7CHAPTER

McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Business Strategy:Innovation and Strategic

Entrepreneurship

Part 2 Strategy Formulation

7–2

LO 7-1LO 7-1 Define innovation and describe its role in the competitive process.

LO 7-2LO 7-2 Describe the competitive implications of different stages in the industry life cycle.

LO 7-3 Apply strategic management concepts to entrepreneurship and innovation.

LO 7-4 Evaluate different types of innovation and derive their strategic implications.

LO 7-5 Describe the long-tail concept and derive strategic implications.

LO 7-6 Evaluate discontinuities and describe the dynamics of paradigm changes.

LO 7-7 Identify the process leading to hypercompetition, and explain why competitive advantage can often be sustained through continuous innovation.

7–3

Innovation Funnel

7–4

The Development of Technology: From Knowledge Generation to Diffusion

The Development of Technology: From Knowledge Generation to Diffusion

Basic Knowledge

Invention Innovation Diffusion

IMITATION

ADOPTION

Supply side

Demand side

7–5

The Development of Technology: Lags Between Knowledge Generation and Commercialization

The Development of Technology: Lags Between Knowledge Generation and Commercialization

BASIC FIRST PRODUCT IMITATIONKNOWLEDGE PATENTS LAUNCH

Xerography late 19th and 1940 1958 1974

early 20th centuries

Jet Engines 17th-- early 1930 1957 1959

20th centuries

Fuzzy logic 1960’s 1981 1987 1988

controllers

Appropriation of Value:- How are the Benefits from Innovation Distributed?

Appropriation of Value:- How are the Benefits from Innovation Distributed?

Customers

Suppliers

Imitators and other

“followers”

Innovator

7–7

The Profitability of InnovationThe Profitability of Innovation

• Legal protection

• Complementary resources

• Imitability of the technology

•Lead time

Profits from

Innovation

Value of the innovation

Innovator’s ability to

appropriate the value of the innovation

7–8

Legal Protection of Intellectual PropertyLegal Protection of Intellectual Property

• Patents —exclusive rights to a new product, process, substance or design.

• Copyrights —exclusive rights to artistic, dramatic, and musical works.

• Trademarks — exclusive rights to words, symbols or other marks to distinguish goods and services; trademarks areregistered with the Patent Office.

• Trade Secrets — protection of chemical formulae,

recipes, and industrial processes.

Also, private contracts between firms and between a firm and itsiemployees can restrict the transfer of technology and know how.

7–9

U.S. Managers’ Perceptions of the Effectiveness of Different Mechanisms for Protecting Innovation

U.S. Managers’ Perceptions of the Effectiveness of Different Mechanisms for Protecting Innovation

Processes Products

Patents to prevent duplication 3.52 4.33

Patents to secure royalty income 3.31 3.75

Secrecy 4.31 3.57Lead time 5.11 5.41

Moving quickly down the learning 5.02 5.09curve

Sales or service efforts 4.55 5.59

1 = not at all effective 7 = very effective

Source: Levin, Klevorick, Nelson & Winter. Brookings Papers on Economic Activity, 1987.

The Technology Transfer Process

Research Disclosure IP Decision

IP Protection

Commercialization Strategy Licensing

$29.5

billion

6,375 patent

applications

13,039

disclosures

4,362 licenses

454 new companies3,764 issued

patents

Source: AUTM

Licensing Survey:

FY 20007-11

Risk & Return

CompetingResources

Examples

LicensingOutsourcing

certain functions

Strategic Alliance

Joint Venture

Internal Commercialization

Small risk, but limited returns also (unless patent position very strong

Limits investment, but dependence on suppliers & partners

Benefits of flexibility; risks of informal structure

Shares investment & risk. Risk of partner conflict & culture clash

Biggest risks & benefits. Allows complete control

Few Allows outside resources & capabilitiesTo be accessed

Permits pooling of the resources/capabilities of more than one firm

Substantial resource requirements

Konica licensing its digital camera to HP

Pixar’s movies (e.g. “Toy Story”) marketed & distributed by Disney.

Apple and Sharp build the “Newton” PDA

Microsoft and NBC formed MSNBC

TI’sdevelopment of Digital Signal Processing Chips

Alternative Strategies for Exploiting InnovationAlternative Strategies for Exploiting Innovation

