about projects that succeed against all odds because of the almost fanatical zeal and persistence of their champions, bankruptcy courts are full of companies that should have been less zealous in pursuing some projects. Managers who have invested their reputations and years of their lives in development projects may find it very difficult to cut their losses, in much the same way that individuals tend to hold losing stocks much longer than they should due to the temptation to try to recoup what they have lost. Though the champion’s seniority is an asset in gaining access to resources and facilitating coordination, this same seniority may also make others in the firm unwilling to challenge the project champion even if it has become apparent that the project’s expected value has turned negative.14Firms may benefit from also developing “antichampions” who can play the role of devil’s advocate. Firms should also encourage a corporate culture open to the Final PDF to printer
sch87956_ch11_249-276.indd 258 11/12/18 10:32 AM258 Part Three Implementing Technological Innovation StrategyResearch Brief Five Myths about Product ChampionsStephen Markham and Lynda Aiman-Smith argue that a number of myths have become widely accepted about new product champions. While Markham and Aiman-Smith believe that product champions are critical to new product development, they also argue that for product champions to be effective, their role in the development process must be completely understood. Markham and Aiman-Smith conducted a systematic review of the theoretical and empirical literature on product champions and identified five popular myths: Myth 1: Projects with champions are more likely to be successful in the market. Markham and Aiman-Smith’s review of the empirical data on use of project champions found that projects with champions were just as likely to be market failures as market successes. Markham and Aiman-Smith point out that while champions may improve the likelihood of a project being completed, the factors determin-ing its market success are often beyond the champion’s control.a Myth 2: Champions get involved because they are excited about the project, rather than from self-interest. Markham and Aiman-Smith report that empirical evidence suggests champions are more likely to support projects that will benefit the champion’s own department.b Myth 3: Champions are more likely to be involved with radical innovation projects. Empirical evidence from multiple large sample studies indicates that champions were equally likely to be involved with radical versus incremental innovation projects. Myth 4: Champions are more likely to be from high (or low) levels in the organization. Markham and Aiman-Smith argue that there are myths about both high-level and low-level managers being more likely to be product champions. Though stories abound featur-ing prominent senior managers supporting projects, as do stories featuring low-level champions fighting vigorously for a project’s success, empirical evidence suggests that champions may arise from any level in the organization. (Note that this research does not indicate champions from all levels of the firm are equally effective.) Myth 5: Champions are more likely to be from marketing. Markham and Aiman-Smith argue that while anecdotal evidence may more often emphasize champions who have mar-keting backgrounds, an empirical study of 190  champions found that champions arose from many functions of the firm. Specifically, the study found that 15 percent of champions were from R&D, 14 percent were from market-ing, 7  percent were from production and opera-tions, and 6 percent were general managers. Interestingly, 8 percent of champions were potential users of the S. Markham, S. Green, and R. Basu, “Champions and Antagonists: Relationships with R&D Project Characteris-tics and Management,” Journal of Engineering and Tech-nology Management 8 (1991), pp. 217–42; S. Markham and A. Griffin, “The Breakfast of Champions: Associations between Champions and Product Development Environ-ments, Practices, and Performance,” The Journal of Prod-uct Innovation Management 15 (1998), pp. 436–54; and S. Markham, “Corporate Championing and Antagonism as Forms of Political Behavior: An R&D Perspective,” Organi-zation Science 11 (2000), pp. 429–47.b Markham, “Corporate Championing and Antagonism as Forms of Political Behavior.”c D. Day, “Raising Radicals: Different Processes for Cham-pioning Innovative Corporate Ventures,” Organization Science 5 (1994), pp. 148–72.expression of dissenting opinion, and champions should be encouraged to justify their projects on the basis of objective criteria, without resorting to force of personality.15 The accompanying Research Brief describes five myths that have become widely accepted about project champions.Final PDF to printer
sch87956_ch11_249-276.indd 259 11/23/18 08:10 AMChapter 11 Managing the New Product Development Process 259INVOLVING CUSTOMERS AND SUPPLIERS IN THE DEVELOPMENT PROCESSAs mentioned previously, many products fail to produce an economic return because they do not fulfill customer requirements for performance and price, or because they take too long to bring to market. Both of these problems can be reduced by involving customers and suppliers in the development process.Involving CustomersFirms often make decisions about projects on the basis of financial considerations and level of production and technical synergy achieved by the new product proposal rather than on marketing criteria. This can lead to an overemphasis on incremental product updates that closely fit existing business activities.16 The screening decision should focus instead on the new product’s advantage and superiority to the consumer, and the growth of its target market.17 The end customer is often the one most able to identify the maximum performance capabilities and minimum service requirements of a new product. Including the end customer in the actual development team or design-ing initial product versions and encouraging user extensions can help the firm focus its development efforts on projects that better fit customer needs.18 Distributors can also be valuable partners in the new product development process. These organiza-tions will often be the first to know who is buying the product, how they are using it, and be the first to hear of problems with the product or suggestions for how it might be improved.19Customers may be involved in the new product development process as an informa-tion source, or as actual co-developers of a new product.20 Many firms use beta testing to get customer input early in the development process. A beta version of a product is an early working prototype of a product released to users for testing and feedback. Beta versions also enable a firm to signal the market about its product features before the product reaches the commercial production stage. Agile development processes (that are now often used in software development) take this approach even further. In agile development, the product is divided into many smaller features or functional-ities, and these are rapidly developed into minimum viable products and presented to the customer for feedback, enabling rapid incremental adaptation. Other firms involve customers in the new product development process in even more extensive ways, such as enabling customers to co-create the end product (this is discussed more in the sec-tion below on crowdsourcing).Some studies suggest that firms should focus on the input of lead users in their development efforts rather than a large sample of customers. Lead users are those who face the same needs of the general marketplace but face them months or years earlier than the bulk of the market, and expect to benefit significantly from a solu-tion to those needs.21 According to a survey by the Product Development & Manage-ment Association, on average, firms report using the lead user method to obtain input into 38 percent of the projects they undertake. Not surprisingly, when customers help co-create an innovation, the resulting innovations tend to better fit their needs or expec-tations.22 More detail on how firms use lead users is provided in the accompanying Theory in Action section: The Lead User Method of Product Concept Development.agile developmentA process com-monly used in software whereby the overall product is broken down into smaller indepen-dent pieces that are worked on by autonomous, self-organizing teams. Features are developed and presented to customers quickly so that the overall product can be rapidly and continuously adapted.lead usersCustomers who face the same general needs of the marketplace but are likely to experience them months or years earlier than the rest of the market and stand to benefit dispro-portionately from solutions to those needs.Final PDF to printer
260sch87956_ch11_249-276.indd 260 11/12/18 10:32 AMHilti AG, a European manufacturer of construction components and equipment, turned to the lead user method in its development of a pipe hanger (a steel support that fastens pipes to walls or ceilings of build-ings). The firm first used telephone interviews to iden-tify customers who had lead user characteristics (were ahead of market trends and stood to benefit dispropor-tionately from the new solution). The lead users were invited to participate in a three-day product concept generation workshop to develop a pipe hanging sys-tem that would meet their needs. At the end of the workshop, a single pipe hanger design was selected as the one that best met all the lead users’ objectives. The company then presented this design to 12 routine users (customers who were not lead users but who had a long, close relationship with Hilti). Ten of the 12 routine users preferred the new design to previously available solutions, and all but one of the 10 indicated they would be willing to pay a 20 percent higher price for the product. Not only was the project successful, but the lead user method was also faster and cheaper than the conventional market research methods the firm had used in the past to develop its product con-cepts. Hilti’s typical process took 16 months and cost $100,000, but the lead user method took 9 months and cost $51,000.Source: C. Herstatt and E. von Hippel, “Developing New Prod-uct Concepts via the Lead User Method: A Case Study in a Low-Tech Field,” Journal of Product Innovation Management 9 (1992), pp. 213–21.Theory in Action The Lead User Method of Product Concept DevelopmentInvolving SuppliersMuch of the same logic behind involving customers in the new product development process also applies to involving suppliers. By tapping into the knowledge base of its suppliers, a firm expands its information resources. Suppliers may be actual members of the product team or consulted as an alliance partner. In either case, they can contrib-ute ideas for product improvement or increased development efficiency. For instance, a supplier may be able to suggest an alternative input (or configuration of inputs) that would achieve the same functionality but at a lower cost. Additionally, by coordinat-ing with suppliers, managers can help to ensure that inputs arrive on time and that necessary changes can be made quickly to minimize development time.23 Consistent with this argument, research has shown that many firms produce new products in less time, at a lower cost, and with higher quality by incorporating suppliers in integrated product development efforts.24Boeing’s development of the 777 involved both customers and suppliers on the new product development team; United employees (including engineers, pilots, and flight attendants) worked closely with Boeing’s engineers to ensure that the airplane was designed for maximum functionality and comfort. Boeing also included General Electric and other parts suppliers on the project team, so that the engines and the body of the airplane could be simultaneously designed for maximum compatibility.CrowdsourcingFirms can also open up an innovation task by directing an innovation challenge to third parties such as the general public, or specific, targeted groups of innovators from different networks. Sometimes firms work with third parties directly, and other crowdsourcingA distributed problem-solving model whereby a design problem or production task is presented to a group of people who voluntarily contribute their ideas and effort in exchange for compensation, intrinsic rewards, or a combination thereof.Final PDF to printer
sch87956_ch11_249-276.indd 261 11/12/18 10:32 AMChapter 11 Managing the New Product Development Process 261times they use a professional crowdsourcing service provider with their own net-work of innovators. For example, one professional crowdsourcing service provider, NineSigma, manages innovation challenges using a network of more than two  million scientists and engineers globally. Similarly, Topcoder helps firms access a com-munity of more than one million software coders. Some of these service providers (such as InnoCentive) operate their service as a closed network where the firm seek-ing the innovation does not know the details of the solution provider. Others (such as NineSigma) operate open networks where the firm seeking the innovation solution can see all the solution proposals submitted, as well as all contact details of all solution providers that submitted a response to the challenge.Crowdsourcing challenges typically go through a four step process: 1. Need translation. A clear, concise, and compelling need statement is articulated that reduces industry jargon to a minimum, and that brings the challenge down to its most basic science. For example, NineSigma helped a client seeking ways to reduce wrinkles in shirts coming out of a dryer by producing a statement that read: “Our client is seeking ways to reduce surface tension of an organic material.” The advantage of such a statement is that the specific application is removed, which invites interest from solution providers from seemingly unrelated industries. In this example, a professor doing integrated circuit research had developed a special polymer that was the solution most favored by the client. The need statement is usually a short one- to two-page document, often called a Request for Proposal. Andy Zynga of NineSigma notes, “It is very important to have a very clean and concise need statement to trigger interest. There may be a temptation to put two needs into one statement, but that is highly discouraging to solution providers and will reduce the chances of success.”25 2. Connecting. The innovation challenge must be broadcast to the network of poten-tial solution providers that have been selected as most suitable to respond. 3. Evaluation/Selection. Submitted proposals get an in-depth review, and the most interesting solution proposals get selected and collated in the form of a report. 4. Acquisition. The firm engages with the solution provider and negotiates an agree-ment to transfer knowledge, a license, patent, and so on. This usually involves a monetary or other compensation scheme. It may also be necessary to adapt the incoming solution to the specific needs of the firm.Thousands of companies and many public bodies have used crowdsourcing to solve challenges that seemed almost impossible to solve. For example, reducing plastics in our oceans, or addressing the opioid crisis are “Grand Challenges” that are being tack-led with crowdsourcing approaches right now.People participate in crowdsourcing for a variety of reasons that often do not include monetary rewards. For example, Ben & Jerry’s asked its customers to invent new vari-eties of ice cream flavors—the submitters of the best flavors were given a trip to the Dominican Republic to see a sustainable fair trade cocoa farm. However, individuals also often participate for the sheer excitement and challenge of solving the problem,26 or for social or reputational benefits.27 For example, Fiat Brazil used crowdsourcing to develop a new concept car called the Fiat Mio (“My Fiat”). Fiat created a Web site inviting people to create the car of the future. More than 17,000 people from around Final PDF to printer
sch87956_ch11_249-276.indd 262 11/12/18 10:32 AM262 Part Three Implementing Technological Innovation Strategythe world submitted over 11,000 ideas—and not just in the design. Participants were invited to contribute solutions at every stage of the development process, including solving problems related to fuel efficiency and production. Participants received no rewards from their participation other than the pleasure they derived from interacting with Fiat and with each other, and the satisfaction they felt at having their ideas incor-porated into the car. Hundreds of Fiat Mio’s co-creators turned up at the unveiling of the car at a Sao Paulo motor show.TOOLS FOR IMPROVING THE NEW PRODUCT DEVELOPMENT PROCESSSome of the most prominent tools used to improve the development process include stage-gate processes, quality function deployment (“house of quality”), design for man-ufacturing, failure modes and effects analysis, and computer-aided design/computer-aided manufacturing. Using the available tools can greatly expedite the new product development process and maximize the product’s fit with customer requirements.Stage-Gate ProcessesAs discussed in a previous section, escalating commitment can lead managers to support projects long after their expected value has turned negative, and the cost of pushing bad projects forward can be very high. To help avoid this, many managers and researchers suggest implementing tough go/kill decision points in the product development process. The most widely known development model incorporating such go/kill points is the stage-gate process developed by Robert G. Cooper.28 The stage-gate process provides a blueprint for moving projects through different stages of devel-opment. Figure 11.2 shows a typical stage-gate process.At each stage, a cross-functional team of people (led by a project team leader) undertakes parallel activities designed to drive down the risk of a development project. At each stage of the process, the team is required to gather vital technical, market, and financial information to use in the decision to move the project forward (go), abandon the project (kill), hold, or recycle the project.In Stage 1, the team does a quick investigation and conceptualization of the project. In Stage 2, the team builds a business case that includes a defined product, its busi-ness justification, and a detailed plan of action for the next stages. In Stage 3, the team begins the actual design and development of the product, including mapping out the manufacturing process, the market launch, and operating plans. In this stage, the team also defines the test plans utilized in the next stage. In Stage 4, the team conducts the verification and validation process for the proposed new product, and its marketing and production. At Stage 5, the product is ready for launch, and full commercial pro-duction and selling commence.29Preceding each stage is a go/kill gate. These gates are designed to control the qual-ity of the project and to ensure that the project is being executed in an effective and efficient manner. Gates act as the funnels that cull mediocre projects. Each gate has three components: deliverables (these are the results of the previous stage and are the inputs for the gate review), criteria (these are the questions or metrics used to make go/kill decision pointsGates established in the develop-ment process where managers must evaluate whether or not to kill the project or allow it to proceed.Final PDF to printer
sch87956_ch11_249-276.indd 263 11/12/18 10:32 AMChapter 11 Managing the New Product Development Process 263the go/kill decision), and outputs (these are the results of the gate review process and may include a decision such as go, kill, hold, or recycle; outputs should also include an action plan for the dates and deliverables of the next gate).Because each stage of a development project typically costs more than the stage preceding it, breaking down the process into stages deconstructs the development investment into a series of incremental commitments. Expenditures increase only as uncertainty decreases. Figure 11.3 shows the escalation costs and cycle time for each stage of a typical development process in a manufacturing industry.Many companies have adapted the stage-gate process to more specifically meet the needs of their firm or industry. For example, while managers at Exxon were strong advocates of using a stage-gate process to track and manage development projects, they also felt that the standard five-stage system did not adequately address the needs of a company in which basic research was a primary component in generating inno-vations. Exxon managers created their own extended stage-gate system to include directed basic research. The resulting stage-gate system included two basic research stages (Stages A and B in Figure 11.4) and five applied research and development stages. In Stage A, the company identifies the potential business incentives and com-petitive advantages of an envisioned technology. The company then develops a basic research plan that establishes specific scientific deliverables, the methods of achieving FIGURE 11.2Typical Stage-Gate Process, from Idea to LaunchSource: R. G. Cooper, “Stage-Gate Idea to Launch System,” Wiley International Encyclopedia of Marketing: Product Innovation & Manage-ment 5, B. L. Bayus (ed.), (West Sussex UK: Wiley, 2011).Gate 1: Idea Screen Gate 2: Does idea justify more research? Gate 3: Is the business case sound? Gate 4: Should project be moved to external testing? Gate 5: Is product ready for commercial launch? STAGE 1: ScopingBrief, preliminary scoping of the project, utilizing easy-to-obtain information that enablesnarrowing the list of potential projects. DISCOVERY: Idea GenerationSTAGE 2: Build the Business CaseMore detailed research (both market and technical) to build business case: product definition,project justification, and plan for project.STAGE 3: DevelopmentDetailed product design, development, and testing. Plans are also developed for production and launch.STAGE 4: Testing & ValidationTesting of proposed new product and its production and marketing. May include production trials and trial selling.STAGE 5: LaunchFull production, marketing and selling commences.POST-LAUNCH REVIEWHow did we do versus projects? What did we learn?Final PDF to printer