7–12

The Comparative Success of Leaders and Followers

The Comparative Success of Leaders and Followers

PRODUCT INNOVATOR FOLLOWER WINNER

Jet Airliners De Havilland (Comet) Boeing (707) Follower

Float glass Pilkington Corning Leader

X-Ray Scanner EMI General Electric Follower

Office P.C. Xerox IBM Follower

VCRs Ampex/Sony Matsushita Follower

Diet Cola R.C. Cola Coca Cola Follower

Instant Cameras Polaroid Kodak Leader

Pocket Calculator Bowmar Texas Instruments Follower

Microwave Oven Raytheon Samsung Follower

Plain Paper Copiers Xerox Canon Not clear

Fiber Optic Cable Corning many companies Leader

Video Games Players Atari Nintendo/Sega/Sony Followers

Disposable Diapers Proctor & Gamble Kimberly-Clark Leader

Web browser Netscape Microsoft Follower

PDA Psion, Apple Palm Follower

MP3 music players Diamond Multimedia Sony (&others) Followers

7–13

Uncertainty & Risk Management in Tech-based IndustriesUncertainty & Risk Management in Tech-based Industries

Sources ofuncertainty

Technologicaluncertainty

Selection process for standards and dominant designs emerge is complex and diifficult to predict, e.g. future of 3G

Customer acceptance and adoption ratesof innovations notoriously difficult topredict, e.g. PC, Xerox copier, Walkman

Marketuncertainty

Strategies formanaging risk

Cooperating with lead usersearly identification of customer requirements

–assistance in new product development

Flexibilility—keep options open—use speed of response to adapt

quickly to new information—learn from mistakes

Limiting risk exposure—avoid major capital commitments

(e.g. lease don’t buy)—outsource—alliances to access other firms’

resources & capabilities—keep debt low

7–14

Sources of Network ExternalitiesSources of Network Externalities

• User linkages, e.g. – Telephone systems—only value of telephone is connection to

other users– Video game consoles—same platform allows users to

exchange games and play interactively– On-line auction—value of auction depends on number of

buyers and sellers participatingAlso, social identification—listening to same music, watching

same TV shows, wearing same clothes in order to conform

• Availability of complementary products, e.g. – Most PC applications software written for Windows, not Mac.– In economy autos, easier to get parts and repair for a Ford

Focus than for a Maruti or Proton

• Economizing on switching costs, e.g.– In suites of office software, users of Microsoft Office more

likely to avoid switching costs that users of Lotus SmartSuitewhen they move jobs

7–15

Competing for Standards:Value Appropriation vs. Market Acceptance

Competing for Standards:Value Appropriation vs. Market Acceptance

Maximize value

appropriation

Maximize market

acceptance

LOOSE TIGHT

VHS

IBM-PC Mac

Betamax

The Conditions for Creativity:“Operating” and “Innovating” Organizations

The Conditions for Creativity:“Operating” and “Innovating” Organizations

Operating Organization Innovating Organization

Structure Bureaucratic. Specialization and division of labor. Hierarchical control

Flat organization without hierarchical control. Task-oriented project teams.

Processes Operating units controlled and coordinated by top management which undertakes strategic planning, capital allocation and operational planning.

Processes directed toward generation, selection, funding and development of ideas. Strategic planning flexible, financial and operating controls loose.

Reward

Systems

Financial compensation, promotion up the hierarchy, power and status symbols.

Autonomy, recognition, equity participation in new ventures

People Recruitment and selection based upon the needs of the organization structure for specific skills: functional and staff specialists, general managers, and operatives.

Key need is for idea generators which combine required technical knowledge with creative personality traits. Managers must act as sponsors and orchestrators.

7–17

Strategy Implementation: Invention to Innovation

Strategy Implementation: Invention to Innovation

• While invention depends upon creativity, successful innovation requires integrating new knowledge with multiple business functions.

• Need to link R&D departments with other functions (the problem of Xerox’s PARC)

• The role of cross-functional new product development teams as vehicles for integration

• The role of product champions--in achieving integration and counteracting organizational inertia.

Chapter Case 7 Chapter Case 7 From Encyclopedia Britannica to

Encarta to Wikipedia

• 18th century Scottish Enlightenment creates Encyclopedia Britannica (E.B.) 65,000 topics by 4,000 scholars In 1991, E. B. sales $650M (market was $1.2 billion annually)

Price ~$2,000 per set of books

• Microsoft launches Encarta in 1993 for $99 ea. By 1996 Encarta U.S. sales over $100M & E.B. ~$300M

• Mr. Wales launches Wikipedia in 2001 for $0 ea. 3.6 million articles in English ( 40X E.B. !)

18 million total in 281 languages

In ‘09 Microsoft shut down Encarta Peer-reviewed study of 42 topics found 4 errors in Wiki…3 in

E.B. 7–19

From Encyclopedia Britannica to Encarta to Wikipedia

• The innovation of CD-based encyclopedia

Destroyed more than ½ the revenue of encyclopedias

• Technology allowed Wikipedia to increase value and decrease costs

• The innovative business model:

"Crowd wisdom" for big value

But NO revenue

Wikipedia is funded by donations of time and money

Chapter Case 7 Chapter Case 7

7–20

Competition Driven by Innovation

• Invention is discovery of new ideas/products Wright brothers – airplane flight

• Innovation is the commercialization of invention Boeing & Airbus – selling the airplanes

• Schumpeter’s “gale of creative destruction”

Encyclopedias to Wikipedia…

Typewriters to PCs to ???