sch87956_ch11_249-276.indd 264 11/12/18 10:32 AM264 Part Three Implementing Technological Innovation Strategythese deliverables, and the required resources. In Stage B, Exxon’s research division begins to execute the plan developed in Stage A, using scientific methods to generate leads for addressing the business opportunity. Stage 1 then identifies the best leads, using “proof-of-principle” assessments to establish whether the leads are feasible.30 Stages 2 through 5 proceed according to a typical stage-gate process.According to studies by the Product Development and Management Association, nearly 60 percent of firms (including IBM, Procter & Gamble, 3M, General Motors, and Corning) use some type of stage-gate process to manage their new product devel-opment process. Corning has made the process mandatory for all information system development projects, and Corning managers believe that the process enables them to better estimate the potential payback of any project under consideration. They also report that the stage-gate process has reduced development time, allows them to iden-tify projects that should be killed, and increases the ratio of internally developed prod-ucts that result in commercial projects.31FIGURE 11.3Escalation of Development Time and Costs by StageSource: Adapted from F. Buggie, “Set the ‘Fuzzy Front End’ in Concrete,” Research Technology Management 45, no. 4 (2002), pp. 11–14.StageTimeCost0.“Here’s an idea!”1.Formulate–describe and sketch1 week$1002.Conduct preliminary investigations2 weeks$1,0003.Design and define specifications1 month$10,0004A.Develop prototype and test4B.Market research4C.Strategic fit evaluation and NPV2 months$100,000risk analysis5A.Scale up, build pilot plant5B.Market test8 months$1 million6A.Build plant6B.Promote, launch, market16 months$10 millionTime28 MonthsCost$11,111,100FIGURE 11.4Exxon Research and Engineering’s Stage-Gate SystemStage AOpportunityIdentificationStage BEnablingScience &Idea GrowingGate AGate BStage 1LeadDefinitionStage 2Pre-DevelopmentAssessmentStage 3DevelopmentStage 4ValidationStage 5Commercial-izationGate 3Gate 2Gate 1Gate 4Final PDF to printer
sch87956_ch11_249-276.indd 265 11/12/18 10:32 AMChapter 11 Managing the New Product Development Process 265Quality Function Deployment (QFD)—The House of QualityQFD was developed in Japan as a comprehensive process for improving the com-munication and coordination among engineering, marketing, and manufacturing personnel.32 It achieves this by taking managers through a problem-solving process in a very structured fashion. The organizing framework for QFD is the “house of quality” (see Figure 11.5). The house of quality is a matrix that maps customer requirements against product attributes. This matrix is completed in a series of steps. 1. The team must first identify customer requirements. In Figure 11.5, market research has identified five attributes that customers value most in a car door: it is easy to open and close, it stays open on a hill, it does not leak in the rain, it isolates the occupant from road noise, and it protects the passengers in the event of crashes. 2. The team weights the customer requirements in terms of their relative importance from a customer’s perspective. This information might be obtained from focus group sessions or direct interaction with the customers. The weights are typically entered as percentages, so that the complete list totals 100 percent. 3. The team identifies the engineering attributes that drive the performance of the product—in this case, the car door. In Figure 11.5, four attributes are highlighted: the weight of the door, the stiffness of the door hinge (a stiff hinge helps the door stay open on a hill), the tightness of the door seal, and the tightness of the window seal. 4. The team enters the correlations between the different engineering attributes to assess the degree to which one characteristic may positively or negatively affect another. The correlations are entered into the matrix that creates the peaked roof FIGURE 11.5Quality Function Deployment House of Quality for a Car Door EngineeringAttributesImportanceWeight ofDoorStiffness ofHingeTightness ofDoor and SealTightness ofWindow SealCompetitor ACompetitor BEvaluation ofNew DesignEasy to Open159374Stays Open on Hill103967Does Not Leak359976Isolates Occupantfrom Road Noise2019947CustomerRequirementsCrash Protection 20947Relative Importance of Each EngineeringAttribute365135495495Design TargetsCorrelation betweenTechnical Specifications–Final PDF to printer
sch87956_ch11_249-276.indd 266 11/12/18 10:32 AM266 Part Three Implementing Technological Innovation Strategyof the house. In this case, the negative sign between door weight and hinge stiff-ness indicates that a heavy door reduces the stiffness of the hinge. 5. The team fills in the body of the central matrix. Each cell in the matrix indicates the relationship between an engineering attribute and a customer requirement. A number (in this example, one, three, or nine) is placed in the cell located at the intersection of each row (customer requirements) with each column (engineering attributes), which represents the strength of relationship between them. A value of one indicates a weak relationship, a three indicates a moderate relationship and a nine indicates a strong relationship. The cell is left blank if there is no relation-ship. The ease of opening the door, for example, is strongly related to the weight of the door and moderately related to the stiffness of the door hinge, but is not related to the tightness of the door seal or window seal. 6. The team multiplies the customer importance rating of a feature by its relationship to an engineering attribute (one, three, or nine). These numbers are then summed for each column, yielding a total for the relative importance of each engineering attribute. For example, the stiffness of the hinge influences how easy the door is to open, and whether the door stays open on a hill. Thus to calculate the rela-tive importance of the stiffness of the hinge, the team multiplies the customer importance rating of how easy the door is to open by its relationship to the stiff-ness of the hinge (15 × 3 = 45), then multiplies the customer importance rating of the door staying open on a hill by its relationship to the stiffness of the hinge (10 × 9 = 90), and then adds these together for the total relative importance of the hinge stiffness (45 + 90 = 135). These scores indicate that the tightness of the door and window seals is the most important engineering attribute, followed by the weight of the door. 7. The team evaluates the competition. A scale of one to seven is used (one indicat-ing a requirement is not addressed, and seven indicating a requirement is com-pletely satisfied) to evaluate the competing products (in this case A and B) on each of the customer requirements. These scores go in the right-hand “room” of the house of quality. 8. Using the relative importance ratings established for each engineering attribute and the scores for competing products (from step 7), the team determines tar-get values for each of the design requirements (e.g., the door’s optimal weight in pounds). 9. A product design is then created based on the design targets from step 8. The team then evaluates the new design that was created. The team assesses the degree to which each of the customer requirements has been met, entering a one to seven in the far right column of the house of quality, permitting it to compare the new design with the scores of the competing products.The great strength of the house of quality is that it provides a common language and framework within which the members of a project team may interact. The house of qual-ity makes the relationship between product attributes and customer requirements very clear, it focuses on design trade-offs, it highlights the competitive shortcomings of the company’s existing products, and it helps identify what steps need to be taken to improve them. The house of quality is used in settings as diverse as manufacturing, construction, Final PDF to printer