Pharmaceuticals to custom treatments

(individualized medicine)

7–21

EXHIBIT 7.1 Innovation: A Novel and Useful Idea that is Successfully Implemented

Innovation is an invention that is implemented in the marketplace7–22

Innovation and the Industry Life Cycle

• Innovations create new industries Big box retailing Express delivery Nanotechnology still evolving

• Four stages of industry development

1. Introduction

Early adopters will pay a premium Only a few innovators in the market – differentiated Strategy here — market acceptance & seeds for growth

– Network effects helpful • Positive effects ONE user has for other users

7–23

EXHIBIT 7.2 The Industry Life Cycle and Consumer-Adoption Categories

1–25

STRATEGY HIGHLIGHT 7.1STRATEGY HIGHLIGHT 7.1 Apple Leverages NetworkEffects to Propel Growth

• Apple launched iPhone in summer ‘07

Launched app store a year later

Small programs but BIG business!

- Over $4 billion in 2012

Virtuous cycle of 10 billion Apple apps downloaded by 2011

Apps increase value of the iPhone (& iPad too!)

More devices sold, incentivizes software developers

Recent iBook store likely to grow the network effects still more

7–25

EXHIBIT 7.3 Leveraging Network Economics: Apple’s iPhone

Virtuous Cycle for iPhone (& iPad)7–26

Innovation and the Industry Life Cycle

• Four stages of industry development (cont'd)2. Growth Stage

Early majority buyers increase growth rapidly Dominant design is set

– IBM PC: Wintel– Government influence – GSM standard for mobile phones– QWERTY keyboards

Core competencies move to manufacturing & marketing

An example of growth stage Women’s shapeware industry

– Spanx started in 1998• Sold over 5M units & over $750 million in sales by 2008

– Maidenform, Body Wrap, & Miraclesuit are competitors

7–27

EXHIBIT 7.4 Product and Process Innovation and the Emergence of an Industry Standard

After an industry standard is established, process innovations become more important.

7–28

STRATEGY HIGHLIGHT 7.2STRATEGY HIGHLIGHT 7.2 Some Standards Die Hard:QWERTY vs. DSK

• QWERTY introduced in 1870s

Slowed down typing to avoid jamming keys

• Dvorak introduced in 1930s

Minimized finger reach to speed up typing

7–29

Innovation and the Industry Life-Cycle

• Four stages of industry development (cont'd)3. Maturity

Late majority buyers & more limited market growth– Increased competitive rivalry

Cost leadership firms tend to drive industry– Weaker firms will exit

Oligopoly is dominant industry structure in this stage

4. Decline Laggards are buyers and market size shrinks Four strategic options:

– Exit – get out of the industry– Harvest – stay with limited investments (Olivetti)– Maintain – stay & continue marketing (Marlboro)– Consolidate – buy rivals, near monopoly (IBM mainframes)

7–30

EXHIBIT 7.5 Features of the Industry Life Cycle

Not all industries emerge through these stages and some can rejuvenate such as the steel industry with mini-mills.

7–31

LO 7-1 Define innovation and describe its role in the competitive process.

LO 7-2 Describe the competitive implications of different stages in the industry life cycle.

LO 7-3LO 7-3 Apply strategic management concepts to entrepreneurship and innovation.

LO 7-4LO 7-4 Evaluate different types of innovation and derive their strategic implications.

LO 7-5 Describe the long-tail concept and derive strategic implications.

LO 7-6 Evaluate discontinuities and describe the dynamics of paradigm changes.

LO 7-7 Identify the process leading to hypercompetition, and explain why competitive advantage can often be sustained through continuous innovation.

7–32

Strategic Entrepreneurship

• Entrepreneurs are the change agents for creative destruction. Create new opportunities and exploit them

Jeff Bezos – Amazon.com– Saw growth of Internet in 1994– Chose books as the first product for online sales

Oprah Winfrey – Harpo Productions– Rose from abuse & poverty to over $2 billion net worth– Ended talk show to devote time to OWN TV channel

Jeff Hawkins – Palm Computing (founded in 1992)– PalmPilot and Treo products

How to combine entrepreneurial with strategic actions? Example: P&G continued innovations in detergent

7–33

EXHIBIT 7.6 Types of Innovation: Combining Markets and Technologies

Categorizing according to technology and markets yields 4 quadrants

Intel 386 to 486 processors

MRI radiologyGPS to handheld consumer devices

Digital photography

7–34

1–35

STRATEGY HIGHLIGHT 7.3STRATEGY HIGHLIGHT 7.3 From King Gillette to Kingof Incremental Innovation

1930s 2011

7–35

1–36

STRATEGY HIGHLIGHT 7.3STRATEGY HIGHLIGHT 7.3 From King Gillette to Kingof Incremental Innovation

• Gillette invented the safety razor in 1903

A radical innovation at the start

Innovative business model

Make money from the blades NOT the razors

Incremental innovation

Moved from 1 to six blades (so far…)

Top selling blades today! Over $1 billion in sales

Prices steady to higher for the blades!

7–36

EXHIBIT 7.7Disruptive Innovation Invading DifferentMarket Segments from the Bottom Up

Google’s Chrome OS could be a disruptor of traditional Microsoft operating systems for computers…

7–37

1–38

STRATEGY HIGHLIGHT 7.4STRATEGY HIGHLIGHT 7.4 GE’s Reverse Innovation:Disrupt Yourself!

• GE Healthcare – global leader in diagnostics

Ultrasound machine for research hospitals – $230,000

Limited market for these in developing countries

2002 local team at GE China – developed portable US

Laptop-based technology – Under $30,000 for U.S. rollout

2009 introduced a handheld US – about $10,000

Vscan - large cell phone – shaped device

GE Vscan Video7–38

LO 7-1 Define innovation and describe its role in the competitive process.

LO 7-2 Describe the competitive implications of different stages in the industry life cycle.

LO 7-3 Apply strategic management concepts to entrepreneurship and innovation.

LO 7-4 Evaluate different types of innovation and derive their strategic implications.

LO 7-5LO 7-5 Describe the long-tail concept and derive strategic implications.

LO 7-6 Evaluate discontinuities and describe the dynamics of paradigm changes.

LO 7-7 Identify the process leading to hypercompetition, and explain why competitive advantage can often be sustained through continuous innovation.

7–39

The Internet as Disruptive Force: The Long Tail

• Long tail in a digital world

Both opportunity and threat

80% sales in a given category are NOT “hits” Pareto principle

Technology enables easier access to the ‘tail’ Selling “less of more” Online firms can gain a large share of revenue from

selling a small number of nearly unlimited choices

• Short head is the mainstream Available at brick & mortar stores

Significant inventory costs

Ray Kurzwiel Video7–40

EXHIBIT 7.8 The Short Head and the Long Tail

The Internet and inventory management software drive down costs to match customer demand, increasing the tail to the black dotted line.

7–41

EXHIBIT 7.9 The Long-Tail Consequences: Selling Less of More

25% to 45% of sales for online retailers is from products NOT available in traditional retail stores. 7–42

LO 7-1 Define innovation and describe its role in the competitive process.

LO 7-2 Describe the competitive implications of different stages in the industry life cycle.

LO 7-3 Apply strategic management concepts to entrepreneurship and innovation.

LO 7-4 Evaluate different types of innovation and derive their strategic implications.

LO 7-5 Describe the long-tail concept and derive strategic implications.

LO 7-6 Evaluate discontinuities and describe the dynamics of paradigm changes.

LO 7-7 Identify the process leading to hypercompetition, and explain why competitive advantage can often be sustained through continuous innovation.

7–43

Discontinuities: Periods of Paradigm Change

• Periods when underlying standard changes

Paradigm shift New technology revolutionizes existing industries

– New standard is established Technology “S-curve”

– Physical limits nearing or reached

Incumbents need absorptive capacity Existing firms must place “good bets” on new technologies

Examples of Discontinuities Airplanes: propellers to jets Cameras: film to digital TV screens: vacuum tube to flat panel Music storage: vinyl to CDs to MP3 storage

Steven ChuPlant Energy Video

Absorptive Capacity and a Firm’s Technical Knowledge

Absorptive capacity Technical knowledge

Spillovers of competitors’ knowledge,Extra-industry knowledge

Internal R&D

Adapted from: Cohen and Levinthal, 1990

EXHIBIT 7.10Likelihood of Discontinuity Increases as Technology Approaches Physical Limit

The Internet and inventory management software drive down costs to match customer demand, increasing the tail to the black dotted line.

7–46

Ex: Hybrid as Intermediate Step for Autos

Hybrid

Combustion

Ra

te o

f T

ec

hn

olo

gic

alP

rog

res

s(r

ed

uc

tio

nin

em

iss

ion

s)

Time

Electric

Hybrid

Combustion

Ra

te o

f T

ec

hn

olo

gic

alP

rog

res

s(r

ed

uc

tio

nin

em

iss

ion

s)

Time

Electric

Combustion has been automobile standard for over 100 years… Is it time for a new standard? This is one scenario from the “swarm”

(for more discussion, see MiniCase 7). 7–47

EXHIBIT 7.11Hypercompetition Driven by

Continuous Innovation

Subsequent innovations sustain competitive advantage for a shorter time frame.

7–48