sch87956_ch11_249-276.indd 267 11/12/18 10:32 AMChapter 11 Managing the New Product Development Process 267police service, and educational curriculum design.33 Advocates of QFD maintain that one of its most valuable characteristics is its positive effect upon cross-functional com-munication and, through that, upon cycle time and the product/customer fit.34Design for ManufacturingAnother method of facilitating integration between engineering and manufacturing, and of bringing issues of manufacturability into the design process as early as pos-sible, is the use of design for manufacturing methods (DFM). Like QFD, DFM is simply a way of structuring the new product development process. Often this involves articulating a series of design rules. Figure 11.6 summarizes a set of commonly used design rules, along with their expected impact on performance.As shown in Figure 11.6, the purpose of such design rules is typically to reduce costs and boost product quality by ensuring that product designs are easy to manufac-ture. The easier products are to manufacture, the fewer the assembly steps required, the higher labor productivity will be, resulting in lower unit costs. DEKA Research makes a point of bringing manufacturing into the design process early, because as founder Dean Kamen points out, “It doesn’t make sense to invent things that ultimately are made of unobtanium or expensium.”35 In addition, designing products to be easy to manufacture decreases the likelihood of making mistakes in the assembly process, resulting in higher product quality.The benefits of adopting DFM rules can be dramatic. Considering manufacturing at an early stage of the design process can shorten development cycle time. In addi-tion, by lowering costs and increasing product quality, DFM can increase the product’s fit with customer requirements. For example, when NCR used DFM techniques to redesign one of its electronic cash registers, it reduced assembly time by 75 percent, reduced the parts required by 85 percent, utilized 65 percent fewer suppliers, and reduced direct labor time by 75 percent.36Failure Modes and Effects AnalysisFailure modes and effects analysis (FMEA) is a method by which firms identify poten-tial failures in a system, classify them according to their severity, and put a plan into FIGURE 11.6Design Rules for Fabricated Assembly ProductsSource: Adapted from M. A. Schilling and C. W. L. Hill, “Managing the New Product Development Process,” Academy of Management Execu-tive, vol. 12, no. 3, pp. 67–81.Design RuleImpact on PerformanceMinimize the number of partsSimplifies assembly; reduces direct labor; reduces material handling and inventory costs; boosts product qualityMinimize the number of part numbers (use common parts across product family)Reduces material handling and inventory costs; improves economies of scale (increases volume through commonalty)Eliminate adjustmentsReduces assembly errors (increases quality); allows for automation; increases capacity and throughputEliminate fastenersSimplifies assembly (increases quality); reduces direct labor costs; reduces squeaks and rattles; improves durability; allows for automationEliminate jigs and fixturesReduces line changeover costs; lowers required investmentFinal PDF to printer
sch87956_ch11_249-276.indd 268 11/12/18 10:32 AM268 Part Three Implementing Technological Innovation Strategyplace to prevent the failures from happening.37 First, potential failure modes are iden-tified. For example, a firm developing a commercial aircraft might consider failure modes such as “landing gear does not descend,” or “communication system experi-ences interference”; a firm developing a new line of luxury hotels might consider fail-ure modes such as “a reservation cannot be found” or “guest experiences poor service by room service staff.” Potential failure modes are then evaluated on three criteria of the risk they pose: severity, likelihood of occurrence, and inability of controls to detect it. Each criterion is given a score (e.g., one for lowest risk, five for highest risk), and then a composite risk priority number is created for each failure mode by multiply-ing its scores together (i.e., risk priority number = severity × likelihood of occur-rence × inability of controls to detect). The firm can then prioritize its development efforts to target potential failure modes that pose the most composite risk. This means that rather than focus first on the failure modes that have the highest scores for sever-ity of risk, the firm might find that it should focus first on failure modes that have less severe impacts, but occur more often and are less detectable.FMEA was originally introduced in the 1940s by the U.S. Armed Forces and was initially adopted primarily for development projects in which the risks posed by fail-ure were potentially very severe. For example, FMEA was widely used in the Apollo Space Program in its mission to put a man on the moon, and was adopted by Ford after its extremely costly experience with its Pinto model (the location of the gas tank in the Pinto made it exceptionally vulnerable to collisions, leading to fire-related deaths; Ford was forced to recall the Pintos to modify the fuel tanks, and was forced to pay out record-breaking sums in lawsuits that resulted from accidents).38 Soon, however, FMEA was adopted by firms in a wide range of industries, including many types of manufacturing industries, service industries, and health care. A recent PDMA study found that firms report using FMEA in 40 percent of the projects they undertake.39Computer-Aided Design/Computer-Aided Engineering/ Computer-Aided ManufacturingComputer-aided design (CAD) and computer-aided engineering (CAE) are the use of computers to build and test product designs. Rapid advances in computer technology have enabled the development of low-priced and high-powered graphics-based work-stations. With these workstations, it is now possible to achieve what could previously be done only on a supercomputer: construct a three-dimensional “working” image of a product or subassembly. CAD enables the creation of a three-dimensional model; CAE makes it possible to virtually test the characteristics (e.g., strength, fatigue, and reliability) of this model. The combination enables product prototypes to be devel-oped and tested in virtual reality. Engineers can quickly adjust prototype attributes by manipulating the three-dimensional model, allowing them to compare the character-istics of different product designs. Eliminating the need to build physical prototypes can reduce cycle time and lower costs as illustrated in the accompanying Theory in Action: Computer-Aided Design of an America’s Cup Yacht. Visualization tools and 3-D software are even being used to allow nonengineering customers to see and make minor alterations to the design and materials.Computer-aided manufacturing (CAM) is the implementation of machine- controlled processes in manufacturing. CAM is faster and more flexible than traditional Final PDF to printer
269sch87956_ch11_249-276.indd 269 11/12/18 10:32 AMTeam New Zealand discovered the advantages of using sophisticated computer-aided-design techniques in designing the team’s 1995 America’s Cup yacht. The team had traditionally relied on developing smaller-scale prototypes of the yacht and testing the models in a water tank. However, such prototypes took months to fabricate and test and cost about $50,000 per prototype. This greatly limited the number of design options the team could consider. However, by using computer-aided-design technologies, the team could consider many more design specifications more quickly and inexpensively. Once the basic design is programmed, variations on that design can be run in a matter of hours, at little cost, enabling more insight into design trade-offs. Computer-aided design also avoided some of the problems inherent in scaling up prototypes (some features of the scaled-down prototype boats would affect the flow of water differently from full-scale boats, resulting in inaccurate results in prototype testing). The team would still build prototypes, but only after considering a much wider range of design alternatives using computer-aided-design methods. As noted by design team member Dave Egan,Instead of relying on a few big leaps, we had the abil-ity to continually design, test, and refine our ideas. The team would often hold informal discussions on design issues, sketch some schematics on the back of a beer mat, and ask me to run the numbers. Using traditional design methods would have meant wait-ing months for results, and by that time, our thinking would have evolved so much that the reason for the experiment would long since have been forgotten.Source: M. Iansiti and A. MacCormack, “Team New Zealand,” Harvard Business School case no. 9-697-040, 1997.Theory in Action Computer-Aided Design of an America’s Cup Yachtmanufacturing.40 Computers can automate the change between different product varia-tions and allow for more variety and customization in the manufacturing process.A recent incarnation of computer-aided manufacturing is three-dimensional printing (also known as additive manufacturing), whereby a design developed in a computer-aided design program is literally printed by laying down thin horizontal cross sections of material until the model is complete. Unlike traditional methods of constructing a model, which typically involve machining a mold that can take several days to complete, three-dimensional printing can generate a model in a few hours. By 2018, three-dimensional printing was being used to create products as diverse as food, clothing, jewelry, solid-state batteries, and even titanium landing gear brackets for supersonic jets.41 Biotechnology firms were even using three-dimensional printing for use in creating organs by depositing layers of living cells onto a gel medium.42 This method has recently begun rapidly replacing injection molding for products that are produced in relatively small quantities.TOOLS FOR MEASURING NEW PRODUCT DEVELOPMENT PERFORMANCEMany companies use a variety of metrics to measure the performance of their new product development process. In addition to providing feedback about a particular new product, such performance assessments help the company improve its innovation three- dimensional printingA method whereby a design developed in a computer aided design program is printed in three dimensions by laying down thin strips of material until the model is complete.Final PDF to printer
270sch87956_ch11_249-276.indd 270 11/12/18 10:32 AMAt Microsoft, almost all projects receive either a post-mortem discussion or a written postmortem report to ensure that the company learns from each of its devel-opment experiences. These postmortems tend to be extremely candid and can be quite critical. As noted by one Microsoft manager, “The purpose of the document is to beat yourself up.” Another Microsoft manager notes that part of the Microsoft culture is to be very self-critical and never be satisfied at getting things “halfway right.” A team will spend three to six months putting together a postmortem document that may number anywhere from less than 10 pages to more than 100. These post-mortem reports describe the development activities and team, provide data on the product size (e.g., lines of code) and quality (e.g., number of bugs), and evaluate what worked well, what did not work well, and what the group should do to improve on the next project. These reports are then distributed to the team members and to senior executives throughout the organization.Source: M. A. Cusumano and R. W. Selby, Microsoft Secrets (New York: Free Press, 1995).Theory in Action Postmortems at Microsoftstrategy and development processes. For example, evaluating the performance of its new product development process may provide insight into which core competencies the firm should focus on, how projects should be selected, whether or not it should seek collaboration partners, how it should manage its development teams, and so on.Both the metrics used by firms and the timing of their use vary substantially across firms. In a survey by Goldense and Gilmore, 45 percent of companies reported using periodic reviews at calendar periods (e.g., monthly or weekly) and at predetermined mile-stones (e.g., after product definition, after process design, post launch, etc.).43 Microsoft, for example, uses postmortems to measure new product development performance, as described in the accompanying Theory in Action: Postmortems at Microsoft. Measures of the success of the new product development process can help management to: ∙ Identify which projects met their goals and why. ∙ Benchmark the organization’s performance compared to that of competitors or to the organization’s own prior performance. ∙ Improve resource allocation and employee compensation. ∙ Refine future innovation strategies.44Multiple measures are important because any measure used singly may not give a fair representation of the effectiveness of the firm’s development process or its overall innovation performance. Also, the firm’s development strategy, industry, and other environmental circumstances must be considered when formulating measures and interpreting results. For example, a firm whose capabilities or objectives favor development of breakthrough projects may experience long intervals between product introductions and receive a low score on measures such as cycle time or percent of sales earned on projects launched within the past five years, despite its success at its strategy. Conversely, a firm that rapidly produces new generations of products may receive a high score on such measures even if it finds its resources are overtaxed and its projects are overbudget. Additionally, the success rate of new product develop-ment can vary significantly by industry and project type. Some authors argue that even firms with excellent new product development processes should not expect to have a greater than 65 percent success rate for all new products launched.45Final PDF to printer
sch87956_ch11_249-276.indd 271 11/12/18 10:32 AMChapter 11 Managing the New Product Development Process 271New Product Development Process MetricsMany firms use a number of methods to gauge the effectiveness and efficiency of the development process. These measures capture different dimensions of the firm’s ability to successfully shepherd projects through the development process. To use such methods, it is important to first define a finite period in which the measure is to be applied in order to get an accurate view of the company’s current performance; this also makes it easier for the manager to calculate a response. The following questions can then be asked: 1. What was the average cycle time (time to market) for development projects? How did this cycle time vary for projects characterized as breakthrough, platform, or derivative? 2. What percentage of development projects undertaken within the past five years met all or most of the deadlines set for the project? 3. What percentage of development projects undertaken within the past five years stayed within budget? 4. What percentage of development projects undertaken within the past five years resulted in a completed product?Overall Innovation PerformanceFirms also use a variety of methods to assess their overall performance at innova-tion. These measures give an overall view of the bang for the buck the organization is achieving with its new product development processes. Such measures include: 1. What is the firm’s return on innovation? (This measure assesses the ratio of the firm’s total profits from new products to its total expenditures, including research and development costs, the costs of retooling and staffing production facilities, and initial commercialization and marketing costs.) 2. What percentage of projects achieve their sales goals? 3. What percentage of revenues are generated by products developed within the past five years? 4. What is the firm’s ratio of successful projects to its total project portfolio? 1. Successful new product development requires achieving three simultaneous objec-tives: maximizing fit with customer requirements, minimizing time to market, and controlling development costs. 2. Many firms have adopted parallel development processes to shorten the development cycle time and to increase coordination among functions such as R&D, marketing, and manufacturing. 3. Many firms have also begun using project champions to help ensure a project’s momentum and improve its access to key resources. Use of champions also has its risks, however, including escalating commitment and unwillingness of others in the organization to challenge the project. 4. Involving customers in the development process can help a firm ensure that its new products match customer expectations. In particular, research indicates that involving lead users can help the firm understand what needs are most important Summary of ChapterFinal PDF to printer
sch87956_ch11_249-276.indd 272 11/12/18 10:32 AM272 Part Three Implementing Technological Innovation Strategyto customers, helping the firm to identify its development priorities. Involving lead users in the development process can also be faster and cheaper than involv-ing a random sample of customers in the development process. 5. Many firms use beta testing to get customer feedback, exploit external develop-ment of the product, and signal the market about the firm’s upcoming products. 6. Firms can also involve suppliers in the development process, helping to minimize the input cost of a new product design and improving the likelihood that inputs are of appropriate quality and arrive on time. 7. Stage-gate processes offer a blueprint for guiding firms through the new product development process, providing a series of go/kill gates where the firm must decide if the project should be continued and how its activities should be prioritized. 8. Quality function deployment can be used to improve the development team’s understanding of the relationship between customer requirements and engineering attributes. It can also be a tool for improving communication between the various functions involved in the development process. 9. Failure Modes and Effects Analysis can be used to help firms prioritize their development efforts in order to reduce the likelihood of failures that will have the greatest impact on the quality, reliability, and safety of a product or process. 10. Design for manufacturing and CAD/CAM are additional tools development teams can use to reduce cycle time, improve product quality, and control development costs. 11. Firms should use a variety of measures of their new product development effectiveness and overall innovation performance to identify opportunities for improving the new product development process and improving the allocation of resources. 1. What are some of the advantages and disadvantages of a parallel development pro-cess? What obstacles might a firm face in attempting to adopt a parallel process? 2. Consider a group project you have worked on at work or school. Did your group use mostly sequential or parallel processes? 3. Name some industries in which a parallel process would not be possible or effective. 4. What kinds of people make good project champions? How can a firm ensure that it gets the benefits of championing while minimizing the risks? 5. Is the stage-gate process consistent with suggestions that firms adopt parallel processes? What impact do you think using stage-gate processes would have on development cycle time and development costs? 6. What are the benefits and costs of involving customers and suppliers in the devel-opment process?Discussion QuestionsClassicsClark, K. B., and S. C. Wheelwright, Managing New Product and Process Develop-ment (New York: Free Press, 1993).Cooper, R., and E. J. Kleinschmidt, “New Product Processes at Leading Industrial Firms,” Industrial-Marketing-Management 20, no. 2 (1991), pp. 137–48.Suggested Further ReadingFinal PDF to printer
sch87956_ch11_249-276.indd 273 11/12/18 10:32 AMChapter 11 Managing the New Product Development Process 273Griffin, A., and J. R. Hauser, “Patterns of Communication Among Marketing, Engi-neering and Manufacturing,” Management Science 38 (1992), pp. 360–73.Loch, C., and S. Kavadias, Handbook of New Product Development Management. (Oxford, UK: Elsevier Ltd., 2008).Recent WorkChang, W., and S. A. Taylor, “The Effectiveness of Customer Participation in New Product Development: A Meta-Analysis.” Journal of Marketing, 80, no. 1 (2016), pp. 47–64.Cooper, R. G., “Agile-Stage-Gate Hybrids,” Research-Technology Management, 59 (2016), pp. 1, 21–29Lawson, B., D. Krause, and A. Potter, “Improving Supplier New Product Develop-ment Performance: The Role of Supplier Development.” Journal of Product Innova-tion Management 32 (2015), pp. 777–92.Piezunka, H., and L. Dahlander, “Distant Search, Narrow Attention: How Crowding Alters Organizations’ Filtering of Suggestions in Crowdsourcing,” Academy of Man-agement Journal, 58 (2015), pp. 856–880.Prpic, J., P. P. Shukla, J. H. Kietzmann, and I. P. McCarthy, “How to Work a Crowd: Developing Crowd Capital Through Crowdsourcing,” Business Horizons, 58 (2015), pp. 77–85. 1. E. Berggren and T. Nacher, “Introducing New Products Can Be Hazardous to Your Company: Use the Right New-Solutions Delivery Tools,” Academy of Management Executive 15, no. 3 (2001), pp. 92–101. 2. M. A. Schilling, “Technological Lockout: An Integrative Model of the Economic and Strategic Factors Driving Success and Failure,” Academy of Management Review 23 (1998), pp. 267–84; and W. B. Arthur, Increasing Returns and Path Dependence in the Economy (Ann Arbor: Uni-versity of Michigan Press, 1994). 3. A. Dhebar, “Speeding High-Tech Producer, Meet Balking Consumer,” Sloan Management Review, Winter 1996, pp. 37–49. 4. M. C. Crawford, “The Hidden Costs of Accelerated Product Development,” Journal of Product Innovation Management 9, no. 3 (1992), pp. 188–200. 5. G. Pacheco-de-Almeida and P. Zemsky, “The Creation and Sustainability of Competitive Advantage: Resource Accumulation with Time Compression Diseconomies,” mimeo, Stern School of Business, 2003. 6. E. J. Nijssen, A. R. Arbouw, and H. R. Commandeur, “Accelerating New Product Develop-ment: A Preliminary Empirical Test of a Hierarchy of Implementation,” Journal of Product Innovation Management 12 (1995), pp. 99–104; R. W. Schmenner, “The Merits of Mak-ing Things Fast,” Sloan Management Review, Fall (1988), pp. 11–17; A. Ali, R. Krapfel, and D. LaBahn, “Product Innovativeness and Entry Strategy: Impact on Cycle Time and Break-Even Time,” Journal of Product Innovation Management 12 (1995), pp. 54–69; and R.  Rothwell, “Successful Industrial Innovation: Critical Factors for the 1990s,” R&D Man-agement 22, no. 3 (1992), pp. 221–39.EndnotesFinal PDF to printer
sch87956_ch11_249-276.indd 274 11/12/18 10:32 AM274 Part Three Implementing Technological Innovation Strategy 7. A. Griffin, “Evaluating QFD’s Use in US Firms as a Process for Developing Products,” Journal of Product Innovation Management 9 (1992), pp. 171–87; and C. H. Kimzey, Summary of the Task Force Workshop on Industrial-Based Initiatives (Washington, DC: Office of the Assistant Secretary of Defense, Production and Logistics, 1987). 8. A. De Meyer and B. Van Hooland, “The Contribution of Manufacturing to Shortening Design Cycle Times,” R&D Management 20, no. 3 (1990), pp. 229–39; R. Hayes, S. G. Wheelwright, and K. B. Clark, Dynamic Manufacturing (New York: Free Press, 1988); R. G. Cooper, “The New Product Process: A Decision Guide for Managers,” Journal of Marketing Management 3 (1988), pp. 238–55; and H. Takeuchi and I. Nonaka, “The New Product Development Game,” Harvard Business Review, January–February (1986), pp. 137–46. 9. K. Eisenhardt and B. N. Tabrizi, “Accelerating Adaptive Processes: Product Innovation in the Global Computer Industry,” Administrative Science Quarterly 40 (1995), pp. 84–110; and C. Terwiesch and C. H. Loch, “Measuring the Effectiveness of Overlapping Development Activities,” Management Science 45 (1999), pp. 455–65. 10. B. J. Zirger and M. A. Maidique, “A Model of New Product Development: An Empirical Test,” Management Science 36 (1990), pp. 867–83; R. Rothwell, C. Freeman, A. Horley, P.  Jervis, A. B. Robertson, and J. Townsend, “SAPPHO Updates—Project SAPPHO, PHASE II,” Research Policy 3 (1974), pp. 258–91; A. H. Rubenstein, A. K. Chakrabarti, R. D. O’Keffe, W. E. Souder, and H. C. Young, “Factors Influencing Innovation Success at the Project Level,” Research Management, May (1976), pp. 15–20; F. A. Johne and P. A. Snelson, “Product Devel-opment Approaches in Established Firms,” Industrial Marketing Management 18 (1989), pp. 113–24; and Y. Wind and V. Mahajan, “New Product Development Process: A Perspective for Reexamination,” Journal of Product Innovation Management 5 (1988), pp. 304–10. 11. T. F. Gattiker and C. R. Carter, “Understanding project champions’ ability to gain intra- organizational commitment for environmental projects,” Journal of Operations Management 28 (2010), pp. 72–85. 12. E. Roberts, “Benchmarking Global Strategic Management of Technology,” Research Technol-ogy Management, March–April (2001), pp. 25–36. 13. E. Rudden, “The Misuse of a Sound Investment Tool,” Wall Street Journal, November 1, 1982. 14. M. Devaney, “Risk, Commitment, and Project Abandonment,” Journal of Business Ethics 10, no. 2 (1991), pp. 157–60. 15. Devaney, “Risk, Commitment, and Project Abandonment.” 16. F. A. Johne and P. A. Snelson, “Success Factors in Product Innovation,” Journal of Product Innovation Management 5 (1988), pp. 114–28; and F. W. Gluck and R. N. Foster, “Manag-ing Technological Change: A Box of Cigars for Brad,” Harvard Business Review 53 (1975), pp. 139–50. 17. R. G. Cooper, “Selecting Winning New Product Projects: Using the NewProd System,” Journal of Product Innovation Management 2 (1985), pp. 34–44. 18. J. E. Butler, “Theories of Technological Innovation as Useful Tools for Corporate Strategy,” Strategic Management Journal 9 (1988), pp. 15–29. 19. M. Restuccia, U. Brentani, and R. Legoux, “Product Life-Cycle Management and Distributor Contribution to New Product Development,” Journal of Product Innovation Management, 33 (2106), pp. 69–89. 20. A. S. Cui and F. Wu, “The Impact of Customer Involvement on New Product Development: Contingent and Substitutive Effects,” Journal of Product Innovation Management, 34 (2016), pp. 60–80. 21. C. Herstatt and E. von Hippel, “Developing New Product Concepts via the Lead User Method: A Case Study in a Low-Tech Field,” Journal of Product Innovation Management 9 (1992), pp. 213–21.Final PDF to printer
sch87956_ch11_249-276.indd 275 11/12/18 10:32 AMChapter 11 Managing the New Product Development Process 275 22. D. Mahr, A. Lievens, and V. Blazevic. “The value of customer cocreated knowledge during the innovation process.” Journal of Product Innovation Management 31 (2014), 599–615. 23. Asmus and Griffin found that firms that integrate their suppliers with engineering, manu-facturing, and purchasing gain cost reductions, shortened lead times, lowered development risks, and tightened development cycles. D. Asmus and J. Griffin, “Harnessing the Power of Your Suppliers,” McKinsey Quarterly, no. 3 (1993), pp. 63–79. Additionally, Bonaccorsi and Lipparini found that strategic alliances with suppliers lead to shorter product develop-ment cycles and better products, particularly in rapidly changing markets. A. Bonaccorsi and A.  Lipparini, “ Strategic Partnership in New Product Development: An Italian Case Study,” Journal of Product Innovation Management 11, no. 2 (1994), pp. 134–46. 24. L. Birou and S. Fawcett, “Supplier Involvement in New Product Development: A Comparison of US and European Practices,” Journal of Physical Distribution and Logistics Management 24, no. 5 (1994), pp. 4–15; and A. Ansari and B. Modarress, “Quality Function Deployment: The Role of Suppliers,” International Journal of Purchasing and Materials Management 30, no. 4 (1994), pp. 28–36. 25. Interview with Andy Zynga, former CEO of NineSigma, March 13, 2018 26. N. Franke and M. Schreier. “Why customers value self-designed products: The importance of process effort and enjoyment.” Journal of Product Innovation Management 27 (2010), pp. 1020–1031. 27. W. D. Hoyer, R. Chandy, M. Dorotic, M. Krafft, and S. S. Singh, “Consumer cocreation in new product development,” in Journal of Service Research 13 (2010), issue 3, 283–296. 28. R. Cooper and E. J. Kleinschmidt, “New Product Processes at Leading Industrial Firms,” Industrial-Marketing-Management 20, no. 2 (1991), pp. 137–48; and R. G. Cooper, “Doing It Right,” Ivey Business Journal 64, no. 6 (2000), pp. 54–61; and R.G. Cooper, “Stage-Gate Idea to Launch System,” Wiley International Encyclopedia of Marketing: Product Innovation & Management 5, B.L. Bayus (ed.), (West Sussex UK: Wiley, 2011). 29. R.G. Cooper, “Stage-Gate Idea to Launch System,” Wiley International Encyclopedia of Mar-keting: Product Innovation & Management 5, B.L. Bayus (ed.), (West Sussex UK: Wiley, 2011). 30. L. Y. Coyeh, P. W. Kamienski, and R. L. Espino, “Gate System Focuses on Industrial Basic Research,” Research Technology Management 41, no. 4 (1998), pp. 34–37. 31. A. LaPlante and A. E. Alter, “Corning, Inc: The Stage-Gate Innovation Process,” Computer-world 28, no. 44 (1994), p. 81. 32. J. J. Cristiano, J. K. Liker, and C. C. White, “Key Factors in the Successful Application of Qual-ity Function Deployment (QFD),” IEEE Transactions on Engineering Management 48, no. 1 (2001), p. 81. 33. I. Bier, “Using QFD to Construct a Higher Education Curriculum,” Quality Progress 34, no. 4 (2001), pp. 64–69; N. Eldin, “A Promising Planning Tool: Quality Function Deployment,” Cost Engineering 44, no. 3 (2002), pp. 28–38; and W. J. Selen and J. Schepers, “Design of Quality Service Systems in the Public Sector: Use of Quality Function Deployment in Police Services,” Total Quality Management 12, no. 5 (2001), pp. 677–87; J. A. Carnevalli and P. C. Miguel, “Review, analysis and classification of the literature on QFD—types of research, difficulties and benefits,” International Journal of Production Economics 114 (2008), pp. 737–54. 34. K. B. Clark and S. C. Wheelwright, Managing New Product and Process Development (New York: Free Press, 1993); J. R. Hauser and D. Clausing, “The House of Quality,” Harvard Business Review, May–June (1988), pp. 63–73; A. Griffin, “Evaluating QFD’s Use in US Firms as a Process for Developing Products,” Journal of Product Innovation Management 9 (1992), pp. 171–87; and A. Griffin and J. R. Hauser, “Patterns of Communication among Marketing, Engineering and Manufacturing,” Final PDF to printer
sch87956_ch11_249-276.indd 276 11/12/18 10:32 AM276 Part Three Implementing Technological Innovation Strategy 35. E. I. Schwartz, “The Inventor’s Play-Ground,” Technology Review 105, no. 8 (2002), pp. 68–73. 36. K. B. Clark and S. C. Wheelwright, Managing New Product and Process Development (New York: Free Press, 1993); J. R. Hauser and D. Clausing, “The House of Quality,” Harvard Business Review, May–June (1988), pp. 63–73; A. Griffin, “Evaluating QFD’s Use in US Firms as a Process for Developing Products,” Journal of Product Innovation Management 9 (1992), pp. 171–87; and A. Griffin and J. R. Hauser, “Patterns of Communication among Marketing, Engineering and Manufacturing,” Management Science 38 (1992), pp. 360–73. 37. S. Kumar, E. C. Aquino, and E. Anderson, “Application of a Process Methodology and a Stra-tegic Decision Model for Business Process Outsourcing,” Information Knowledge Systems Management 6 (2007), pp. 323–42; and J. W. Langford, Logistics: Principles and Applications (New York: McGraw-Hill, 1995). 38. L. P. Chao and K. Ishii, “Design Error Classification and Knowledge Management,” Journal of Knowledge Management Practice, May (2004); and P. Valdes-Dapena, “Tagged: 10 Cars with Bad Reputations,” (accessed April 23, 2009). 39. G. Barczak, A. Griffin, and K. B. Kahn, “Trends and Drivers of Success in NPD Practices: Results of the 2003 PDMA Best Practices Study,” Journal of Product Innovation Management 26 (2009), pp. 3–23. 40. M. R. Millson, S. P. Raj, and D. Wilemon, “A Survey of Major Approaches for Accelerating New Product Development,” Journal of Product Innovation Management 9 (1992), pp. 53–69. 41. “The printed World,” The Economist (2011), February 10, 2011; K. Lee, “Foodini 3D printer cooks up meals like the Star Trek food replicator,” (2013): December 9th; Fitzgerald, M. “With 3-D printing the shoe really fits.” MIT Sloan Management Review (2013), 15th. 42. J. Silverstein, “Organ Printing Could Drastically Change Medicine,” ABC News, February 10, 2006. 43. B. L. Goldense and J. Gilmore, “Measuring Product Design,” Machine Design 73, no. 14 (2001), pp. 63–67. 44. T. D. Kuczmarski, “Measuring Your Return on Innovation,” Marketing Management 9, no. 1 (2000), pp. 24–32. 45. Ibid.Final PDF to printer
277sch87956_ch12_277-296.indd 277 11/16/18 12:19 PMChapter TwelveManaging New Product Development TeamsInnovation Teams at the Walt Disney CompanyThe Walt Disney Company is probably the best-known entertainment company in the world. Founded in 1923 as a producer of animated films, it grew to become an entertainment conglomerate that includes theme parks, live action film produc-tion, television, publishing, retail, and more. In 2014, it earned over $48 billion in revenues and had 180,000 employees.a Despite the range of its businesses, most of them (with some notable exceptions) leverage the same key competitive advan-tage: the magical and wholesome stories and characters of its animated films.The Making of an Animated FilmIn the very early stages of generating and refining an idea for a movie, the development department assembles a small incubation team that includes a director, a writer, some artists, and some storyboard people.b This team draws storyboards that are edited together with dialogue and temporary music, creat-ing “story reels.” These story reels show the sequence of the movie and help the team craft and refine the story into one that will have visual and emotional appeal. They also help to reveal problems that have to be solved, which tend to be numerous in the early stages of production.cOnce approved for development, a typical movie enters production using computer-aided design (CAD) systems. Artists would create a model in a CAD sys-tem, which could then apply mathematical models to simulate lifelike textures, move-ment, and lighting.d This computing intensive phase was also managed by small autonomous teams, each focused on a particular specialty such as Tech Support, Renderfarm, and Post Production. Disney’s Director of Systems, Jonathan Geibel, had noticed that when teams had seven or more participants, individual contribution would drop significantly, lowering the quality of the discussion. Geibel thus deter-mined that teams should have only between two and six people, including one who would be designated as a Team Lead. Team Leads were chosen because of their technical expertise and their vision for the project. Their seniority played Final PDF to printer
sch87956_ch12_277-296.indd 278 11/16/18 12:19 PM278 Part Three Implementing Technological Innovation Strategylittle role—rather they were chosen based on how compelling their vision was, and how good management thought they would be in driving the progress of the team. The remaining employees were assigned as “primary” members to a particular team to which they would give most of their time and effort and might also serve as “ secondary” members on other teams when those teams needed their help.eWorkspace and CollocationGeibel was also concerned about how the physical structure of the workspace and proximity would influence team dynamics and productivity. After running several experiments involving the location of team members, he decided to reconfigure the entire division so that teams were collocated. He noted, “Collocating individu-als allowed ideas to flow each day through ad hoc meetings. Individuals would often brainstorm, pause, and walk over to a whiteboard for further development rather than needing to arrange a specific time and space to meet. With high priority and chaotic work, physical proximity was key.”f Geibel also believed that people tended to contribute less in formal conference rooms, so he created small casual meeting spaces that teams could meet in, that did not require advance scheduling.In keeping with his belief that immediate and informal communication was key, Geibel himself gave up his office and moved to a desk without walls in the center of the Systems area. He would conduct frequent walkabouts, conferring with the teams so that if something was going on, he would know about it immediately.Team CommunicationTo help foster communication and coordination between teams, teams were asked to create yearly roadmaps of their goals that were broadcast to everyone within the Systems group. A master calendar was also created on whiteboards in a main hallway that showed major milestones throughout the year. Teams put post-it notes on the calendar to show major events.gThe teams also used “dailies”—a practice from traditional film production that had been brought in when Disney acquired Pixar. In the “dailies,” artists had to show their ongoing work to directors and peers. This informal audience could then provide direct feedback about both the creative and technical elements of the project. As Brad Bird, Oscar-winning director, described, “As individual anima-tors, we all have different strengths and weaknesses, but if we can interconnect all our strengths, we are collectively the greatest animator on earth. . . . We’re going to look at your scenes in front of everybody. Everyone will get humiliated and encouraged together. If there is a solution, I want everyone to hear the solu-tion, so everyone adds it to their tool kit.”h Initially, people were afraid to speak up, but after two months of seeing artists hear and benefit from the blunt sugges-tions of Bird and others, people began to feel safe enough to speak up.Creating a Creative CultureTeams were given considerable autonomy so long as their work got done. Teams could choose their own hours, attire, office arrangements, project man-agement routines, meeting structure, and more. As described by Ed Catmull, Final PDF to printer
sch87956_ch12_277-296.indd 279 11/16/18 12:19 PMChapter 12 Managing New Product Development Teams 279OVERVIEWNew product development often requires activities that are the responsibility of dif-ferent departments within the organization. To facilitate coordination and cooperation across division boundaries, many organizations create cross-functional new product development teams to lead and manage the development process for the project. There is considerable variation, however, in how teams are formed and managed. In this chapter, we will look at several factors that affect the new product development team’s performance, including its size, composition, structure, administration, and leadership.president of both Pixar and Walt Disney Animation Studios, “We believe the cre-ative vision propelling each movie comes from one or two people and not from either corporate executives or a development department. Our philosophy is: You get creative people, you bet big on them, you give them enormous leeway and support, and you provide them with an environment in which they can get honest feedback from everyone.”iInitially, it was not always easy for the engineers to embrace this kind of autonomy—they tended to continue to ask permission about minor aspects of team organization. As Geibel noted, “We’ve built teams where technical leads don’t have to ask for permission to change the way they are running their teams. . . . We’re still working on people thinking that way spontaneously. The culture is ingrained in everybody because the average tenure is 15–40 years. If you’ve worked in a top-down organization for that long, it’s going to take a while to adapt to a new culture where everyone is expected to challenge the status quo and where there’s an expectation that critical thinking is happening at all levels.”Discussion Questions 1. Why does Disney keep its development teams small? 2. What are the pros and cons of the teams being so autonomous? 3. Is Disney’s team approach mostly suited to creative projects, or would it work equally well in other kinds of industries? a b Catmull, E. “How Pixar fosters collective creativity,” Harvard Business Review (2008), September: 65–72. c Catmull, E. “How Pixar fosters collective creativity,” Harvard Business Review (2008), September: 65–72. d Edmondson, AC, Ager, DL, Harburg, E, and Bartlett, N. “Teaming at Disney Animation,” Harvard Business School (2015), May 18. e Edmondson, AC, Ager, DL, Harburg, E, and Bartlett, N. “Teaming at Disney Animation,” Harvard Business School (2015), May 18. f Edmondson, AC, Ager, DL, Harburg, E, and Bartlett, N. “Teaming at Disney Animation,” Harvard Business School (2015), May 18. g Edmondson, AC, Ager, DL, Harburg, E, and Bartlett, N. “Teaming at Disney Animation,” Harvard Business School (2015), May 18. h Rao, H, Sutton, R, and Webb, AP. “Innovation lessons from Pixar: An interview with Oscar-winning director Brad Bird,” McKinsey Quarterly, April, 2008. i Catmull, E. “How Pixar fosters collective creativity,” Harvard Business Review (2008), September: 65–72.Final PDF to printer
sch87956_ch12_277-296.indd 280 11/16/18 12:19 PM280 Part Three Implementing Technological Innovation StrategyCONSTRUCTING NEW PRODUCT DEVELOPMENT TEAMSIn constructing new product development teams, the organization must consider how the team’s size and composition will affect its mix of skills, its access to resources, and its effectiveness in providing communication and coordination across the divisions.Team SizeNew product development teams may range from a few members to hundreds of members. For example, the development team that created the IBM personal com-puter had 19 members, but the average team size for development projects at IBM is close to 200.1 The Yahoo! Internet portal was developed by 13 software developers, split into several small teams of one to three members.2 Though there is consider-able research suggesting that individuals may be better off working alone during early ideation phases (see the Research Brief on “Why Brainstorming Teams Kill Break-through Innovation”), teams are often extremely valuable for refining and executing on those ideas. By combining the efforts and expertise of multiple individuals, groups can often outperform individuals on many problem-solving tasks, implying that the size of the development team might be related to its potential for success.3Bigger, however, is not always better. Large teams can create more administrative costs and communication problems, leading to costly delays. Additionally, the larger the team, the harder it can be to foster a shared sense of identity among team mem-bers. Further, as the size of the team increases, the potential for social loafing also increases. Social loafing occurs when, as the size of the team increases, individuals perceive that they will not receive full credit (or blame) for their contribution to the group effort and so their effort and commitment decrease.4 The average team size used by U.S. organizations is 11  members,5 but there is considerable variance in the size of teams used by organizations, and each team may vary in size over the course of a new product development project.Team CompositionA lack of communication among the marketing, R&D, and manufacturing functions of a company can be extremely detrimental to new product development. A lack of cross-functional communication can lead to a poor fit between product attributes and customer requirements. R&D cannot design products that fit customer requirements unless it receives and attends to input from marketing regarding those requirements. The manufacturing/R&D interface is also of critical importance because of manufactur-ing’s role in determining two key attributes of a product—quality and price. By working closely with R&D, manufacturing can ensure that R&D designs products that are rela-tively easy to manufacture. Designing for ease of manufacturing can lower both unit costs and product defects, which translates into a lower final price and higher quality. Similarly, a lack of cross-functional communication between functions can lead to longer cycle times as a product iterates back and forth between different stages in the process.One of the ways that firms address this problem is by building cross-functional product development teams.6 Cross-functional teams include members drawn from more than one functional area, such as engineering, manufacturing, or marketing.7 For instance, in Chrysler’s “vehicle deployment platform teams,” team members are drawn social loafingWhen an indi-vidual in a team does not exert the expected amount of effort and relies instead on the work of other team members.cross- functional teamsTeams whose members are drawn from multiple func-tional areas in the firm such as R&D, marketing, manufacturing, distribution, and so on.Final PDF to printer
sch87956_ch12_277-296.indd 281 11/16/18 12:19 PMChapter 12 Managing New Product Development Teams 281Research Brief Why Brainstorming Teams Kill Breakthrough IdeasaOver a half a century ago, Alex Osborne wrote an influential book called Applied Imagination that opined, “the average person can think up twice as many ideas when working with a group than when working alone.” Managers must have been con-vinced because brainstorming teams took off in pop-ularity and are still used widely to this day. In fact, in business schools it is almost heretical to argue that teams are not more creative than individuals.The only problem is that Osborne was wrong. Dozens of laboratory studies tried to confirm Osborne’s arguments, but found the opposite: brain-storming groups produced fewer ideas, and ideas of less novelty, than the sum of the ideas created by the same number of individuals working alone.bHow could this be? Aren’t ideas supposed to cross-fertilize, generating new and unusual hybrids?c It turns out group idea cross-fertilization is more likely to result in ideas that are mediocre compromises; more exciting ideas come from going solo. There are three main reasons that groups are less creative than individuals working on their own.1. FEAR OF JUDGMENTA series of studies by Professors Michael Diehl, Wolf-gang Stroebe, Bernard Nijstad, Paul Pauhus, and others found that people self-censor many of their most creative ideas in group brainstorming sessions for fear of being judged negatively by others.d When the scientists told groups that their ideas would be judged by their peers, they came up with significantly fewer and less novel ideas than groups that were told they would be evaluated by anonymous judges.As Isaac Asimov, one of the most famous science fiction writers of all time (and also a biochemistry professor at Boston University) put it, “My feeling is that as far as creativity is concerned, isolation is required. . . . The presence of others can only inhibit this process, since creation is embarrassing. For every new good idea you have, there are a hundred, ten thousand foolish ones, which you naturally do not care to display.”e2. PRODUCTION BLOCKINGWhen people take turns to voice their ideas, those bringing up the rear may forget their ideas before having a chance to voice them. Worse still, the pro-cess of attending to another person’s ideas redirects a listener’s train of thought, essentially hijacking their own idea generation process. Scientists were able to demonstrate this by separating individuals into rooms where they would speak their ideas into a microphone when lights indicated it was their turn. In some of the rooms the individuals could hear the contributions of others, and in some they could not. This study resulted in big creativity losses: being required to wait to give ideas caused people to submit far fewer ideas, and even fewer ideas if they could hear the contributions of others.Now imagine what happens when people do not have to take turns but instead volunteer ideas at will: the most outgoing people in the group will domi-nate the idea submission while the quieter people, or those more worried about social pressure, do not submit many (or any) of their ideas. Furthermore, if they do submit their ideas, they may submit only those ideas that build upon the ideas that were already contributed—a sure way to drive out novelty.3. FEASIBILITY TRUMPS ORIGINALITYAnother series of studies by Professor Eric Rietzschel and colleagues shows that teams are not just bad for idea generation; they even impair idea selection.f If you let people work alone to generate ideas but then let the group select the best ideas to pursue, they will tend to make decisions that reduce nov-elty. Studies showed that when groups interactively ranked their “best” ideas, they chose ideas that were less original than the average of the ideas produced, and more feasible than the average of the ideas pro-duced. In other words, people tended to weight “fea-sible” more highly than “original.” If a brainstorming group is intended to elicit novel ideas, asking groups to select and submit their best ideas is not the way to achieve that outcome.continuedFinal PDF to printer
sch87956_ch12_277-296.indd 282 11/16/18 12:19 PM282 Part Three Implementing Technological Innovation Strategyfrom design, engineering, purchasing, manufacturing, product planning, finance, and marketing. Firms around the world rely heavily on cross-functional teams for their new product development efforts. In 2000, 77 percent of U.S. firms, 67 percent of European 8THE BENEFITS OF SPENDING TIME ALONESolitude is extremely valuable for creativity; it affords a person the time to think and pursue those things they find intrinsically interesting. It can help them to develop their own beliefs about how the world works, and to develop a self-concept that is less structured by the opinions of others.gResearch on serial breakthrough innovators show that many spent significant time alone, invest-ing heavily in self education.h Most were voracious readers—Elon Musk, for example, often read for 10 hours a day, and has his brother Kimbal recalled, “If it was the weekend he could go through two books in a day.”i Elon Musk himself noted in a Rolling Stone interview, “I was raised by books. Books and then my parents.”jThe preceding suggests that when managers want employees to come up with breakthroughs, they need to give them some time alone to ponder their craziest of ideas and follow their paths of asso-ciation into unknown terrain. They should be urged to come up with ideas freely, without fear of judgment. They should be encouraged to commit their ideas to paper, and to flesh each of them out before expos-ing them to others. Managers can also follow Google and 3M’s lead and give employees in creative roles a significant percentage of their time (e.g., 3M uses 15 percent of work hours) to pursue products of their own creation and choosing. Google’s Gmail and Google News, 3M’s Post-it Notes, and many other products, were developed this way.A creative idea can be fragile—easily swept away by the momentum of a group conversation. Almost every team suffers from some degree of groupthink; individuals who are more outspoken or who have forceful personalities can dominate the conversation and the decision making. They can herd a team onto a particular trajectory without even intending to do so, or worse, they can bring everyone to a mediocre com-promise. A little isolation and solitude can give other individuals a better chance to develop their break-through ideas. These individuals should have time to elaborate their ideas and engage in some initial plan-ning and prototyping before their idea are subjected to review or moved into team development.a Adapted from Schilling, M.A. Why brainstorming groups kill breakthrough ideas (and what to do instead). Inc., February 9, 2018.b Diehl, M., and W. Stroebe, “Productivity Loss in Brainstorm-ing Groups: Toward the Solution of a Riddle,” Journal of Personality and Social Psychology 53 (1987): 497–509; Mullen, B., C. Johnson, and E. Salas, “Productivity Loss in Brainstorming Groups: A Meta-Analytic Integration,” Basic and Applied Social Psychology 12, no. 1 (1991): 3–23; and Stroebe, W., B. A. Nijstad, and E. F. Rietzshel, “ Productivity Loss in Brainstorming Groups: The Evolution of a Ques-tion,” in Advances in Experimental Social Psychology, eds. M. P. Zanna, and J. M. Olson (San Diego, CA: Academic Press, 2010), 43: 157–203.c Alton, L. 5 Strategies for team brainstorming to use in your next meeting. Inc., October 30, 2017.d Diehl, M., and W. Stroebe, “Productivity Loss in Brainstorm-ing Groups: Toward the Solution of a Riddle,” Journal of Personality and Social Psychology 53 (1987): 497–509; Pauhus, P.B., M. T. Dzindolet, G. Poletes, and L.M. Camacho, “Perception of Performance in Group Brainstorming: The Illusion of Group Productivity,” Personality and Social Psychol-ogy Bulletin 19 (1993): 78–89; and Mullen, B., C.  Johnson, and E. Salas, “Productivity Loss in Brainstorming Groups: A Meta-Analytic Integration,” Basic and Applied Social Psychol-ogy 12, no. 1 (1991): 3–23.e Asimov, I., “Isaac Asimov Asks, ‘How Do People Get New Ideas?’” MIT Technology Review (1959 essay, reproduced in October 20, 2014).f Rietzschel, E. F., B. A. Nijstad, and W. Stroebe, “Productivity Is Not Enough: A Comparison of Interactive and Nominal Brainstorming Groups on Idea Generation and Selection,” Journal of Experimental Social Psychology 42, no. 2 (2006): 244–51.g Long, C. R., and J. R. Averill, “Solitude: An Exploration of Benefits of Being Alone,” Journal for the Theory of Social Behavior 33 (2003): 21–44.h Schilling, M.A., Quirky: The Remarkable Story of the Traits, Foibles, and Genius of Breakthrough Innovators Who Changed the World (New York: Public Affairs, 2018).i Vance, A., Elon Musk: Tesla, SpaceX, and the Quest for a Fantastic Future (New York: Harper Collins, 2015).j Strauss, N., “E